The Good and the Bad of Spotify Founder Daniel Ek's Streaming Defense

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Spotify CEO Daniel Ek

Spotify CEO Daniel Ek doesn't walk away from a challenge. After Thom Yorke and Nigel Godrich blasted his company's business model, Ek responded with comments on Twitter. Now, after Taylor Swift drew huge attention by pulling her catalog from Spotify, Ek posted an 1,800-word response at the Spotify blog.

A mix of hard numbers and soft persuasion, Ek's post had some good aspects and a couple drawbacks. First, here are the positives.

1. Proper Context. Payouts will grow as streaming services grow. To put Spotify's numbers into perspective, Ek wrote that 500 thousand streams on Spotify is the same as "it having been played one time on a U.S. radio station with a moderate sized audience." He also reminded readers a label gets paid nothing for radio spins (which is true, outside of a small number of deals between broadcasters and mostly independent labels). The concept is correct -- a single radio spin has an audience of more than one listener -- but the actual numbers are likely to be much different.

Take Jason Aldean, who pulled his new album, Old Boots, New Dirt, from Spotify Monday. As seen on the Country Airplay chart in this week's Billboard Country Bulletin, Aldean's single "Burnin' It Down" had an audience of 36.9 million last week, according to Nielsen BDS (good for #7 on the chart). Since it received 5,764 plays, the average audience size for each spin was 6,395. Now, keep in mind that "Burnin' It Down" has been on the chart for 16 weeks (it was previously at #5), so its aggregate audience is much larger than 36.9 million.

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Streaming royalties might seem low, but that's because a streaming audience isn't all that big. To put a one-week audience of 36.9 million into perspective, consider that Aldean's entire album set a Spotify record for first-week streams by a country album with "more than 3 million," according to the AP. Put another way, a single song's radio audience was more than 12 times greater than the full album's Spotify audience.

2. A Reminder About Piracy. A debate about streaming royalties shows how much the music business has evolved in the last decade. Not long ago, many people inside and outside the industry believed file sharing was a mortal threat to legal digital music. Even teen buyers of Christian music were pirating music. The notion that free music should drive other revenue streams was mainstream. Ek's blog post reminded people that Spotify was created to offer consumers a better alternative to piracy while paying creators and right holders.

People have mostly stopped worrying about piracy. Today there are many legal alternatives to piracy -- YouTube, ad-supported webcasters like Pandora (in a few countries), SoundCloud -- that either didn't exist or were far less popular back when Spotify launched in 2008. The industry has come a long way in encouraging and licensing these services. There's plenty of evidence that illegal file sharing is down around the world. Although lawsuits, court decisions and political efforts have played roles in reducing piracy, services like Spotify deserve credit as well.

3. Defense of the freemium model. "Why link free and paid?" Ek asked. "Because the hardest thing about selling a music subscription is that most of our competition comes from the tons of free music available just about everywhere." In order to launch, Spotify convinced labels that a two-tiered service -- free and paid listening -- was an effective way to fight piracy and generate revenue. Given the number of places people can listen to free music, this is a reasonable approach for a subscription service. After all, as Ek wrote, "the vast majority of music listening is unpaid."

But does the freemium model work? According to Ek, Spotify now has 12.5 million subscribers, the majority of subscribers are under the age of 27, and more than 80 percent of subscribers started out as free users. So, judging by number of subscribers, the demographic of subscribers and the conversion rate, Spotify can argue it has effectively utilized its freemium model to create more value for rights holders. Ek could have bolstered his case by pointing to the United Kingdom, where Spotify grew subscription revenue 42 percent in 2013 (and the division eked out a small profit). A gain in subscription revenue of that magnitude is highly suggestive of strong conversion of free to paid listenership.

Ek's missive lacked some things, however.

1. What About this Transparency Thing? In one regard, Ek's post was like a campaign speech: He brought up the topic of transparency, but left out the details. "The more we grow, the more we’ll pay you," he wrote. "We’re going to be transparent about it all the way through." The creative community would be right to ask exactly how Spotify will be transparent. The company already offers a website, Spotify for Artists, that walks people through its business model and royalties. And it has an artist relations team to help answer questions. So what else can it do?

There are serious impediments to transparency, however. Due to non-disclosure agreements, Spotify is limited in what it can reveal about its licensing terms. What about digital breakage? Major labels are widely believed to receive minimum payments based on market share. Spotify hasn't revealed how licensing terms differ between small and big labels. Exactly what percent of revenue does the company pay to rights owners? It says "around 70 percent" but doesn't offer the exact amount, or explain if the amount can vary from year to year, or market to market. In addition, artists and songwriters' visibility into royalties also depends on the transparency provided by their record label or music publisher -- the parties that actually pay the creators.

2. The Notion of Fairness. The size of royalties isn't the only complaint coming from the creative community. Another complaint is related to Spotify's freemium business model. Some people are unhappy about accepting smaller royalties for ad-supported streams in hopes that Spotify can turn these free users into paying customers. It's an old argument, and one that has frequently been used against Pandora. People have for years felt streaming services paid too little to creators while building multi-billion-dollar businesses with their art. The company strives for a payoff -- an acquisition or an IPO -- that will benefit investors but not creators. To some people, it's an unfair system.

Ek kind of addressed this point briefly. "The more we grow, the more we'll pay you," he wrote. What he likely meant was Spotify payouts will increase as it gains subscribers, not that per-stream royalties will change as the company grows. But Ek argued that Spotify's interests are aligned with creators' interests. Unlike some of its peers, Spotify is a pure-play music service, meaning it doesn't use music to drive sales of books, smartphones, groceries or software. Thus, Spotify succeeds only if it can create greater value for rights holders and creators. Still, Spotify should address the sense of unfairness held by some creators.