Spotify, the popular music subscription service, is due to meet in the coming weeks with its major counterparts in the record industry to renew their licensing agreements. The Verge has learned that managers at Spotify are expected to ask for substantial price breaks from the music labels as well as the rights to extend its free pricing tier to mobile devices.
The Stockholm-based Spotify has already started negotiations with Warner Music and will begin talks with Sony and Universal in the coming weeks, according to several music industry sources. (A Spotify spokesperson declined to comment on this story.) These negotiations with music’s "big three" labels will likely go a long way to determining whether Spotify reaches profitability, a crucial threshold as it increasingly competes with Apple and other cash-rich players in the digital music market.
Negotiations with "Big Three" will determine whether Spotify becomes profitable
Fans and casual observers might think Spotify has already won the streaming music war because of its large and growing audience. But while Spotify has amassed a following of 5 million paying subscribers and 20 million total users worldwide, its business model is still unproven.
70 percent of Spotify's revenue goes to licensing fees
About 70 percent of Spotify’s revenues pays music-licensing fees while another 20 percent covers customer acquisition, these sources said. That leaves 10 percent to pay all of the company’s other costs, including its much praised technology platform. Insiders have told The Verge that this cost structure zeroes out Spotify’s profits.
Any attempts to plead poverty by Spotify are likely to be met with skepticism by the recording industry. For years, music acts have reported receiving far skimpier royalty checks from Spotify than from other music services, such as iTunes. Some acts, including Coldplay, Adele, and Taylor Swift, have refused to distribute their songs through Spotify and other subscription services (It's important to note that many of these holdouts are now on the service). Meanwhile, Spotify raised $100 million last year in its latest funding round. If artists bail on Spotify, it doesn’t matter what cuts labels might be willing to accept. Everyone loses.
If artists bail, everyone loses
Record company executives have heard for a decade that they need to cut prices. The industry doesn’t appear to be willing to give much ground. Internet radio service Pandora is lobbying Congress to lower its statutory rates for playing songs. The record companies are spending big to thwart the attempt.
The record companies have plenty of digital music alternatives to Spotify. Apple, Google, Microsoft, Amazon, Sony are all companies with very deep pockets who sell music at razor-thin margins or even at a loss. To these companies, music is just one of the ways that they sex up their other businesses.
Spotify wants labels to expand its free trial for mobile
Simple rate renegotiation isn’t the only thing on the table. According to sources, Spotify is also trying to convince the labels to extend its ad-supported free tier for mobile devices, offering "more of a taste" than the current 30 day trial. Restricting mobile to paying or pro subscribers limits both the total number of Spotify customers and their overall usage. But it’s a risky bet. Without access to mobile music as an incentive, will users continue to convert from ad-supported to paid subscriptions? Or is it users’ inability to see the value of Spotify on mobile that makes them less likely to buy in?
broad trends all favor Spotify's model
Spotify is still in a good negotiating position. Apple remains the leader in online music distribution but overall, sales of music downloads have slowed to a trickle. Downloads just aren't making up for the decline in CD sales. We keep hearing that Apple is going to launch a subscription radio service similar to Pandora, but music industry sources say Apple and the labels are still far apart on licensing. As for Google and the others, their music offerings have yet to ignite much interest.
The broad trends all favor subscription streaming on a wide range of devices, and Spotify is the only subscription service that has generated real scale. The labels are big fans of the subscription model, which gives them predictable income across their entire catalog. The major labels have a vested interest in making sure subscription-based music continues to grow and thrive.
Also in Spotify’s favor: in some markets, the company is close to converting 20 percent of its users of the free service to a paid plan, sources said. If Spotify can parlay its current pole position into more favorable rates, it may be able to retain its lead even as giants like Amazon and Apple come nipping at its heels.
"Everybody in the industry wants to see Spotify succeed."
While it’s unclear exactly how far the two sides are willing to bend, It’s inconceivable that the labels or Spotify would walk away without a deal.
"Everybody in the industry wants to see Spotify succeed," one industry insider told The Verge. "Nobody in the industry can afford to see them go down the tubes."
Tim Carmody and Ben Popper contributed to this report.