The music streaming market is currently the most dynamic segment in the music industry. The market entry of Apple with iTunes Radio and Google with All Access underpin the relevance of music streaming. It is just a question of time when Amazon will announce the launch of its rumoured music streaming service. Google, Apple & Co., however, enter a highly contested market. In the relatively small Austrian music market, eight streaming operators offer their services to the consumers (IFPI Austria 2013: 13) – not counted are the myriads of Internet radios, video streaming platforms such as YouTube, TapeTV, Vimeo and Hulu as well as the cloud-based music services of Amazon, Apple and Google.
Is Streaming the Next Big Thing? – The business model of music streaming services
However, streaming services differ. In the first part of this article the different services are put in a typology and then the business model of personalised streaming services are analysed to assess their economic potential.
A typology of music streaming services
Passive Internet radios and webcasters
Internet or web radios broadcast conventional radio programs online that can be listened without any interactive and/or personalised features. Most of them are free of charge and thus ad-supported. In Germany, market researcher Goldmedia (2012) counted over 3,000 web radios in 2012. 2,470 are just online-based radios, which broadcast mainly music, but also news, sports and other events as well as comedy shows. In addition, there are about 380 online radio stations operated by classical FM radios (simulcaster) with further 150 online sub-brands. Most of them are ad-supported, but the public radios’ online programs are also fee-funded. The online web radio market is highly dynamic. In 2012, 800 programs were closed down whereas 750 were newly established. The web radio market in Germany, thus, slightly shrank by 1 percent for the first time. The number of GEMA licensed web radios decreased by even 17 percent from 1,697 to 1,410 from 2011 to 2012 (Goldmedia 2012).
Non-interactive personalised web radio
Non-interactive but personalised web radios such as LastFM, Pandora and Apple’s iTunes Radio provide a more innovative concept than conventional online radios. Algorithms help to detect the listeners’ music taste to generate playlists. The playlists can be saved and shared with other users. It is not possible to replay a song. Therefore the program has to be restarted again. These services, thus, are non-interactive, but personalised in its use. The absence of interactivity, therefore, is the main criteria of distinction to music streaming services in the narrower sense that enable a music choice without any restrictions. Hence, full streaming services such as Spotify has to be directly licensed to the owners of the master recordings, whereas for non-interactive webcasters such as US-based Pandora licensing is compulsory and the licensing rate is determined by the Copyright Royalty Board (CRB). Non-interactive services, thus, are mainly ad-supported with supplementary subscription which has not generated a significant amount of money until yet (more about Pandora’s business model can be read later).
Interactive personalised web radio
Interactive streaming services enable the users to choose songs without any restrictions from a vast catalogue of several million titles. They offer different models. In the ad-supported version the consumer gets the music for free. This so-called freemium model is usually limited in time and bandwidth. On Spotify music can be listened for free only in the first six month. After this period free music streaming is limited to ten hours per month. On Deezer the free music consumption is restricted after a year to two hours per month and on Simfy just 30 seconds of a song can be streamed for free after a free trial period of two months. Just Xbox Music offers an unlimited ad-supported freemium model. Some streaming services such as Rara, Musicload and Google’s All Access offer exclusively subscription models without any freemium models. The monthly subscription fees range from EUR 4.99 per month for unlimited but desktop only versions to EUR 9.99 per month for a full premium services with online and mobile access. Therefore, the interactive streaming services rely on a revenue mix of ad-support and subscription.
Video streaming platforms
YouTube is by far the best known and widely used video streaming platform. Google Inc. purchased YouTube in November 2006 for US$ 1.65bn. YouTube enables its users to upload their (self-made) videos. Thus, YouTube is a so called user generated content platform. Music videos are a very popular content on YouTube. Since most of them are copyrighted, it is a copyright infringement to upload them. The law suits by Viacom and the dispute with German collecting society GEMA on royalty payments are still pending in this respect. YouTube, however, recently offers subscription channels to content creators to benefit not only from monthly fees but also from revenues of premium advertising. In addition, YouTube also shares the advertising revenue from its freemium model with the right holders.
Video streaming sites such as Hulu, Vevo and Tape.tv operate a different business model. Their platforms offer no user generated content, but streams of licensed music videos. Most of them a pure ad-supported.
Cloud-based music services
enable the users to upload their music files on a server in the so-called cloud to stream then the music from any device. The most popular cloud-based music services are Amazon’s “Cloud Drive” with the “Cloud Player”, Google’s “Play Music” (formerly “Music Beta”) und Apple’s “iCloud” with “iTunes Match”. The companies offer a limited free upload capacity, but beyond that the users have to pay for further gigabytes. In Amazon’s “Cloud Drive” 5 GB of storage capacity is available for free. Then the user has to pay US$ 1 for an additional gigabyte. “iTunes Match” users have to pay for the scan-and-match-service US$ 24,99 per year. For further details on cloud-based music services please read the blog entry “There Is Music in the Cloud”.
The business model of personalised music streaming services
As pointed out earlier we can distinguish between two different types of personalised music streaming services – interactive ones such as Spotify and non-interactive ones such as Pandora. The difference is not just a question of userbility, but affects also the services’ revenue models. Non-interactive services mainly rely on advertising revenue and have only recently established subscription models. In contrast, interactive service have launched freemium models and subscription models side by side from the beginning to convince as many of their users to convert from the free and ad-supported model to the subscription model.
Content acquisition is another essential difference between the two services. In the U.S., non-interactive services such as Pandora are treated as webcaster that use the music content on the basis of statutory licensing. Therefore, they have to pay for mechanical rights the compulsory rates of the U.S. Copyright Royalty Board (CRB). Currently the rate per non-subscription stream is US$ 0,00120 and per subscription stream US$ 0,00220.
Figure 1: The royalty structure applicable for Pandora Media Inc.
Source: Pandora (2013: 14).
We can see (Fig. 1), that the rates Pandora has to pay to digital collecting society SoundExchange are lower than the Copyright Royalty Board rates. The Webcaster Settlement Acts of 2008 and 2009 permits webcasters to negotiate alternative royalty rates directly with SoundExchange. Thus, Pandora has applied the so called “pureplay” rate – because of the “Pureplay Settlement – since 2009.
Pandora paid US$ 238.7m of performance rights royalties for the use of sound recordings to SoundExchange in 2012. SoundExchange channelled 50 percent (US$ 119.4m) to the holders of the master rights (typically labels), 45 percent (US$ 107.4m) to the interpreters and 5 percent (US$ 11.9m) to the session musicians.
In addition, Pandora has to obtain public performance licenses and to pay performance rights royalties to copyright owners (composers, songwriters and publishers) and their agents respectively. Thus, Pandora paid US$ 18.4m to the collecting societies ASCAP, BMI and SESAC as well as EMI Publishing and Sony/ATV Publishing.
In total, Pandora had to pay US$ 258.7m for content acquisition in 2012. Content acquisition costs, therefore, account for 60.6 percent of the overall revenue of US$ 427.1m. The revenue consists of US$ 375.2m of advertising income (87.8 percent of total revenue) and US$ 51.9m (12.2 percent of total revenue) of subscription fees and other sources.
Figure 2: Pandora’s revenues and content costs, 2008-2012
The high proportion of content acquisition costs also explains the operative loss of US$ 37.7m in 2012, despite increasing advertising and subscription revenues (Pandora 2013: 71). In fact, the content acquisition costs grew faster than the total revenue – 67.7 percent compared to 73.2 percent – from 2011 to 2012. The increase in costs is, thus, higher than the growth of listener hours of 72.9 percent in the same period. The number of active users increased 56.1 percent from 29 to 66 million in 2012. This means that content acquisition costs per active user rose in 2012.
Figure 3: Statement of operations for Pandora Media Inc., 2008-2013
Source: After Pandora (2012: 40) and Pandora (2013: 71).
The crucial factor of Pandora’s business model is, therefore, to control the content acquisition costs with increasing advertising and subscription revenues at the same time. This is urgent, since advertising revenue per thousand listener hours decreased from US$ 33.65 to US$ 29.13 in 2012 (Pandora 2013: 49), which indicates a falling tendency in advertising revenue. Thus, the mobile music segment with smartphones and tablet computers becomes more and more important as well as relationships with automobile manufacturers to integrate Pandora in the car radios.
Interactive streaming services have to pay a higher licensing rate per stream than non-interactive ones. According to PrivCo, an U.S.-based financial intelligence service, Spotify’S cost of sales reached 98 percent of the company’s revenue in 2011. If we deduct 3 percent for credit card payment fees, Spotify had to pay US$ 234.8m out of a total revenue of US$ 244.5m to the right holders. PrivCo, thus, concludes that Spotify had to pay nearly all its revenue for music licensing. Other costs for personnel, marketing & sales as well as for overheads, therefore, cannot be paid out of the cash flow. In 2011, this results in a net loss of operations of US$ 59.1m for Spotify AB.
Figure 4: Financial statement for Spotify AB, 2010-2011
Source: After PrivCo (2013).
Glenn Peoples, Billboard’s chief analyst, counters PrivCo’s assumption that Spotify’s business model is not sustainable by pointing at Spotify’s ability to successfully collect risk capital resulting in cash and cash equivalents of EUR 104.3m (US$ 135m). Further he argues that consolitated financial results does include also high costs for market development, which bias the results. As soon as Spotify would have successfully establish its freemium model in a market it is only a question of time to make them paying subscribers. Spotiy U.K. is, therefore, a good case study. Spotify Ltd. was established in 2008 and was already profitable already in 2011 according to Peoples.
In comparing the financial statements of different subsidiaries of Spotify the overall picture is mixed. Spotify AB showed a loss of EUR 33.7m and Spotify (UK) Ltd. of EUR 2.5m in 2011. The Swedish, Norwegian and Spanish branches accomplished small profits in the same year. Since the costs of content acquisition are not broken out in the financial statements, we can only speculate about their negative impact on the financial results. Only for Spotify UK costs of goods sold were reported. Thy accounted for 81 percent of the total revenue in 2011. In 2010, they were even higher with a 102 percentage of the total revenue. Spotify’s costs of content acquisition are, thus, remarkable higher than Pandora’s. Spotify, therefore, has even more pressure to increase advertising and subscription revenues.
Figure 5: Annual reports of Spotify’s national branches, 2010-2011
Thus, it is crucial for interactive streaming services to convert as many freemium users as possible to paying subscribers. According to Midia Consulting, which compared the conversion rate of several services, Spotify and Deezer were much more successful in attracting paying subscribers than Pandora. Although Pandora counted 66m active users in 2012, just a small proportion of 2m or 3 percent were subscribers. In contrast, 32 percent of Spotify’s active users were subscribers and for Deezer this ratio was even 38 percent.
Figure 6: Active and paying users of freemium services
Source: Midia Consulting (2013).
Nevertheless the rate of conversion from freemium to subscription models is still too low according to the music industry analyst Mark Mulligan. In his Music Industry Blog Mulligan argues that the gap between freemium and premium services is too wide for most of the services: “Whereas the gap from zero to $0.99 for Angry Birds free to paid is a modest step, from zero to $9.99 for Spotify or Deezer portable is a much more sizeable hurdle. Thus converting to paid for music subscription services is a more sizeable achievement than for low priced gaming apps. More needs to be done to bridge the divide. This can be achieved in through bundles and innovative pricing. Though this must be set against the risk of cannibalizing full price tiers.” (Midia Consulting 2013).
Another problem, according to Mulligan (Midia Consulting 2013), is that freemium models are simply too good for the users to convert to premium models as in Pandora’s case. Therefore, Spotify, Deezer and other interactive music streaming services offer limited freemium models with a lower streaming rate. However, if the quality of the freemium model is considered too low, there is the danger that music fans avoid using the system at all. Thus, it is a thin line of success music streaming services has to walk along.
We can identify different music streaming services – web radios, personalised music streaming services, user generated content services and cloud-based music platforms – with a different cost structure especially for content acquisition.
The number of registered users is not essential for the economic success of music streaming services. Much more important is the number of active users and the ratio of freemium users and subscribers. An increasing ratio is therefore the main factor of success.
The integration of music streaming in automobile radios and the bundling of music streaming with other digital content by ISPs and mobile service providers is maybe the most important precondition for a high market penetration, but no guarantee that the users pay for music streaming.
An increasing cost pressure and intensifying competition will result in fewer music streaming services. Just those services will survive that successfully control their costs of content acquisition and increase the number of subscribers.
In fact, music streaming will not be the cash cow of music industry – at least not for the streaming services.
Billboard.biz, “Business Matters: Spotify UK Shows That Freemium Model is Not ‘Unsustainable’“, October 9, 2012 (accessed Mai 23, 2013)
Billboard.biz, “YouTube Scores Win in Viacom Lawsuit”, April 18, 2013 (accessed May 20, 2013).
Billboard.biz, “YouTube Launches Paid Subscription Channels”, May 9, 2013 (accessed May 20, 2013).
Goldmedia, 2012, Webradiomonitor 2012 im Auftrag der Bayrischen Landeszentrale für Neue Medien, July 2012.
Midia Consulting, 2013, “Making Freemium Add Up”, Music Industry Blog, May 21, 2013 (accessed: May 23, 2013)
MusicWeek, “GEMA calls for 1.6m Euros of damages from YouTube in copyright infringement case”, January 14, 2013 (accessed May 20, 2013)
Musikmarkt, “Mit YouTube Geld machen”, April 26, 2013 (accessed Mai 20, 2013)
Pandora, 2012, Annual Report for the Fiscal Year ended January 31, 2012.
Pandora, 2013, Annual Report for the Fiscal Year ended January 31, 2013.
PrivCo, “SPOTIFY’s Just –Closed-Year Financials Obtained”, October 5, 2012 (accessed May 20, 2013).
 This amount has been calculated on the basis of Pandora’s 2012 annual report, in which it is stated that the payments to ASCAP, BMI, SESAC, EMI and Sony/ATV Publishing for performance rights account for 4.3 percent of the total revenue (Pandora 2013: 24).
 Billboard.biz, “Business Matters: Spotify UK Shows That Freemium Model is Not ‘Unsustainable’“, October 9, 2012 (accessed May 23, 2013).