Waiting for Spotify, act gazillion and one

We've seen lots of positive press about Spotify, but the European music service trying to jump to the U.S. just can't seem to put nagging doubts about its business model behind it.

Greg Sandoval Former Staff writer
Greg Sandoval covers media and digital entertainment for CNET News. Based in New York, Sandoval is a former reporter for The Washington Post and the Los Angeles Times. E-mail Greg, or follow him on Twitter at @sandoCNET.
Greg Sandoval
5 min read

For anyone following the attempts by European music service Spotify to launch in the United States, it should be plain that the company and supporters are trying hard to rally support among music aficionados.

Daniel Ek founded music service Spotify, a European music juggernaut struggling to make the hop to the U.S. Ian Phillips-McLaren

All the headlines about Spotify have teased a potential American audience for months. The latest example came yesterday when the blog Music Ally reported that Spotify, which is attempting to obtain the music licenses and launch a U.S. service, has paid about 40 million euros, or the equivalent of $55 million, to music rights holders since launching there two years ago. The blog also wrote that most of the money, 30 million euros ($41 million), was generated over the last eight months.

Yesterday, sources close to the company also told CNET that Spotify's conversion rates--the ability of a company to convince users of the start-up's free streaming services to adopt a paid-subscription offer--is improving. This has been a major sticking point with the labels. When it comes to licensing free-music services, the labels want to see a business partner turning people into paying customers.

The numbers sound impressive and show improvement. But take a closer look before you celebrate the biggest music juggernaut to hit the states since Abba: there are plenty of unanswered questions about Spotify's ability to make big bucks as it attempts to license music from the four major record labels in hopes of launching a U.S service before the end of the year.

Converting the unbelievers?
Certainly, Spotify's publicity machine is functioning at a high level. The company has seemed almost ubiquitous in the tech press during the past few months. There's the one about Sean Parker, a Spotify investor, declaring at a tech conference that the company can solve the music sector's piracy problem, and the one about Spotify launching an app for the Windows Phone. Oh yeah, and here's a story about Spotfy being an acquisition target.

Let's try to separate fact from fiction about this company, founded in Sweden by Daniel Ek. Spotify seems to be making some improvements in key areas, such as in converting users to the paid service, but there's still plenty to be skeptical about.

When it comes to converting new users to Spotify, managers have told their label counterparts that the number of people who convert to the paid offering in their first month has more than doubled recently, the sources said. The start-up is telling music execs that this kind of improvement bodes well for the future.

Spotify's conversion rates have hovered around 5 or 6 percent, according to sources close to the company, numbers that underwhelm leaders at the big labels who want about 15 percent, the sources said. Still, Spotify managers are telling record executives that their conversion rates aren't static, according to the music sources. They go up over time and with each added feature, such as the recent launching of the company's mobile app on the Windows Phone, the sources said.

Doubts linger
Then, there's the issue of how much money Spotify earns for rights holders. Let's take the numbers that Music Ally reported the company generated during the first eight months of the year and give Spotify the benefit of the doubt. Let's say the company will pay the same rate for the entire year. In that case, rights owners would receive $61.5 million for the year, or about $15 million per quarter. In reality, the independent labels would get a chunk of that money, but for this exercise, let's say the pot is divided equally among the four largest labels.

That would mean that Universal Music Group, Sony Music Entertainment, Warner Music Group, and EMI Music, would each receive $3.8 million a quarter from Spotify.

Warner, the third largest music label, reported for the quarter ended June 30 that it made $652 million in total revenue and $179 million in digital revenue. Spotify's contribution would add less than a percent to the record company's total revenue and about 2 percent to digital.

Europe is a smaller market than the U.S. but Spotify boasts 10 million users. It seems clear that thus far the start-up's contribution to the labels' bottom line is at best modest.

Jim Butcher, Spotify's spokesman, couldn't talk internal numbers but said: "We're really happy that Spotify has become a major revenue generator in Europe's digital music space."

These are hard times for the music industry and can the labels afford to turn their backs on $61 million? They might if they believed Spotify was siphoning dollars away from more lucrative revenues sources.

While Spotify has crowed about making more money in Europe than iTunes, some at the labels are wondering whether Spotify's free service has cut into iTunes sales, leading to less overall money for the record companies. There's some support for this. Russ Crupnick, an analyst with market researcher NPD Group, said in February that his research showed U.S.-based free streaming-music sites lead to a 13 percent decrease in paid downloads.

"We're eating our young," Crupnick said during a music industry conference. "For some, more listening just means more listening and tends to lead to less purchasing."

Prove the model
What may help label managers get over their reticence is that Spotify has shown a willingness to boost the amount of money it advances to the record companies. Earlier this week, I reported that this has helped the company make progress in the negotiations over licensing.

The big question I have is why is Spotify in such a hurry to get to the United States if the company is doing so well in Europe. If the labels are asking for too much money or have doubts about its business model, why not prove the model in Europe and then negotiate from a stronger position later?

Some have wondered whether Spotify isn't trying so hard to launch here so it can make the company more attractive to potential buyers. Spotify has discussed selling the company in the past, multiple sources have told me.

TechCrunch reported this week that both Google and Apple had approached Spotify about an acquisition. Spotify denied such discussions ever took place with Apple. The company, however, did not respond to questions about Google. Spotify and Google did indeed discuss such a deal, according to sources with knowledge of the talks.

The way I see it, much of Spotify's troubles can be traced to the company's inability to keep quiet. Why promise to launch when you don't have signed agreements? Why set arbitrary deadlines and make them public? When you negotiate deals in public you run the risk of showing up the other party.

If Spotify can't make this deadline, it should go home, focus on the markets where it already operates and worry about jumping here only when the labels are the ones begging for a Spotify U.S.A.