Business Matters: Flaws in the Argument That Spotify Will 'Never' Be Profitable
Business Matters: Flaws in the Argument That Spotify Will 'Never' Be Profitable

Flaws in the Argument That Spotify Will 'Never' Be Profitable
After a few years of media infatuation, success is making Spotify a popular target for criticism. First, Spotify withstood months of criticism about payouts to artists - a flawed concept since Spotify pays labels, not artists. Now its financial model - the part that dictates it pays labels in the first place - is being called out.

Digital music entrepreneur Michael Robertson believes Spotify "can never" be profitable. Putting the royalties in terms of hot dog sales, Robertson's example sees Spotify paying the greater of "$1 per hot dog sold OR $2 for every customer served OR 50 percent of all revenues for anything sold in the store."

Spotify's New Direction: A Big Step Forward for the App Movement

Spotify et al do indeed face some challenging financial prospects. But "never" is probably not the best word to use when talking about the profitability of a digital music startup. Instead, let's take a long-term view of Spotify, somewhere between the near term (one to three years) and eternity (the timeline implied by the word never). Contracts with rights owners are near-term restraints on profitability. But over a longer period of time, Spotify has a chance to gain more leverage in negotiations and get more favorable terms. Look at the download market (iTunes) and the brick-and-mortar retail market (Walmart, Best Buy) for market leaders who wield negotiating power with record labels.

Here's one thing that Robertson overlooks: as Spotify scales it will get leverage. And with scale comes better margins. Digital music services are in their infancy. They may accept certain terms now in order to launch, but the situation will change as the services and marketplace mature. At some point the lesser of the three royalty obligations in Robertson's example becomes 50 percent of all revenues. That's about the same as Pandora's content acquisition costs, and it's far less than what download stores like iTunes pay (around 70 percent). A digital music service can turn a profit when paying half of its revenue to content owners.

There is special irony here that has gone unnoticed. Robertson's comments actually provide a counterargument to the ongoing criticisms about Spotify's payouts. Popular opinion holds that Spotify pays out too little to artists (or rather it pays out too little to labels, who then pay out too little to artists according to the particular details of each artist contract). There has been a great deal of discontent in the latter half of 2011.

But Robertson is effectively arguing that Spotify is paying out too much to rights owners. After all, Spotify would have a better chance to turn a profit if it paid out less, not more, to rights owners. Paying less wouldn't guarantee profitability, but it would certainly help.

In any event, a lack of profit wouldn't be the end of Spotify. After establishing a position of market leadership and offering evidence of potential for profitability, Spotify's investors can exit through an acquisition (more likely) or an IPO (less likely). Companies are routinely acquired before ever turning a profit (Napster, for example -- twice). And many Internet companies turn an accounting profit after, not before, going public (Pandora, for example).

At the heart of Robertson's comments is an uncomfortable truth, however. Digital music companies need to turn a profit at some point. Cash on hand will get a startup only so far. Eventually resources will dry up and the company becomes a distressed acquisition - either whole or for parts. At the very least a service needs to hang on long enough to gain some traction and put itself in a position to be acquired. Content owners have every right to extract their pound of flesh from music services that want to use their catalogs, but they have to accept the aftermath if tough licensing deals speed the evolutionary process. (Michael Robertson blog)

Clear Channel Digital Names Bob Stohrer CMO
-- Clear Channel has hired Bob Stohrer to be the Chief Marketing Officer of Clear Channel Digital. Stohrer was previously at Sprint Nextel and will report to Brian Lakamp, President of Clear Channel Digital. In this new position, Stohrer will oversee the national marketing plans, brand execution and social marketing efforts for Clear Channel Digital with a focus on iHeartRadio.

Clear Channel's digital division has been going through some changes this year. Lakamp was named to the newly created position of president of Clear Channel Digital in October and Pablo Calamera, who came over in the Thumbplay acquisition, was named CTO. It was that Thumbplay acquisition that allowed Clear Channel to relaunch iHeartRadio as a personalized Internet radio service a la Pandora. Also in October, former COO Gerrit Meier become Spotify's general manager of distribution and partnerships. (Press release)

Grooveshark Signs Licensing Deals With Five Labels
-- Grooveshark, still dealing with two lawsuits from Universal Music Group, forges onward with new licensing deals with five labels: American Myth Recordings, Partisan Records, Daly City Records, Zodlounge and Foundation Media. The addition of these labels brings over 400 new albums to the music service. (Press release)