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Adding video and fitness could save Spotify from the terrible economics of streaming music

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Ad-supported listeners are three-quarters of Spotify's user base, but less than 10 percent of its revenue

Last week we told you that Apple was pressuring the labels to kill off Spotify's free tier. It would likely find a friendly ear at Sony and Universal Music Group, who have spoken publicly about their belief that the free tier is hurting the business. The artist-owned Tidal has made similar arguments and launched without a free tier. Warner is the only major label to recently take the position that the free tier has value. To help shake up that equation, Spotify today introduced video, podcast, and fitness to its offerings.

Ads are becoming less valuable on Spotify

Spotify's finances make clear where the anxiety over free music stems from. The average revenue it earns per user in the free, ad-supported tier has been falling dramatically, from around 40 cents per month in 2012 to 26 cents per month in 2014. As a percentage of overall revenue advertising now makes up just 9 percent, down from 13 percent in 2012. Yet these subscribers make up three-quarters of the 60 million people that use Spotify every month.

One thing is clear: despite its impressive growth, Spotify is still struggling to turn a profit. It represent over half the dollars flowing into streaming music, according to Ek. But while its overall revenues have more than doubled since 2012, so have its losses. In its most recent financial disclosure, the company revealed that it lost $165 million, up 65 percent from one year earlier. That's because around 80 percent of its revenues flow out the door to rights holders, namely the major labels. Today's announcement was a play to escape the onerous economics of a pure play digital music service and become a more broad-based streaming media platform.

Podcasts are the most natural extension of Spotify's current model, and may be more profitable, since ad revenue can be split with partners while avoiding expensive royalties and advances. Adding video in the mix could have an even bigger impact. As Verizon's recent purchase of AOL demonstrated, video, and more specifically mobile video, is considered the most promising medium for marketing. Spotify could use video as a way to boost the amount of money it makes in the free tier. It could also use exclusives and bonus content as a way to lure customers up into the paid tier.

Video can up ad rates and help convert users to paid subscribers

The ladies behind Broad City came on stage to joke about how Spotify reached just the right demographic of hip, young viewers and made sense as a place for short, bite-sized clips. They hinted some would be Spotify exclusives, no doubt bookended by ads on both sides, unless you're paying $9.99 a month. Along with Comedy Central, CEO Daniel Ek said Walt Disney, Vice, ESPN, and many other big brands are apparently all joining the platform.

On the fitness side Spotify is adding music that matches the pace of your run and will be integrated with Nike+. As MyFitnessPal and FitBit have proved, there is a lot of money to be made in offering people digital health and fitness help on their smartphone.