Is Spotify's business model broken?

Spotify's financial performance in 2011 was abysmal.

Spotify CEO Daniel Ek.
(Credit: Sarah Tew/CNET)

As revenue increased 151 per cent from 2010, the on-demand streaming music service saw losses widen to 60 per cent for the same period, according to documents posted last week by PrivCo, a company that sells data on non-publicly traded companies.

A Spotify spokeswoman told CNET that the numbers posted to PrivCo's site were accurate, but it turns out that the figures aren't exactly new. They were first reported in August by The Wall Street Journal, which tucked them into a story titled "Spotify to launch in Canada", and the revelation failed to generate a lot of attention.

Spotify's financial performance for the years 2011 and 2010.
(Credit: PrivCo)

Spotify is a music service that attracted a large and loyal following in Europe, before making the jump to the United States last year and Australia this year. The privately held company is now building a large audience in this country.

But there have long been sceptics who have said that Spotify won't ever generate profits while supplying users with free music and paying the royalty rates it does. The company offers songs free of charge to new users, which the company must still pay for, and then later tries to convince user to sign up for the monthly subscription fee.

Spotify appears to be struggling.

In 2010, Spotify, which is led by founder and CEO Daniel Ek, reported a net loss of US$37.5 million on US$97 million in revenue. For 2011, the company's revenue increased to US$244 million, but losses also widened to US$59 million, PrivCo reported.

PrivCo said that Spotify's business model is "unsustainable", and wrote to its clients that "something must change soon on Spotify's business model if the company is to survive".

Spotify isn't in any danger, as long as it's able to convince investors that music is still a worthwhile venture. According to reports, the company has recently received new funding based on a US$4 billion valuation. I haven't met any industry watcher who has heard that figure and not smirked.

Spotify's play is to build market share, and the strategy for accomplishing that in the online music sector is old, but proven. Give away songs for free and you'll find an audience. This method isn't cheap, and the trick for music services has always been about getting into users' wallets once you get them to your site.

For Spotify, the question is: can the service eventually shift enough users to the company's paid-subscription offer to make any profit?

That hasn't been determined yet. While multiple music industry sources have said that Spotify has improved its ability to convert users of the free service to the paid service, some insiders worry that Spotify still isn't drawing enough people into the free service so that it can later funnel them to a subscription plan.

Spotify should have enough investor money to keep it going for a while. It will be interesting to see if the service can continue to expand into new overseas markets, while paying for free music and maybe spending more on advertising, which is what some at the labels want to see.


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