How Record Labels Make Money from Spotify

Wondering why all the majors such as Universal, Sony, EMI, and Warner Music signed up so quickly with Spotifiy, given that “Spotify is free” and at first glance it seems that they’re giving away their music? It may be that free is the future of business, however if you run a record label consider too the following example:

Imagine your artist records a new song and you release it on iTunes. It’s instantly copied (actually, it’s probably copied many weeks before you put it on iTunes) and is available in the same or better audio quality for free via filesharing sites like the Pirate Bay. In an ideal world with no filesharing, you might have expected to sell 10,000 copies of the song at a dollar each. In this ideal world, you would earn $10,000 dollars. Nice! This is how things were for the record industry before the Internet.

Now, in today’s real world (where filesharing happens), you sell only 1,000 copies and 100,000 are “stolen” by the filesharers downloading the song for free using torrent websites. Of course this does not mean you’ve lost 99,000 sales: you just got an audience of 99,000 people who probably wouldn’t have bought the song anyway. Some of these music fans might even go and see your artist on tour, now that they’ve heard them. But regardless, you didn’t sell as many copies of the song as before the dirty old internet came along and made everything free. You still lost 9,000 sales. 9,000 x zero dollars = zero. For the 1,000 you did sell, you make $1,000.

Now let’s say your artist’s song is also on Spotify. Most former illegal filesharers will now just get it from Spotify instead, since it’s easier and quicker than using Pirate Bay torrent downloads. It’s so easy in fact (and legal) that some of your actual law-abiding loyal customers who would have bought the song will now use Spotify too. So your total sales go down even more: let’s say you sell only 500copies of the song. But – many of those 100,000 former thieving filesharers also now use Spotify instead to hear the song. Spotify keeps a record of every time a song is played, and when this happens, a teeny tiny amount is paid out by Spotify to the record label that owns the copyright for that song (this money comes for the advertising slots, premium subscribers, and the venture capital). Spotify doesn’t pay back much, but 100,000 x a little bit = a damn sight more than zero dollars.
One last thing to consider is the demographic of your customer base, and in particular their age and expected b(r)and loyalty. You can probably assume that younger people are more likely to be illegal filesharers that older ones, simply due to the small (but relevant) technical difficulty in installing a bittorrent client, going to the right website and understanding the concepts. This is fine for the computer semi-literate youth, but a bit more of a challenge for Generation X. Most older music fans are set in their ways and will carry on regardless buying the CDs and the new-fangled downloads from iTunes. The older audience has more disposable income (and perhaps a better appreciation for the value of the music), so if this is your target market then it may be that Spotify is not such a good idea, as it might eat into too much of your loyal customer-base who wouldn’t fileshare anyway. If, however, your label’s output is aimed at a younger market (say, below 35) then your music is more likely to be fileshared. In this case you have less to lose (and more to gain) by adding it to Spotify.

This is why all the majors have signed up to Spotify.

Of course, please note all these figures above are purely examples – I don’t work for Spotify and they’re very careful not to release this sort of information to the public.

Update 17 April 2009

A couple of interesting quotes from Daniek Ek in a recent mediaweek article:

 

Freemium: Theoretically, if you can make 10% of your users pay, you’re really good, and we’re striving to be really good. We’re counting on the vast majority of our users being ad-supported. But the combination of the ad-funded and subscription businesses will bring in a significant amount of money.

Revenue: Depending on how popular a certain tune is, the labels get a bigger share of the revenue than they do for artists who don’t get played. It’s an equal and just system. If you get played more, you get a bigger share. But the payout is based on what we make.

That last sentence is interesting: this may be what will stop Spotify going down the same plughole as Spiral Frog…

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