Why the Cost of Spotify and Other Music Streaming Services Must Increase

The music business has taken a beating the past few years as the industry struggles to find a model that works.

Since pirating songs became something anyone with a computer could easily do, album sales have plummeted. That was somewhat mitigated over the last few years by digital downloads, but even those numbers have plateaued and entered a slight decline. The future of music has increasingly seemed to be digital streaming services, and recent data released by Nielsen and Billboard suggest that the future is now.

On-demand streaming, which includes audio and video, was up 42% over last year in the first six months of 2014, with on-demand audio up 50.1%, and on-demand video up 35.2%. 

This comes in a period where sales of albums were down 14.9%. Vinyl album sales, the industry loves to point out, were up 40.4%, but vinyl is a tiny niche. Only 4 million LPs sold during the period -- far fewer than the 53.8 million digital album downloads and 62.9 million physical CDs that moved during the six-month period. It's like a supermarket trumpeting that it sold 40% more octopus than the year before, while failing to mention that sales for beef, chicken, pork, and produce all dropped dramatically.

The streaming numbers are a different story. The growth of on-demand streaming is a positive, as it shows that people still have a taste for music. But it's troubling that none of the streaming companies make money and all are struggling to find models that work.

Where does streaming stand?
Streaming has become big, but it may not be fair to say it has become "big business." Artists make more money selling a digital copy of an individual song than they do by having many more people stream it. The top streaming song for the first six months of 2014 was Katy Perry's "Dark Horse," according to Nielsen. That song was streamed more than 65 million times as an audio file. The same song sold just over 4 million digital downloads.

To figure out how much Perry and her record label made on those plays/sales, let's use some rough calculations. All the streaming services have different methods of paying, most of which are secret. But Pandora  (NYSE: P  ) is one of the biggest, so let's use a number that comes from its founder, Tim Westegren, in a June 2013 blog post. Westegren said a million plays of a song on Pandora might be equivalent to a single play of a song on a large FM station. For those million "spins," Pandora would pay the artist/label "about $1,370."

If we use that rate as the average for all the streaming services, Perry would have earned $89,050 for her popular song during the first six months of 2014 from streaming.

Apple's  (NASDAQ: AAPL  ) iTunes is the leading store for digital downloads of music. Apple generally offers a 70/30 split with publishers on digital content, with the publisher/musician getting the 70%. Perry's song sells for $1.29, so she would make roughly $0.91 on each digital download -- with her record label taking the lion's share of that. With more than 4 million copies of "Dark Horse" sold via download, Perry and her label received roughly $3.6 million. 

So, despite having roughly 16 times more streams than sales, Perry made a lot more money from selling copies of her song. Radio stations pay similarly tiny sums for spinning songs, but that was always seen as OK because radio play was viewed as a commercial that led to album/single sales. With streaming on its way to replacing actual ownership of songs, artists and labels are left without a way to make money off of their creations.

Streaming, which can be done for free -- or for less than the cost of buying one CD or album -- may be great for consumers, but it's not a sustainable business model for artists or Pandora, Spotify, or any of the other companies that need streaming revenues to outpace expenses. Yes, Amazon (NASDAQ: AMZN  ) and Apple can afford to use streaming as a loss leader to sell other products, but that does not create a viable future for the music industry.

Is there any hope for music?
The more that people use Pandora and Spotify, the more money those companies lose -- and that's with paying relatively piddling sums to artists. The chart below details the problem. 

Consumers clearly like streaming music, as it offers them an unlimited selection at a very low price -- Spotify charges $9.99 for its all-you-can-listen service that allows on-demand access to the millions of songs in its library. The challenge is that if physical and digital sales go away, artists have no reason to keep giving their music to streaming services.

At some point, there will be a standoff. Streaming services will either have to pay more, which will force them to raise prices, or face losing content. If Perry did not sell 4 million copies of her song, then the money she made from streaming would not have supported the cost of creating it. If music is going to continue to exist, the public will have to pay for it -- if not fair value, at least a more fair value. 

The bottom line
Like stealing music on Napster back in the day, streaming is only popular because of the price point. Customers may not be willing to pay double or even triple the current going rate of $9.99 a month for unlimited streaming. If artists are forced to charge more and streaming companies raise prices, we may find that people are willing to go back to a model where they pay only for specific music.

Whatever develops going forward, it's clear that streaming in its current guise won't support the music industry. As downloads and physical sales continue to fall, something will have to give -- or a lot of artists will need to find something else to do for a living.

Another industry in peril
You know cable's going away. But do you know how to profit? There's $2.2 trillion out there to be had. Currently, cable grabs a big piece of it. That won't last. And when cable falters, three companies are poised to benefit. Click here for their names. Hint: They're not Netflix, Google, and Apple. 

 


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