Spotify Bleeding From Licensing Costs

empty pockets

Spotify has just published its financial results for 2009, and the European streaming music service is bleeding fast. Spotify may have users “by the balls” (in the words of original Napster founder and Spotify investor Sean Parker), but content owners have Spotify in an even tighter grip.

According to the financial statements for U.K.parent organisation Spotify Limited, published on Music Ally this morning, the company booked 11.32 million pounds in revenue during the year. About 60% of that money comes from its 250,000 paying subscribers. The rest comes from advertisements that Spotify shows to the vast majority of its 7 million users who use the free Web-only version of the service.

But the company’s cost of goods was a whopping 18.82 million pounds, mostly from licensing fees for content. Add in administrative costs, and the company lost 16.66 million pounds for the year. 

The loss shows a big problem with the freemium model for subscription music services, which Rhapsody President Jon Irwin explained to me in an interview earlier this month.

Here’s the simplified version: when rights holders calculate royalty payments, they use one rate for ad-supported services and another higher rate for subscription services. But there’s no hybrid rate–as soon as you set up a subscription service, you’re paying the higher rate on all the content you stream, whether it’s free or fee. So Spotify is presumably paying the higher subscription-level rates for all 7 million customers, but only receiving payments from 250,000 of them. 

That’s not a sustainable business model.

It gets worse. Operating expenses for Spotify probably went way up in 2010, according to Music Ally: the company said it has paid 40 million Euro to rights holders since its inception in 2007, with 30 million of that payment coming in the first eight months of 2010.

The only way Spotify can turn the corner is to convert far more free users into paying users. The company’s been riding a nice hype cycle more than a year now, as music fans and the tech press wait for the well-reviewed service to launch in the U.S. But the subscription music service got incredibly crowded this year with entrants like Thumbplay, MOG, and Rdio. Spotify may have waited too long.

An acquisition is also a possibility, but Apple doesn’t have any great reason to make the purchase, and the rumour mill suggests that if Google’s going to buy any music subscription service to kickstart its music efforts, it’s going to be Rhapsody.

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.