Spotify: Growing like mad, yet so far to go

When Ek sits for a fireside chat at the South By Southwest (SXSW) Interactive Festival here later today, the Swedish-born, aspiring music industry mogul will be able to share some fresh bragging rights: Spotify has signed another 1 million subscribers since December, bringing the total to 6 million and cementing its position as the fastest-growing digital music company ever -- second in reach only to Internet radio company Pandora. A company representative confirmed the numbers for CNET.

It's no small accomplishment. Music-streaming startups have come and gone like one-hit wonders in recent years. And yet, through a mixture of hype, a quality product, great timing, and shrewd execs and backers, Spotify has risen to prominence even as deep-pocketed behemoths like Google andApple appear ready to jump into the music streaming business.

Spotify's latest milestone follows a December company event, held in New York, to make two big announcements: Longtime streaming holdout Metallica had signed on exclusively with Spotify, and the company had surpassed 5 million subscribers, 1 million of whom are in the U.S. All told, the company now boasts 24 million active users, well more than double what it had a year ago.

"Right now," said Spotify Chief Marketing Officer Jeff Levick, "all the conversations we have are about how do we accelerate this business."

That growth comes as Spotify expands its global footprint. Over the past year, it has doubled to 20 the number of countries in which it's available. In February, it added Italy, Poland, and Portugal. In the coming months, launches are planned across South America and Southeast Asia.

Spotify also has cut deals with automakers Ford and Volvo, ensuring the music-streaming service is available with some new vehicles. The company also is seeking partnerships with Internet providers and wireless companies to find ways to bundle its service, which has played a key role in some of its success in European markets.

Naturally, Spotify is making a splash here in Austin, where at the Spotify House three bands are playing daily. On tap Wednesday night is a show featuring rapper Kendrick Lamar, which Spotify will stream live.

A stream of pennies
Since it burst on the scene in the U.S. 17 months ago, Spotify has caught flak from artists bitter about the paltry payouts they get when their music is streamed on Spotify. It isn't an entirely fair criticism, however, since the payouts to the artists are mostly up to the labels, which treat a stream (in effect, a rented listen) as less valuable than a purchased song. Where artists might earn 7 to 10 cents from a 99-cent song purchased from iTunes, they'll usually make a fraction of a penny when that same song is streamed on Spotify.

One way that problem can go away is through sheer size. Those penny payouts grow to dollars the more people listen. The bigger Spotify gets, the better off things become for the artists and labels.

Spotify could become a cash cow for a big act like Metallica, which owns the rights to all of its songs. This means that any cut that normally goes to the labels and publishers goes straight to the band. That dynamic explains how longtime antagonists Metallica drummer Lars Ulrich and Spotify backer Sean Parker found a way to make nice on that New York stage in December. Parker, you'll remember, helped blow up the music industry more than a decade ago when he co-founded Napster, letting people share music across the Internet -- rights and royalties be damned. Metallica sued Napster and became a standard bearer for the record industry's fight against unlicensed sharing. (Napster, incidentally, was Ek's inspiration).

That nasty fight is an ironic subtext to Spotify's effort to take streaming services mainstream with the public support of Metallica. There's no doubt that after years of disappointment, streaming is catching on: The number of people paying for a music service soared 44 percent in 2012 to 20 million.

The bet from the major music labels -- not to mention Google and probably Apple -- is that more and more people will opt to pay for the features that come with subscribing to services like Spotify. Warner Music Group last week cut deals for two streaming services thatGoogle is aiming to launch this summer, one attached to YouTube, the other attached to Google Play.

Apple again is reportedly trying to launch an iRadio service. And Warner Music's owner, Access Industries, just made a $60 million investment in Beats Electronics' streaming service Daisy, which grew out of the sale of startup MOG. It's set to launch this summer.

The "access anywhere anytime" music-streaming model is creating a fresh source of revenue for the record labels. More promisingly, Spotify, Rhapsody, Deezer, Muve Music, and the rest have not eaten into download sales from Apple's iTunes Store, according to people at the labels. That's been a concern among artists who do well on iTunes, and Metallica's manager has acknowledged that the band is taking a gamble.

Already, Spotify is cutting fat checks to the labels. Since launching in 2008, Spotify has paid out $500 million to the rights holders, and it expects to pay another $500 million this year. As Spotify and others have risen, piracy has fallen.

"What they have is a product that consumers want and a model that the music industry has accepted," said one senior music label executive, who spoke on the condition of anonymity.

Dancing with the labels
Yet Ek and his team know full well they have a long way to go. As it stands, Spotify is on track to bring in more than $684 million this year from subscribers alone, because roughly 90 percent of those 6 million people pay $10 a month -- or the local currency equivalent. The rest pay the $5-a-month version for desktop access. (That's a conservative figure because it neither accounts for ad revenue nor more subscribers signing up as the year goes on.)

Still, it will be a challenge for Spotify to become more than a single-digit-margin business, assuming it can turn a profit. It pays the labels differently depending on whether the users are paid subscribers or listening to ad-supported music. The music companies get paid a percentage of each subscriber, and then get a per-stream rate or a share of the ad revenue, whichever is greater.

No matter what, the music rights holders get roughly a 70 percent split on all revenue, according to people familiar with the terms, and that leaves Spotify 30 cents on every dollar to pay for technology, marketing, employees, and everything else. Plus, Spotify paid the labels big advances to offer free music in the first place.

So Spotify is taking the popular route, spending down the reported $280 million it has raised from private investors. It's aim is to get big fast and bring in so much money for the labels that they'll be willing to offer more favorable terms. This is a critical year, because, according to industry sources, Ek's deal-makers are negotiating new terms with the three majors, Universal Music Group, Warner Music, and Sony Music.

Yet, big threats loom. Google's YouTube, for instance, has 800,000 million unique users a month, and a well-done YouTube streaming service could crush Spotify. The clock is ticking, but Ek and company are getting used to defying the odds.