As I mentioned last week, Spotify has paid all the royalty rights to broadcast songs to its listeners. So if the service is free and Spotify has to pay to stream songs, then how does it operate?

The free Spotify service takes advantage of advertising to cover some of its costs. Every now and then the music is interrupted for a radio ad. Some ads also pop up on the Spotify interface while the music is playing. As far as I can tell, there is no way to minimize or close these ads before their allotted screen time is over. In this way, the advertising is less like the banners you see on websites and more like TV commercials where you have to wait the five minutes to get back to the show.

Spotify also offers a premium service. For $4.99 a month users can access the service ad free, and for $9.99 a month they can use Spotify on a mobile device. As smartphones are becoming more and more popular, this option will probably appeal to more consumers. Those who want to have all the latest music at the gym, in the car, and other places iPods are commonly seen, may switch over to using a cell phone and Spotify.

So these two ways are partly how Spotify hopes to make a profit, but what about the artists?

Spotify is legal because it has contracts with the record companies. The record companies in turn have contracts with their artists. Since record labels are private companies it’s not possible to determine how much money individual artists will make from Spotify. Information is Beautiful has an interesting chart comparing what artists make versus the record companies.

So will Spotify increase or decrease album sales? Some argue that Spotify will decrease album sales because no one will buy music they can get for free. MusicOMH blogger writes, “Ownership of music will become meaningless and people will no longer feel the need to possess something which is available free on tap to their laptop or mobile.” But others, like Kenneth Parks, Spotify’s chief content officer, believes Spotify may increase music sales. He says “There’s no evidence of our service cannibalizing music sales. On the contrary, there’s evidence that we’re generating new revenue from a demographic that hasn’t purchased a lot and are now reengaged.”

So what is the answer? Probably both. Some might buy more, some might buy less. In my point of view, Spotify should only increase music consumption, rather than eliminate it. Let’s look at an example. As of September 2011, 10 million copies of Adele’s 21 Album had been sold. If those were all purchased at an average price of $9.99 on amazon.com, then that would be a profit of $99,900,000. Now let’s say each of those people who bought the CD listens to it only once on Spotify. And let’s say Spotify only pays royalty rates of one cent per listen. Just that one album alone has already made an additional $1,100,000.

It remains to be seen how artists and record labels will benefit from Spotify, but it’s hard to argue against a service that generates revenue for the music industry. Whether it’s listening to an album at a friend’s house, checking out a CD from the library, or looking up a song on the internet, music sharing is here to stay.

Posted on November 22, 2011
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