Business Matters: If Big Radio Had Pandora's Royalty Rate, It Would Owe Billions
Business Matters: If Big Radio Had Pandora's Royalty Rate, It Would Owe Billions

When music subscription service Deezer confirmed Monday it raised $130 million in a round led by Warner Music Group owner Access Industries, the subscription music market suddenly had two well-funded frontrunners putting their support behind a single business model.

It suddenly looks a bit like Coke vs. Pepsi: two leading companies putting out nearly identical products and going after shares of lucrative markets. Other competitors are being left to play supporting roles and find their niches.

Five-year-old Deezer has grown to 2 million subscribers and 7 million active monthly users, the company revealed on Monday. That's about half the 4 million subscribers and 15 million active monthly users as market-leading Spotify.

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A visible gap between competitors has been made more obvious by the $130 million funding. Ten-year-old Rhapsody has half as many subscribers as Deezer but lacks its growth ambitions. Rhapsody gets nearly all its subscribers from the U.S. and has some in the U.K. and Germany from its acquisition of Napster International in January.

Rumors that Rdio is currently in acquisition talks with Microsoft make more sense after Deezer's latest funding. Major investors such as Access Industries are betting subscription services can disrupt and grow the global digital music market. Now is no time to be without financial backing.

Deezer's new funding validates the Paris-based company's global strategy. While its main competitor, Spotify, first expanded through Western Europe and then targeted the United States, Deezer has expanded to every continent but has avoided the United States. The service is available in countries across South America, Asia, Eastern Europe and the Caribbean in addition to Western Europe.

Absent the costs required to enter the world's biggest music market, Deezer has been able to achieve some semblance of profitability. Deezer's press release claims the company has been profitable since 2010, although CEO Axel Dauchez told the Wall Street Journal the company "will return to profit in 2014" due to its current expansion strategy.

The $130 million round is also a validation of Deezer's freemium business model, the same business model used by Spotify. The service offers free, ad-supported streaming for PC listening and mobile access for paying customers.

Spotify has also been able to raise funding with a business model that has its fair share of critics. The company is reported to be near a closing a round of $400 million that values the company at $4 billion. Spotify raised $100 million at a $1 billion valuation in June 2011.

The freemium business model is often criticized as being unsustainable, however. Spotify has posted net losses of €28.4 million in 2010 and €45.4 million in 2011. The loss in 2011 coincides with the July 2011 launch in the United States, the expensive market Deezer has avoided thus far.

But Deezer may not avoid the U.S. for long. "We will come to the U.S. one day," Deezer's head of international Clement Cezart told last month.

Not only does Deezer now have the financial war chest to help it launch in the U.S., it has the benefit of having waited a few years for the marketplace to develop. An NPD survey in the second quarter of 2012 found awareness of Spotify in the U.S. has doubled to 19% from its launch in July 2011. Although American consumers still prefer to buy downloads, the U.S. market will warm to subscription services over time.

Deezer started with low hanging fruit by entering many markets with relatively few legal digital music options. Prying people away from iTunes won't be easy, but the payoff will be huge if Deezer can pry away revenue from the incumbent.

The U.S. digital music market had a trade value of $2.21 billion in 2011, according to the IFPI. With 10% annual growth the U.S. digital market will have a trade value of $2.67 billion in 2013 and $3.24 billion in 2015. Subscription services had just a 6% share of revenue in 2011. A 30% share of revenue in 2015 would be worth $972 million.

Deezer's ultimate goal, according to the press release issued Monday, is a 5% share of the global music market by 2016.

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