Sunday, September 9, 2012

What If Your Cloud Suddenly Vanished?

You have abandoned music possession and are now completely dependent on streaming services in the cloud to deliver their vast-but-low-bit-rate song libraries for your listening enjoyment. Are you prepared for the day when your cloud, or any other cloud, may no longer be there? From all indications, that day may be inevitable.

The most popular streaming services, Pandora and Spotify, have unsustainable business models. If these two pioneering giants can't survive in the long run, what chance does any other service have? Maybe music possession isn't as quaintly 20th Century as pundits would have you believe.

Pandora, which had its IPO in 2011, has never been profitable. Its revenues are growing steadily, but so are its losses. For the quarter ending July 30, 2012 revenue was up more than 50% year-to-year to $101.3M, but its quarterly losses of $5.4M were 3x last year's. According to filings in Spotify's home country of Luxembourg, the company lost $57M on $236M in revenue for fiscal year 2011. The red ink cannot continue indefinitely.

"Cost of sales" is the highest contributing factor to the sustained losses. Pandora operates as a limited-play radio service and does not have to negotiate royalty deals with individual labels. Still, last year the company paid 54% of its revenue out in royalites under the provision of federal copyright law that lets it use (almost) any song. Spotify operates as an unlimited on-demand music service and negotiates directly with labels and publishers for the songs it makes available, paying a staggering 97% of its revenue on licensing fees and distribution costs. (Source: NY Times.)

To climb out of its hole, Pandora is lobbying Congress for a copyright license deal more aligned with satellite radio and cable outlets, the so-called Internet Radio Fairness Act. The licensing rate for satellite is set at 7.5% of gross revenue. Cable music services pay 15% of gross revenue. On the other hand, Pandora pays 2 cents per hour for the more than one billion streaming-hours it runs per month. (Source: LA Times.) Music publishers, becoming more dependent on revenue from streaming as CD sales continue their decline, oppose any change. Additionally, statutory licensing is unique to the USA; overseas growth for Pandora will be hard to achieve without similar license deals in other countries.

To reverse its current fortunes, Spotify faces the daunting task of trying to make monopoly economics work. If the EMI sale closes, there will only be only three major music labels. As explained by Michael Robertson of, the jaw-dropping secret licensing demands of record label monopolies would not be tolerated in any other industry as they "crush innovation, as well as any hope of profitiability." Since failure to reach a deal with any of the labels would put a huge hole in Spotify's catalog, the company really has no choice but to concede to industry demands.

Listeners have embraced streaming audio services in the cloud. At least 33 million people have tried Spotify, more than 150 million have registered for Pandora. But maybe now is not the time to abandon music possession completely in favor of streaming; the current cost structure of the industry is unsustainable. Are you prepared for the day when there is nothing but blue sky where your cloud used to be?

            Vinyl-to-Digital Restoration #42             

Artist: Willie Nelson
Title: Stardust
Genre: Country
Year: 1978

Willie Nelson has never been one to do the safe or expected, and this Booker T. Jones-produced album of pop "standards" from the '30s and '40s certainly fits the profile. The success of Stardust paved the way for the late-career standards album of virtually any singer you can name. I had never heard more than a couple lines from Irving Berlin's cloud-free "Blue Skies" (via montage in the movie White Christmas) until picking up this album as my introduction to Mr. Nelson's work.

© 2012 Thomas G. Dennehy. All rights reserved.


  1. [Author Comment] On Friday 7-September-2012, as I was preparing this piece for publication, both the New York Time and Wall Street Journal reported that Apple was planning an internet radio service to compete with Pandora.

    I chose not to include this development for two reasons:

    1. Apple has not actually announced anything (yet).
    2. The entry of a new formidable competitor into your market is a very different challenge than inherent cost structures that negatively affect profitability potential, a challenge that even the most successful businesses must always be prepared to take on.

  2. On 5-October-2012, financial data firm PrivCo raised some serious questions about the sustainability of Spotify's financial model, based on year-2011 losses. "Spotify's 2011 results indicate that drastic changes must be be made quickly to its business model in order to generate growth while actually improving operating margins so that break-even, let alone profitability, is somewhere, anywhere, on the horizon," Hamade warned. "Either the online music royalty payment model to artists and music companies needs to change, which is highly unlikely in the near term given that digital royalties are record companies only growing revenue stream, or Spotify needs to ASAP introduce a tiered subscription system, as opposed to its current flat monthly fee model, which is clearly a broken business model."

    [Source: Digital Music News]

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