Spotify is a Certified Pandora-Killer
Since the advent of the modern Internet nearly two decades ago, music has been an integral facet of the web, as it is estimated that surfers downloaded nearly 240 million songs per day in 2011. Of this downloading activity, roughly 95 percent is considered to be illegal, obtained through torrent sites like the Pirate Bay or YouTube-to-MP3 converters. For the remaining fraction, Apple’s (NASDAQ: AAPL) ITunes accounts for 9 out of every 10 legal purchases. Considering that this service alone generated $6.3 billion in sales last year, we can begin to understand the sheer size of this virtual market for music.
To read more about black market economics, check this out.
Now, the fact that the majority of listeners prefer not to pay for songs is obviously problematic, though streaming services like Pandora (NYSE: P), Rhapsody, Last.fm – which is owned by CBS Corp (NYSE: CBS) – and the privately-traded Spotify have begun to rectify the piracy issue. See, these sites allow users to listen to their favorite tunes for free, while using advertising to pay performance and publishing royalties to deserving artists. For those not well versed in music industry lingo, the latter is paid to songwriters while performance royalties go to the actual musicians.
In Pandora’s case, subscribers are able to choose a radio station based on their favorite band, song, or genre, and voila: instant tunage. Aside from making a slight profit on ads, this particular radio service makes its money by offering an ad-free ‘premium subscription’. In Pandora’s most recent earnings report, the company reported having over 50 million active users. It’s estimated that just between 1 and 2 percent of subscribers pay $36.00 a year to avoid ads, which is responsible for one-tenth of overall profits ($18.4 million).
The privately owned, Sweden-based Spotify is a newer company that provides a slightly different service. Users are allowed to browse its database of over 15 million songs for free, provided that they sit through an ad every five or so songs. For $4.99 a month, these annoyances can be avoided and for $9.99 a month, playlists can be taken offline for use on a mobile phone. It seems that this model has worked far better than Pandora’s, likely because Spotify-ers can actually choose the exact tracks they want to listen to, while still having the option of a radio service at their disposal.
Earlier this year, Spotify brass announced they had reached 3 million paying subscribers, accounting for nearly 15 percent of its overall user base. Interestingly, this gives Spotify the most pay-to-listen users in the streaming radio market. Doing a bit of basic arithmetic, we can estimate that the company should make north of $300 million by the end of 2012, assuming that it’s paid subscriber breakdown stays constant. Currently, the majority (85%) of paying listeners shell out $9.99 a month to take their music mobile. Its important to note that this $300 million figure is just from subscription services; it is estimated that the company will make an additional $600 million in advertising revenue by year’s end. These figures trump Pandora, which reported $274 million in total revenues in 2011. Last.fm’s top line, meanwhile, is estimated to be around one-twentieth of Pandora’s total. CBS’s service offers a slightly different pricing structure, only offering ad-less radio for $36 a year with no free alternative.
Another thing that makes Spotify so intriguing from a monetization perspective is its bevy of entertaining apps that encourage users to do everything from discovering new music to singing along with karaoke-like lyrics. Though it currently does not charge for this service, its marketing dollars are seeing a boon from big-name brands like Intel and McDonald’s, which are developing their own ‘playlist apps.’ Going forward, it would not be unexpected if Spotify began charging fees to marketers who run apps on its platform. Moreover, a login partnership with Facebook (NASDAQ: FB), which requires listeners to set up an account through Facebook Connect, will be advantageous for the site’s growth. Currently, most user actions on Spotify are automatically shared through the social media giant, which is something that Pandora or Last.fm cannot claim. Additionally, this may have a positive effect on Facebook’s bottom line, which can be read about here.
Looking toward the future, ardent investors are hoping that Spotify will take the IPO plunge and go public. Despite a $4 billion valuation, CEO Daniel Ek has stated that going public is not in the company’s immediate plans, meaning 2014 is likely the earliest you can get your hands on some stock. Here’s hoping that Ek and Co. choose something exciting like SPOT, which is surprisingly still available as a ticker symbol. One thing that seems certain, however, is that Spotify will continue to monetize a far greater percentage of its users than Pandora, while closing the gap in the size of its overall user base. After all, there’s usually only room for one streaming music service in peoples’ lives. By the start of the next decade, we may be looking back at Spotify as the company that killed Pandora.
Disclosure: The author has no holdings in the stocks mentioned in this article and has no plans to initiate any positions within the next 72 hours. He does, however, have the intention of rating these stocks on WealthLift.com, a social media website where investment ideas are shared openly and free.