Do Streaming Music Services Have a Sustainable Business Model?

With Spotify and Pandora  (NYSE: P  ) leading the pack, music streaming subscription services have revolutionized the way people purchase and listen to music. These services have changed everything from the method of listening (Internet-connected computer or mobile device) to how people store music (catalog in the cloud), and it shows no signs of stopping. But are these music streaming subscription services really a sustainable business model for the companies who provide them, and how long will these services' rise to power last?

The benefits of streaming music services

Reasons run the gamut as to why music consumers are shifting from CDs and mp3s to music streaming services:

  • Ease of access. No need for a Walkman or even a separate iPod when you can stream all the music you want directly from your phone or tablet, no matter where you are, as long as you have an Internet connection.
  • Less (read: No) storage. No more boxes of CDs, no more external hard drives filled with music—it's all in the cloud.
  • Breadth of catalog. Imagine how many CDs or mp3 players it would take to hold millions of songs. With music streaming, you have it all with an Internet connection and the touch of a button.
  • Affordability. Millions of songs on CDs and mp3s would have been astronomical to buy, whereas with music streaming, all of it is available either for free (with ads) or for a relatively nominal monthly subscription fee (average $10/month).

Once you've decided to switch to music streaming, the next question is whether to purchase a monthly or annual subscription to one of these services. Most streaming subscriptions have a freemium option wherein you are essentially bombarded with ads, but you get to listen to the music for free. Some, however, have a listening limit and cut off after a certain amount of hours.

If regular intervals of advertisements is too much to handle, you can buy a subscription to the service, which generally removes ads almost entirely. With a subscription, you have unlimited access to the service's catalog with no listening limits, and other features often come along with it.

For example, when Lady Gaga released her album Born This Way, Spotify Premium subscribers had exclusive listening privileges for five days leading up to the release. Spotify Premium allows its subscribers to sync music from Spotify to their computers and listen offline. Also for Spotify Premium subscribers, access to a number of tracks at higher fidelity (320 kbps rather than 160 kbps) attracts those looking for a better sound, which can sometimes be compromised by poor streams.

Music streaming services continue to find new ways to sweeten the deal and attract more paying subscribers.

The big players

Pandora was one of the first big players in the music streaming industry, and earlier this year, it reported 200 million registered users, 70 million active users, and 2.5 million paid subscribers to its Pandora One service. Spotify, the next big player, launched in 2006, has over 24 million active users, and 6 million paying subscribers, making its subscription service more popular than Pandora's though it has nearly a third of the active user base.

When Apple  (NASDAQ: AAPL  ) launched its iTunes Radio, analysts predicted doom for Pandora and other subscription services. In reality, iTunes Radio has attracted casual, less valuable users and only took away 2 million subscribers from Pandora in October 2013, the month of its release. Other corporate hot shots like Microsoft  (NASDAQ: MSFT  ) (Xbox Music) and Google  (NASDAQ: GOOGL  ) (Google Play Music All Access) have also stepped up to bat in the past two years. Though it's been pushed back, Beats Music is also planning to release a subscription streaming service called "Daisy" in the coming months, backed by musical icon Trent Reznor.

YouTube to join the mix?

Google dipped its toe in the water with its Google Play Music All Access in June, but it's taking another step into the music streaming subscription industry with its already dominant music tool, YouTube. YouTube is the go-to service for free music streaming the world over, but that has always been on an ad-generated revenue model. Now Google and YouTube plan to capitalize on the video service's 1 billion unique visitors per month and find a way to turn those music listeners into subscribers. The companies believe that jumping into this market will be a new powerful and sustainable revenue stream.

Are streaming music services sustainable?

Whether or not music streaming subscription services are sustainable is up for debate. Without a doubt, music streaming is on the rise, and subscription services like Pandora, Spotify, and All Access are all seeing increases in subscribers. But nothing in the business world can last forever—particularly not in today's exponentially changing tech era. Remember iTunes? It may still be a music giant, but streaming services have already begun to put a dent in its sales and flipped its mp3-driven business model on its head.

The big players in music streaming have already seen decent revenues in this surging industry. In 2011, Spotify launched in the U.S. and brought in $252 million in revenue for the year. The next year that revenue leapt to $576.5 million, up more than 200% year over year. Pandora reported revenue of $125.5 million for Q1 2013 alone.

But operating costs—particularly licensing fees—are what stifles the growth of this potentially successful business model. With Spotify, for example, artists are currently paid $0.0033 per song streamed, which sounds minuscule. But those fractions of a penny can add up for companies like Pandora and Spotify, who stream hundreds of millions of songs per day. If Spotify streamed 500 million songs per day for 30 days, that would cost them almost $50 million per month. And that's just royalties—though licensing fees takes up about 70% of its revenue, there's also streaming and hosting costs plus all additional operations, administrative and overhead costs to consider.

Subscribers, at 6 million, make up one-quarter of its 24 million active users and would bring in about $60 million per month at the $9.99/month subscription rate. That amount just covers the licensing costs in the example (provided Spotify doesn't stream over 500 million songs in a day, which more than likely it has and/or will), which means, despite ad-generated revenue, Spotify is seeing red year after year: $60 million in 2011 and $77 million in 2012. Similarly, Pandora went from a loss of $11 million in 2011 to a loss of $38.15 million by fiscal year ending in 2013.

It costs more and more to acquire content, and licensing fees are killing these companies slowly but surely. Will these subscription services add enough subscribers fast enough to meet the demands for more content? More subscribers means more money, but more users also means more song streams, which means more licensing fees for artists—artists who are not so happy with their current fractions of a penny per song. Spotify promises artists that it will pay them five times the current amount once it hits 40 million subscribers, but at only 6 million now, that might not be anytime soon.

While these companies are bringing in plenty of revenue each year, the shakiness of extensive costs threatens the sustainability of the music subscription service model. No music listening or purchasing trend lasts forever—the question is how, why, and when music subscription services will fall out of grace and be replaced by the next biggest and brightest technology.

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