E-commerce giant Amazon.com (AMZN -1.64%) currently has two different music-streaming services, Prime Music and Music Unlimited. Prime Music has a fairly limited catalog of just 2 million songs and is included as a free perk for Prime members that pay $119 per year, while Music Unlimited is a paid service that costs $8 per month and includes access to 50 million songs, making it comparable to Apple Music or Spotify (SPOT -3.00%) Premium. Amazon has vaguely previously said that it has "tens of millions" of music subscribers, but that includes Prime members.

Amazon is reportedly working on a third music-streaming service.

Echo Dot on a side table, next to a lamp, a book, and a vase

A free music-streaming service could soon come to Echo devices. Image source: Amazon.

Taking down Spotify

Billboard reports that the serial disruptor is developing a free, ad-supported music-streaming service. The service would naturally be available through Amazon's popular line of Echo smart speakers, although the catalog would be relatively limited, according to the report. Amazon is said to be negotiating licensing agreements with record labels and would pay per stream independent of how much advertising Amazon has sold to monetize the service.

The move represents a potential major threat to Spotify, which had 116 million ad-supported monthly active users (MAUs) at the end of the fourth quarter. Spotify's ad-supported segment isn't very profitable but serves as a strategically important source of premium subscribers. The company has estimated that 60% of gross premium subscriber additions come from the free tier.

"As a reminder, Ad-Supported Gross Margins are relatively strong in our top five markets and relatively weak in our 73 other markets, including newly launched markets," Spotify wrote in its fourth-quarter shareholder letter. "As these markets grow, we believe margins should too."

Once Spotify is able to convert free users to premium subscribers, it typically takes about 12 months for the company to break even, CFO Barry McCarthy said last year. Offering the free tier also allows the Swedish company to expand its presence and market share in regions like emerging markets, where local consumers may be unwilling or unable to pay monthly subscription fees.

An obvious addition to the ad-supported portfolio

As Amazon has been growing its advertising business, it has also been adding to its mix of ad-supported services. The company's IMDb subsidiary launched Freedive earlier this year, which is available for free on IMDb and Fire TV devices. Advertising is also one of the primary ways Amazon monetizes Twitch, the dominant live-streaming platform it acquired in 2014.

Rumors surface every few years that Amazon is considering adding ads to Prime Video, its main video-streaming platform, although the company has shot down the speculation on numerous occasions. "We have no plans to build an ad-supported Prime Video offering for free at this time," Director of Investor Relations Dave Fildes said in October.

An ad-supported music-streaming service is a no-brainer for Amazon, given its dominant position in the smart speaker market. Spotify better watch out.