This Crucial Detail In Spotify's Business Model Could Kill Pandora

daniel ek spotify happy pleasedSpotify founder Daniel Ek.

Photo: Ellis Hamburger, Business Insider

Spotify cuts different, individual song royalty deals with each record label, the music-streaming company tells us, and gives nearly than 70 per cent of its revenues* back to those labels.Its business model is crucially different from Pandora’s—which I’ve long argued is flawed because Pandora’s is based on a fixed set of per-song royal agreements that expires in 2015.

Pandora thus has no flexibility over how much it pays per song. After 2015, royalties could go up—which could render Pandora permanently unprofitable. (It’s unprofitable now based on its current agreement.)

Spotify, by contrast, has struck individual agreements with 400 or so record labels, head of communications Graham James told us. That could give Spotify some flexibility in creating margins that Pandora doesn’t have.

How big those margins might be, however, is an open question. Pandora paid about 69 per cent of its revenues back to record labels in the form of royalties in Q1 2012. It’s arguably unprofitable because CEO Joe Kennedy hasn’t kept a lid on rising administrative and marketing costs. The main problem, however, is that Pandora generates a per-song cost automatically for every song it plays, and can only serve ads if it’s also serving songs. Costs and revenues thus move in lock-step, unless Pandora can raise its ad prices.

At Spotify, its individual agreements could—in theory—allow it to cap or lower royalty costs in a way that Pandora cannot.

Both companies are heavily dependent on advertising. Most of Pandora’s revenues come from ads; Spotify makes user subscriptions more of a priority.

Nonetheless, Spotify will roll out a major sponsorship with Coca-Cola this year, mostly after the Olympics, on TV and radio. James said. Spotify will be Coke’s dedicated music technology, and Coke will help Spotify launch in new territories. (Read more about the Coke-Spotify deal here.)

*Correction: James later said he was mistaken when he said Spotify paid “more than” 70 per cent.


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