Converting free users to paid is key to future

After a banner year, expect music streaming service Spotify to continue being the most alluring and uncertain X-factor in the digital music arena.

Since landing on U.S. shores in 2011, the cultural impact of Spotify has been enormous. Yet assessing the music streaming service’s actual practical and financial impact has proven a far stickier matter.

While the Swedish company’s carefully selective disclosure of sums and figures make it difficult to get a full picture of its business, the data released in recent months presents cause for optimism.

At a press conference last month, Spotify founder Daniel Ek revealed that the service had dispensed $500 million in royalties to rights holders in its four-year existence, with a full half of that coming in the last nine months. It’s a substantial sum, to be sure, though artist complaints over low payment are legion.

All told, the service reaches 20 million users in 17 countries, with a quarter of those paying subscribers. A further $100 million in investment came in several months ago — with frequent marketing partner Coca-Cola becoming a minority investor bumping up the company’s estimated valuation to $3 billion.

What those numbers don’t tell, however, is exactly how Spotify is being consumed, and where developers and potential partners might find room to benefit.

The biggest questions, as always, center around the ratio of free to paying users. Over the past year, Spotify has made itself available on Roku, Sonos, Samsung TVs, TiVo, Marantz, Denon, Kindle Fire and RIM devices, repping a vastly widening sphere of compatibility. However, these devices can only be used with Spotify by the five million who pay for premium service, meaning that the company’s ability to convert free users to paying ones (the essential gamble upon which its future profitability lies) will be key for its hardware and mobile partners as well.

Yet there’s plenty of potential within the service for app-makers, and Spotify has been particularly active in opening up its API, with even more apps such as album review aggregators and a Songkick database of upcoming concerts scheduled to bow early this year.

Further investment in radio functions were well-received enough to put a dent in Pandora’s stock price, and last fall, the service even attempted to “break” its first band, releasing new music from Swedish DJ duo Cazzette. Should it continue this experiment, it could provide an interesting option for unsigned bands.

Going into the new year, expect further investment in the service’s social functions, with the site having unveiled a “Follow” function designed to let users track playlists from friends and artists — a key element of Spotify’s strategy.

“We’ve found that the more social our users are — i.e., they’re sharing music — the faster they grow their own music library,” Ek said last year. “The faster they grow their music library, the faster they become paying customers.”

Perhaps promisingly for Spotify, the market for MP3 players shrunk even more in 2012, with iPod sales dropping from 7.7 million units in the first quarter to 5.3 million in the third, and the continued ubiquity of smartphones further primes the pump for greater streaming adoption. Tellingly, Spotify has ceased selling music downloads completely in the new year.

Beyond that, for a company whose founder sites “growth” as “priority one, two, three, four and five” the potential for international expansion is always a factor, with Canada and Brazil (the latter a gold mine of recent digital music expansion) looking particularly ripe for the picking.

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