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Spotify vs. Apple, Inc.: This Time, David Won't Slay Goliath

By Leo Sun – Jun 14, 2015 at 11:58AM

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Will Apple Music crush Spotify?

Apple (AAPL -3.00%) recently unveiled its new music streaming service, Apple Music. The service will launch with more than 35 million streaming songs, and will be integrated with users' existing iTunes tracks and ripped CDs. Paying users can also download up to 100,000 streaming songs for offline listening.

Apple Music. Source: Apple

The platform also includes Beats 1 radio -- a live Internet radio station that features exclusive content, interviews, guest presenters, and more -- which complements Apple's other genre-specific radio stations. Another feature is Connect, a limited social network which lets musicians share content with fans.

Will Apple's aggressive blitz in the streaming music market topple Spotify, the market leader in paid on-demand music? Or is Apple underestimating the loyalty of Spotify users?

Is Spotify in trouble?
Shortly after Apple's announcement, Spotify released a blog post highlighting its growth figures. Between May 2014 and June 2015, Spotify's paid subscriber base doubled from 10 million to 20 million, while active listeners rose from 40 million to 75 million. Apple reportedly hopes that Apple Music -- which will also arrive on Android later this year -- will eventually reach 100 million paid subscribers.

Both Apple Music and Spotify offer a comparable number of songs. Both services cost $9.99 per month, but Apple offers family sharing for up to six users for $14.99. Spotify offers sharing for just two users for $14.99, although the company recently stated that it would match Apple's prices. Apple is also offering a free three month trial, compared to Spotify's 60-day trial.

Apple Music isn't Apple's first attempt at streaming music. Back in 2011, it launched Match, which charges $25 per year to store iTunes purchases and ripped music in the cloud. But as of last April, the service still had fewer than a million subscribers.

Apple took a bigger leap in 2013 with iTunes Radio, a Pandora (P)-like service. iTunes Radio was free with ads, but ads could be removed with a Match subscription. Apple hasn't disclosed official listener figures for iTunes Radio, but Spotify is the market leader with an 85% share of paid streaming music worldwide, while Pandora remains a primarily ad-supported service with about 80 million active listeners. However, Apple still sells up to 85% of all digital music downloads worldwide through iTunes.

iTunes Radio. Source: Apple

Spotify by the numbers
In Spotify's aforementioned blog post, the company stated that it paid over $300 million in royalties in the first three months of 2015, declaring that it was "good for music," "good for music fans," and "good for music makers." What Spotify didn't mention was that royalties are also really bad for business.

Last year, Spotify's revenue rose 45% annually to €1.08 billion ($1.21 billion), but its net loss widened from €55.9 million to €162 million ($182 million). During that period, royalty and distribution costs rose 46% annually to €882 million ($990 million). Royalty costs outpacing revenue growth is a bad sign, and being forced to match Apple's prices could push Spotify deeper into the red.

Spotify for iOS. Source: iTunes

According to a leaked contract obtained by Digital Music News, Apple will pay master rights holders (artists and performers) 58% of revenue generated by Apple Music subscriptions, although nothing would be paid during the three month trial period. Spotify pays 70% of subscription revenue back to all rights holders, including publishers and composers, but the estimated cut for master rights holders should be comparable to Apple's.

Why Spotify can't last against Apple
Owning iTunes gives Apple much more clout with record labels, which generate more revenue from digital downloads than from streaming subscription royalties. Since merging streaming radio and iTunes will likely generate more track and album purchases, popular musicians like Taylor Swift -- who withdrew her albums from Spotify last year -- have signed with Apple Music.

Spotify has cried foul, leading to a U.S. investigation of Apple's business practices. The U.S. Department of Justice, Federal Trade Commission, and the European Commission have already been investigating accusations that Apple was pressuring labels to drop their contracts with Spotify's free ad-supported tier.

Taking out Spotify's ad-supported tier would cripple its ability to gain new free users and convert them to paying ones. Unlike Pandora, which generates most of its revenue from ads for free users, 91% of Spotify's revenue came from subscription fees last year.

This time, David won't win
Apple is dead serious about conquering the streaming media market, and unless it gets tripped up by regulators, rivals like Spotify and Pandora could be crushed. If Spotify and Pandora resist, Apple could simply lower prices to bleed them out. After the smoke clears, Apple's iTunes revenue -- which declined 5% annually in the first six months of fiscal 2015 -- might start rising again.

Leo Sun owns shares of Apple. The Motley Fool recommends Apple and Pandora Media. The Motley Fool owns shares of Apple and Pandora Media. 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.

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