Plenty of proof that ads don't support Web music

Three years ago this month, the Financial Times and The New York Times chronicled the emergence of an untried but promising new digital-music service: SpiralFrog.

Some of the hurdles that contributed to SpiralFrog's spiral out of the sector are the same confronting former rivals.

The start-up would offer music free of charge to consumers and attempt to hand the bill to advertisers. Since then, we've seen a dozen companies make names for themselves by offering their own twist on the ad-supported music model, including MySpace Music, Imeem, and Pandora. But regardless of how anyone has tweaked it, not a single service in the still-nascent sector has proven that it knows how to offer consumers a compelling free-music service while providing advertisers an effective way to deliver their messages.

Music fans generally refuse to pay to listen online and resent on-site advertising. The hard truth is that to this point, ad-supported music as a standalone business has failed.

Ruckus and SpiralFrog have closed their doors. Imeem faced a financial crisis earlier this year, until receiving new funding from investors and price concessions from the music labels. A year after Qtrax obtained licenses from all four of the top recording companies, the company appears to be struggling to pay its bills and has yet to launch.

In May, CNET News reported that MySpace Music's performance has underperformed. Several music sites have overhauled their business models (Lala) or are trying to do so (iLike).

Pandora's popular iPhone app, meanwhile, has helped spur user growth, but the company has also opted out of ad-supported music for the site's heaviest users. The company said last month that those tuning in for more than 40 hours a month must pay 99 cents to continue listening.

And if you're waiting for the Swedes, in the form of white-hot music service Spotify, to come charging over the hill to show us how to make the model work, you needn't bother. Three industry sources told CNET News last week that the service--expected to debut in the United States next year--is struggling to convert users into paying customers. Just like others on this side of the Atlantic, Spotify hasn't figured out how to make money.

CNET News has recently completed a two-month examination of SpiralFrog, the now-defunct download service that was among the pioneers of the ad-supported model. The review provides an unprecedented view of the many challenges facing companies in this sector. SpiralFrog's tale sheds light on the kind of rates advertisers are willing to pay and the licensing fees the top music labels charge. None of it is very promising.

There's no doubt now that the much-hyped SpiralFrog was never among the front-runners. The service offered music from only two of the four top recording companies. Users couldn't download SpiralFrog's tunes to their iPods. And documents show that the start-up spent millions of dollars on marketing but never attracted a loyal following of significant size.

There may be a temptation to dismiss SpiralFrog's problems as unique to the company. That would be a mistake. There's no question that some of the same factors that stymied SpiralFrog are bearing down on many of the company's former rivals. "This version of ad-supported model is certainly on life support," said Mike McGuire, an analyst at research firm Gartner. "I think we can say this round didn't quite work."

Migration to downloads
One sign that some players in digital music are losing faith in the ad-supported model is the rise in companies looking to sell downloads, according to one music industry executive. "That's become the fallback position," the source said.

A copy of a $1.8 million bounced check written by Qtrax to Oracle, which filed a breach of contract and copyright lawsuit last month against the yet-to-be-launched music service.

(Credit: Screenshot by Greg Sandoval/CNET)

All four of the major music labels declined to comment for this story.

Imeem, which has mostly focused on streaming ad-supported music to users' PCs, has recently begun testing a download store. Music industry sources told CNET News last month that iLike, which powers Facebook's most popular music service, was in talks with the major record companies over licensing downloads.

For two years, Imeem has posted links to Apple's iTunes and Amazon.com's MP3 service on its site to enable visitors a means to buy songs. MySpace Music, YouTube, Pandora, and Spotify do the same. But Imeem is testing how effectively it can sell a limited number of tracks from Warner Music Group and several independent labels directly to consumers.

Selling downloads directly, rather than linking to another retailer, is more lucrative. A music site that sells downloads can make 30 cents from direct sales rather than the 5 cents that the so-called affiliate partners pay, according to an industry source. The trick for any upstart download store is to convince customers of Apple's iTunes and Amazon's MP3 service--by far the leading download stores--to try a new outlet.

Nonetheless, the behemoth record labels are willing to work to help ad-supported sites survive. Imeem is the poster child for how the labels have changed their approach to these services. Founded in 2004, Imeem came very close to running out of money until it found new funding and also negotiated better licensing deals with the labels earlier this year. Some of Imeem's rivals asked and received similar concessions, industry sources said.

That hasn't stopped the complaining, however. The people who run digital-music stores continue to quietly argue that licensing fees charged by big record companies are still too high for stores to eke out a profit. Music industry insiders say it's not their fault that the start-ups have failed to win over advertisers. What are they supposed to do--give their content away? That won't happen, executives say.

Overpaying for music
CNET News' review of SpiralFrog showed that in 2006, SpiralFrog agreed to pay $3.2 million to Universal Music Group, the largest of the top four recording companies, in up-front fees. Documents indicate that in 2008, SpiralFrog set aside $3.5 million to license music from EMI, the smallest of the major labels. That deal triggered a "most favored nation" clause in Universal's contract, and SpiralFrog ended up paying an additional $1 million to Universal.

From a SpiralFrog June 2008 expenditure list. Note: SpiralFrog had no licenses with Warner or Sony. Figures represent amounts the start-up expected labels to charge.

Although SpiralFrog managers never secured deals with Sony Music Entertainment or Warner Music Group, the music service budgeted $5 million and $3.3 million, respectively, to acquire licenses from those services, records show. Those figures were all minimums. Under the agreements reached with Universal and EMI, had SpiralFrog made revenue above those minimums, the company would have been required to split that revenue 50-50 with the labels.

By the time SpiralFrog compensated the labels and music publishers, the company's managers figured that 66 percent of their revenue went to the music industry, records show. SpiralFrog's deal with the major labels was different from those negotiated by most music-streaming Web services, which pay penny-per-play rates. Their agreements are to pay a cent, or some fraction of a cent, each time a song is played.

It appears that it made little difference whether the record companies got their money before or after a sale. The rates they charged forced ad-supported companies to generate big ad revenue in order to cover costs.

SpiralFrog, for its part, never came close to covering costs, documents show. The start-up lost more than $26 million in 2008.

Advertisers are simply unwilling to pay the music sites a premium rate. In order to charge advertisers $10 for 1,000 impressions, ad-supported sites must operate their own sales teams, which is expensive. In SpiralFrog's case, the company's salespeople were successful at signing a few marquee advertisers, including McDonald's and Microsoft, but much too often, the company found itself selling excess ad inventory through remnant ad networks, which typically pay 50 cents or less for 1,000 impressions.

Advertisers aren't willing to give the ad-supported sites top dollar because they know that people aren't necessarily staring at a computer while listening to songs online. Instead, they tend to check e-mail or Facebook, do homework, eat dinner, or browse the Web in other browser tabs. In contrast with radio, Web listeners have become accustomed to music without audible ads embedded into the streams--and they don't want those ads, according to Gartner's McGuire.

Another gripe that advertisers have is that many ad-supported sites don't reach big enough audiences. Mel Schrieberg, SpiralFrog's former CEO, said SpiralFrog couldn't get in the "tier 1" advertising door with fewer than 5 million users. To generate this kind of traffic, SpiralFrog spent $11 million in 2008 on search engine and affiliate marketing, which gobbled up the little revenue the company was able to generate.

But Susan Kevorkian, a digital-music and mobile-entertainment analyst at IDC, points out that a large audience doesn't mean instant success. Although MySpace Music has access to the social network's shrinking but still large audience, she said the service still "hasn't performed to industry expectations."

Is there any hope?
One bright spot is that some investors are sticking with the sector.

In addition to Imeem, Spotify and Pandora found new funding. Investors including British venture capital firm Wellington Partners were part of a $50 million round of financing for Spotify, according to the Financial Times. And Pandora last month announced that it had raised $35 million of additional funding.

Ali Partovi, iLike's CEO, argues that the ad-supported model works for music, but not when you're giving songs away.

"We've built a self-sustaining ad-supported business--positive cash flow over the past eight-month period," Partovi said. "That's with only one full-time ad salesperson. What's our secret? It's simple: we're not trying to help consumers get unlimited music without paying for it. Instead, we're focused on music discovery. We deliver all the other things that music consumers love without risking a lawsuit or paying high royalties."

That may be true, but iLike is among the companies discussing downloads with the music labels.

Click the image above to read the lead story of our series on SpiralFrog. Stories on SpiralFrog's internal strife and customers' private information will appear Tuesday.

Matt Graves, Imeem's spokesman, said his company is trying to be innovative and not solely rely on traditional online advertising, such as on banners and display ads. The company is trying to mix things up with in-stream audio ads and custom-tailored campaigns. The music service recently promoted a download giveaway from Wal-Mart Stores and offered users a chance to remix songs from artists such as rapper Flo Rida.

"If it's all about displays, then users will get ad-blind," Graves said. "We're enabling advertisers to do a deep integration."

IDC's Kevorkian agrees that until now, ad-supported music has failed, but she sees some possibilities.

"This model has some flaws that need to be addressed before it works as a standalone model," Kevorkian said. "That said, there's a possibility that it could be deployed in conjunction with a hybrid paid model to help generate revenue so that the music provider isn't solely dependent on ads."

[tektaktyks]

i do use pandora app,not that much but i do,and if i gotta pay 99 cents i will,i dont c a problem with that

[gailsedotes]

what part of RADIO do they not get...

[contentcreator--2008]

The reason radio doesn't pay to play is the presumption that they are helping sell albums. Since that doesn't happen very much any more, look for radio to lose its "get out of jail free" card.

[monkeyfun14]

@contentcreator

Actually radio stations pay to license the songs.

[Random_Walk]

"contentcreator" is grossly incorrect (as usual): Radio is primarily supported by advertising. They have to pay ASCAP fees, just like any other streaming music entity (and pay substantially more for them than Internet Radio entities). Currently, radio stations are complaining about a massive increase in those fees.

For a list of current fees, see this: http://www.ascap.com/licensing/radio/radiofaq.html

The promotional money and such that he points at is a remnant of the old Payola scheme, and by law cannot be applied towards operating expenses or licensing fees. It also does not mean free license to play music (see the ASCAP fee schedule for an inkling as to why, since most stations pay blanket fees).

[Boter46]

Internet radio has to pay at least twice as much as regular broadcast radio. Meanwhile, on the Internet, people don't want to listen to a three minute long commercial break. Something's off here.

[Random_Walk]

"Internet radio has to pay at least twice as much as regular broadcast radio."

In absolute dollars or as a percentage?

If you're a broadcast radio station, and you make an income over $150k per year gross (which even small commercial radio stations would have to do just to pay the power/FCC/employee bills and wages), you get to cough up ~1.67% of your gross income towards ASCAP fees. That comes out to something just north of $2500/year at an absolute minimum for the ASCAP fees. If you're a middling station in a large city raking in $1.5m per annum (again, gross, not net or profit), that jumps up accordingly to $25k per year in ASCAP fees.

Most Internet radio stations are operating at way lower incomes at best. Consider the cost of a server and some bandwidth for a streaming station online (w/ most of the software costing as low as $0.00), as opposed to the costs of a small 50k watt station - a radio tower, the proper (and approved) equipment, an engineer (properly licensed) to care for feed the gear, leasing fees, zoning considerations, FCC licensing fees, the large power bill, and etc.

[Timtropolis]

Yet another reason why downloading music should be FREEEEEEEEE. I hope all these businesses flounder and die.

[contentcreator--2008]

It should be free because you want it to be, huh? Great reasoning skills.

[Random_Walk]

I can walk down many streets here in PDX and hear music for free (and often --to be honest-- better music than the local ClearChannel affiliate blares out).

[oldguytoo]

Illegally downloading music is a crime.
Do you work for free? Come to my house - I have some yardwork for you to do.

[Renegade Knight]

@contentcreator--2008

It's how the free market works. Buyers say it's worthless, sellers say it's gold plated. When they come to an agreement a sale happens.

[BCF1968]

re:Timtropolis

yes yes everything for free. Why pay for anything? Maybe the company you work for should provide thier products/services for free. Oh wait then they couldn't pay YOU. See how that works? Suspect you live with mom and dad or you are on welfare. Has to be one of the two. No way a person that actually has a job and pays his bills wouldn't understand the concept that there is no such thing as a free lunch.

[BCF1968]

"@contentcreator--2008

It's how the free market works. Buyers say it's worthless, sellers say it's gold plated. When they come to an agreement a sale happens. "

Well then concertrator is it worthless then how come these "buyers" are downloading the music illegally then? I mean if it's worthles then it's not worth having? The fact they want it means it has SOME value. It's up to the SELLER to determine that value. The BUYER has two choices; PAY up or don't possess the item, not "I'll take it for free because I think the price is too high"

[gsekse]

"pandora" how about Pandora's box? The ability to copy was how the music industry started. It has come full circle and now it is going to die the same way. Musician's will still make a living BUT they probably will join the rest of us working slobs who have to work everyday and NOT be multi-millionaires. Only those few that jump on the Disney machine will get rich from it, and they better save well because they will be replaced as soon as they need a new teen idol. The market will "pay" what it want to... or has to, to obtain whatever. Some of us have grown so tired of the present music on the market, that we prefer to listen to what we already have. Hey, you have one boy band album... you have them all. Now that families are short of money, the teenage spenders have been cut down quite a bit.

Long live the rebellion!

[contentcreator--2008]

"Because a few people make a lot of money" is a completely unacceptable justification for saying "they've got too much so I won't pay". They get a lot because MANY MANY people like what they do. And it is a horrible mistake to think that because a few people make a lot, all the 99.99% rest do too, when the vast majority of people are just scraping by, and thievery is sending them to the unemployment line. It's like saying Tiger Woods makes too much, so let's cut the purse by a factor of 100 --- sending all the rest of the tour players down to the poverty line.

[tm_anon]

@contentcreator--2008

I've discovered more than 2 dozen artists I'd never have known about through free music online or through friends sending me mp3s. I haven't paid for any of it but now I know they exist.

I've gone into music stores and haven't seen any of those artists on the shelves. If I had, I'd own their music. I've bought a few CDs simply because I liked the sound (wouldn't have heard it if I had to buy it first).

It seems to me that the artists who end up in the unemployment line weren't put there by people sharing their sound. They were put there by the music industry not knowing what sounds are good ones and by poor advertising of their shows.

If they sound good, they benefit from more people knowing about it. It's as simple as that.

[Random_Walk]

"I've discovered more than 2 dozen artists I'd never have known about through free music online or through friends sending me mp3s."

I'd like to add that as an old fart, I did the same thing years ago - with friends and cassette tapes that were copied while we all hung around and BS'ed.

Even more... my own father did the same thing with his friends and reel-to-reel tapes back in the late '60s and early '70s (many of which I still have in my possession; some of them would be worth a mint, since they contain live recordings made in certain San Francisco clubs in the late 1960's).

Nowadays, the best way to hear good music is to go to a ton of local clubs in and around PDX (You Seattle residents may have your own preferences, but we both know where folks like Nirvana really came from). Anyrate, I would much rather lay my money down for a homemade band CD at a local club, and often hear the band itself request that I give copies to my friends and let 'em know where the next gig is.

THOSE bands deserve support - above and beyond the $15/CD pricetag. When you can see them literally sweat their ***** off in person, and you know the dough goes to them directly? Then for the love of all that is holy, give 'em their due.

The one-hit manufactured megastar mall-rat bands? I wouldn't be caught dead copying their music - not because the RIAA says no, but because -- quite frankly -- they suck.

[clumpkin]

I'm surprised to hear that listeners aren't willing to pay. I thoroughly enjoy Pandora and am willing to hear in stream ads (within reason) and pay a nominal monthly fee if I'm listening excessively. I have discovered groups I love I would never have heard of if it wasn't for Pandora.

[cvaldes1831]

While I'm not surprised to hear about the occasional person who doesn't mind ads, I'm always stunned when I hear such people bewildered that others might not like ads.

[tm_anon]

@cvaldes1831

I've been racking my brain trying to think of a single streaming site that's tried ads. The only one I can think of had loud ads supporting their own streaming site in the middle of white noise.

I'd play it at night while in college in order to drown out the other students on my hall who tended to be rather loud and I needed a way to sleep. Those ads were worse than the other students on my hall so I stopped listening.

Ads aren't a bad idea, poorly implemented ads however.....

[elfstr0m]

In Sweden, Spotify already surpasses iTunes in revenue for the record labels:

"Spotify has since it was launched has reached one million users in Sweden. Both Universal's president Per Sundin and Sony digital boss Mark Dennis confirmed that they earn more on Spotify than they do on Itunes in Sweden."

Qote from an article in today's "Dagens Nyheter"...
http://translate.google.se/translate?js=y&prev=_t&hl=sv&ie=UTF-8&u=http%3A%2F%2Fwww.dn.se%2Fekonomi%2Fdigital-musik-ger-branschen-framtidshopp-1.927769&sl=sv&tl=en&history_state0=&swap=1

[sandonet]

This doesn't mean that Spotify is making money. All signs indicate that it is not.

[sandonet]

One other thing: Sweden's top music site is nice, but one must remember that Los Angeles has a population that is equal to or larger than Sweden's. Spotify has a long way to go before it becomes an iTunes challenger.

[knowles2]

I will stay through it growing very fast in the UK an it starting to attract university students, I know that every student in my dorm a few months ago switch to spotify.
It also signing deals with mobile phone operators.

If I was a betting man, and I am I would probably lay a few quid on them become surviving, they seem well run company, far better than spiralfog.

[birasingh]

This whole debate is wrong. People need to re-think the way we listen to music. People listen to music for various reasons, makes them feel better, dancing, musics puts them in a different mood....etc. Can we all try to envision a world where theirs just too much music. The same way there is too much content online for a person to sift through and make sense of. That's where search engines came in to play. Maybe some needs to build a search engine for music, which is so advanced that it just don't find song track, it creates music for the searcher. Taking music beats, rhythm, parts of songs and CREATES music depending on the search criteria. So consumers of the content "pay" for the creation of music on demand. I know this sounds a little star trek. People we need re-think why we listen to music and move away from linear/simplistic logic about how do we get society to pay for music arguments.

Beam me up Scotty

[Boter46]

Wow, so we don't need artists at all for music? How novel!

The closest thing that there is is Pandora, which searches already-created music and spits out stuff that you'll like.

[BtmnHatesRbn]

Okay, when I worked at a TV station, we obtained a BMI and ASCAP license for use of any music we'd like. We were allowed to use anything, even we downloaded for free from LimeWire or other shady websites. When I admitted to BMI and ASCAP that I was obtained the music that way, they said it doesn't matter because our monthly license payment to them covered the use of the song financially.

And that's what most radio stations do.

[pw1y]

So you used cheap mp3's in your tv programming? How super lame and short sighted. But then again if you're in tv that's the status quo

[knowles2]

Yeah because 90% of people will not be able to tell the difference.
And I bet BMI and ASCAP was happy with them downloading of limewire, it probably save them money distributing the songs themselves.

[Random_Walk]

Agreed with knowles. Think about this - you're converting a sound wave into something that is limited at best (frequency modulation if you're lucky), over a thinly-sliced carrier wave. This transmission medium is not exactly an audiophile's dream...

...trust me - a 128kpbs .mp3 file is going to sound better coming out of a cheap computer (or PMP) sound jack, than you would get with top-end equipment pushing everything over an FM (or worse, AM) signal to even a typical PLL - tuned radio.

[Renegade Knight]

Seems pretty simple. If they can't support online music via adds at the current cost of music they need to pay less for the music.

Conversly if the music companies want to increase profit they will need to charge less for the music. If they charge enough to where non online music company is viable. Nobody wins.

[sodapop2k9]

I work in marketing for a company that sells software to a very narrow channel... We have to carefully select where we advertise. On these music sites, FB, MyS etc the ads are all over the place in regards to industry. Many don't even sell a service or product. The key demographic for music sales is teens to 30s. Kids in their teens and early 20s don't have significant disposable incomes to support advertising. ...Nor is the advertising targeted at their age demographic. In order for advertising to support music sales, the ads should support music ie ticket sales, clothing, merchandising, teen health products etc.

While sites may offer up ads related to the age in the profile, advertisers need to be aware that many people misrepresent their actual age while online.

[tm_anon]

Rather than simply targeting to a single demographic on these sites, why not let the music decide what mood the person is in?

For example, right now I'm listening to Celtic music being streamed from last.fm. It's put me in the mood for something Irish, perhaps Guiness, maybe an Irish restaurant (can be targeted depending on location, given by my internet connection). Travel sites would be welcome advertisement and even a silent advertisement for Irish Spring with a beautiful green background.

It takes a bit more thought to advertise this way but you end up getting a lot more in return.

[Zer0Wolf]

It's surprising how you haven't covered Slacker. I have always listened to it as compared to Pandora and am curious to know how it fares with audible ads.
Yes, it has audible ads too and I don't mind listening to it once in a while for listening to music for free.

[Boter46]

You know why it's so difficult? It's because record companies can't stand to not make every single cent they can. Pandora was doing well until earlier this year when they were forced to pay more than double per song what broadcast radio stations did.

Don't blame ad-supported music - it was working great. Blame the record companies who milk everyone they can for every red cent, and then wonder why people steal their music instead.

[pw1y]

Those red cents are theoretically going to fund the next great album.
Until people realize that you get what you pay for, seasoned producers, engineers, writers, arrangers, composers, instrumentalists don't come cheap. It's not a hobby. You have to invest in these professionals to get QUALITY recordings made. You want the record companies to not be "greedy"? Then get used to listening to sub-par recordings!

[knowles2]

Except Albums are an outdated concept that does not really fit a digital world.
Who want to buy a album where you only like half the tracks and that if you luck.

I have never and will never buy an Album.

[tm_anon]

@knowles2

Albums do have a place in music. However, what's being sold today as an album has nothing more than song numbers in relation to what albums used to be.

Just listen to Pink Floyds' Dark Side of the Moon or Another Brick in the Wall and you'll start to understand.

@pw1y

Those red cents aren't going towards the next great album, they're going towards making a ********* sound better than he actually does.

The best artists I've ever heard sound that way naturally. They play for the love of the music and would play for free and many have done so.

I've played Classical music in High School and College, Big Band in High School, Jazz in College, Sang in a Choir in College and even played a few songs in a cover band. I never charged because I loved playing.

I got paid a few times, would've played for free as the experience was worth it.

If you think the next great album is coming from the record companies then you have a very poor idea of what great music and what great musicians are like.

[vervelife]

I know there is a way that ads can support music, it's just not through the current model used by Pandora and other services. At VerveLife we use the brand platform and create digital music promotions for brands where consumers get rewarded with free downloads through a custom branded microsite. We believe consumers are hotwired to connect with music, and we connect music with brands. It takes more than a simple ad on the side of streaming site like Pandora, but digital promotions are the future of ad supported music. Check it out at www.vervelife.com

[Howie49]

hey vervelife, i met justin at a digital music conference in LA last year, red herring, i believe - he really knows his stuff. how come we don't hear more about vervelife? spiral frog, etc get all the press but their models don't work and they flame out. you guys have an awesome model. cheers

[vervelife]

Hey Howie! I'm glad you got to meet Justin. We have a lot of upcoming project launches so hopefully you'll hear more about us in the future. Thanks for the reply!

[jlasoul0]

you can listen listen to all the free music you want on demand at youtube. thats what kids do. that is the grotesque future of the music business