Spotify looks to be preparing for an initial public offering at the same time it might be facing increased competition in the streaming music space.
Pandora (NYSE:P), the newly launched Beats Music, and many other lesser players already compete with Spotify, but the big boys look like they may get into the game. Apple (NASDAQ:AAPL) is rumored to be considering a more complete streaming service than its current iTunes Radio offering, and Amazon (NASDAQ:AMZN) may be entering the space as well.
Streaming music is becoming more important
As the music industry tries to figure out how to put itself back together, 2013 marked the first time in which sales of digital music decreased along with sales of physical music. The decline in CD sales has been ongoing for years, but the drop in digital sales shows that the music-consuming public (especially the younger parts of it) no longer see music as something to be owned. That's bad news for the few "record" stores that are remaining and it's bad for iTunes download sales, but it's good news for a company that offers both ad-supported and subscription streaming services as Spotify does.
Is Spotfy actually a business?
Spotify, unlike its rival Pandora, derives most of its revenue from subscriptions, not advertising. Pandora, which reported $645 million in revenue in 2013 , made 88% of its money on advertising and 12% on subscriptions, Quartz reported. Spotify has not filed its 2013 earnings yet, but according to its corporate filings for 2012 in Luxembourg, where the company is registered, it more than doubled revenue that year to 435 million euros ($571 million), but had a net loss of 58.7 million euros, Reuters reported.
Spotify makes 85% of its revenue from subscriptions and only 15% from ads, Quartz said. This may be important to the success of an eventual IPO because while ad-driven Pandora lost $26 million in 2013, SiriusXM (NASDAQ:SIRI), DISH Network (NASDAQ: DISH), and DirecTV (NASDAQ: DTV) are just a few examples of how subscription models can be profitable.
What are Apple and Amazon going to do?
The current iTunes Radio works like Pandora where users are fed a stream of songs based on what they like. Spotfiy is more of an all-you-can-listen music service where subscribers can pick the specific music they hear. iTunes Radio and Pandora will play you some Bruce Springsteen songs if you like "The Boss." Spotify will let you choose to listen to "Thunder Road" or "Dancing in the Dark" when you want.
Apple has had talks with music labels about creating a service like Spotify that would not be limited to Apple devices. This is a major change for Apple, which currently controls 40% of U.S. recorded music revenue, according to Billboard, but both the declines in digital download sales and the growth of Android devices has the company considering if it can leverage its market share with the iTunes store into a successful subscription model.
"So when you buy a song for $1.29, and you put it in your library, iTunes might send an email pointing out that for a total of, say, $8 a month you can access that song plus all the music in the iTunes store," a major label source told Billboard. "It's all in the 'what if' stage."
Amazon is exploring a streaming music service that would fall somewhere in between the Spotify all-you-can-listen model and the Pandora streaming radio setup. According to the Wall Street Journal, the Amazon service would allow users to pick specific songs but it might limit how often they can hear them. The Amazon service would be a free add-on for its Prime members (much like its Prime video service) and may not include the the newest music.
The Amazon service, long in the works, has met with serious resistance from the major music labels -- some of which have outright rejected Amazon's payment offer . A deal may happen as it may be hard for a struggling industry to leave millions on the table. But it's unlikely labels will sell out to a service that's in a sense free and likely to steal customers from paid services.
Spotify faces a difficult road
No matter how successful Spotify has been so far, you have to be concerned about any business that loses money and faces competition from two of the biggest companies in the world. If Apple launches a Spotify-like service it may not steal customers but it will close off a growth path for Spotify.
Apple has a tremendous ability to convert iTunes music buyers into subscribers as those customers are already in the Apple ecosystem. Spotify has to go after new customers from scratch and Apple has tens of millions of people in its databases that it already has credit card information for.
Amazon represents another wild card -- if it ever gets a music service off the ground, it has a huge user base that may find they have no reason for Spotify once they get access to the Amazon service. Amazon may not steal customers from Spotify but the millions of Prime customers who suddenly get a music service for free -- even a mediocre one -- may decide they don't need to pay for a better one.
Spotify faces a very tough road in a market where it's very hard to differentiate yourself from your competition. SiriusXM did so with exclusive content -- think Howard Stern and out-of-market NFL games -- but that is unlikely to be possible (or affordable) for Spotify. If Apple or Amazon (or both) actually launch their services, Spotify faces at the very best a highly difficult challenge and at worst an utter disaster that will drive it out of business.
Daniel Kline has no position in any stocks mentioned. His Pandora station is built around Buffalo Tom and The Replacements. The Motley Fool recommends Amazon.com, Apple, DirecTV, and Pandora Media. The Motley Fool owns shares of Amazon.com, Apple, Pandora Media, and Sirius XM Radio. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.