You'd be forgiven if you thought streaming music was the hottest business to be in right now.
At every turn in 2013, tech companies big and small were pouring into online music services. Longtime players like Spotify and Slacker launched new features or shook things up with updates. Giants like Apple and Google shoved their way to the front of the race with new services like iTunes Radio and All Access, ventures they believe will help sell phones and other products. Google can't seem to get enough, and is said to be rolling out another subscription service through YouTube next year, as others are poised to join it, like Beats' paid subscription-only service and French streamer Deezer's US entrance.
Not a bad turnout for a business where nearly no one makes money. Yes, despite the popularity of these services, online streaming has yet to yield any standalone players making a profit. But factors next year may align to produce one -- and it may just be the service the recorded music industry hates most.
Even if Pandora is the service squarely on the industry's bad side, profitability problems are endemic to the online streaming world. The headliners remain loss-making enterprises, sometimes fantastically loss-making. Smaller guys such as Rdio have cut positions in order to save money. Slacker is profitable, thanks to a combo of telecom and content partnerships as well as a delicate balance of free-versus-paid features. But Slacker remains small.
The reason behind the red ink? Royalties.
Music licensing is the top cost for all streaming services, and it's a big one. Pandora, the Internet's biggest radio service, pays out more than half its revenue in royalties, and Spotify, like all the services with direct deals with the music labels, returns 70 percent to rights holders.
That high price of licensing is a persistent challenge, said Tom Conrad, chief technology officer of Pandora.
"If you're building a service like Twitter or Facebook, you don't have those kinds of costs. You can take what would go to licensing and put it back into R&D," he said. "In music, you have to get to tremendous scale and be really, really good at monetization to be able to make the kind of investments that let you innovate faster."
The costs can keep opportunities out of reach for longer than expected. YouTube, Beats, and Spotify's free mobile offering are the latest examples of a music service's goals taking longer to materialize than anticipated.
No sign of change for copyright costs
So why is there any reason to believe that will change? In some ways it won't. The licensing landscape doesn't hold any signs that copyright costs will be coming down.
Take the biggest services in the two main categories of streaming music: Pandora for Radio and Spotify for on-demand. Pandora pays its licenses under a regulatory framework set in Washington, DC, and the next rate-setting decision from the Copyright Royalty Board won't come until at least 2015. Spotify goes the route of direct licenses, and after it announced the fruits of its latest round of deal renewals with labels and publishers, it still said it pays out 70 percent of revenue in copyright.
Pandora also generates most of its revenue from advertising, while subscription services like Spotify rely on individuals signing up for paid premium tiers, but neither has reported resounding profit. In the case of Spotify, its losses are only widening as it grows.
For the majority of streaming services that take the direct deal route, the recorded music industry is showing signs that it is getting more flexible on other terms. Earlier this month, Sweden-based Spotify rolled out a free mobile product after a long process of renewing its deals with rights holders. It allows mobile users to listen to any song in the catalog -- narrowed down to a single artist, a single album, or a single playlist -- without a fee, so long as the songs are shuffled. It's a compromise from the on-demand its desktop version is capable of, but it is the biggest bet the industry has made yet on subscription services that are increasingly catering to mobile listeners.
With the free-mobile announcement, Spotify Chief Content Officer Ken Parks said the company was looking forward to "a year of explosive growth."
"We can't put the genie back in the bottle -- this is the way people want to listen to music," he said. "The challenge is to get the entire planet on a path to eventually subscribe and pay something for music. The first task is to get them on the conveyor belt to paid consumption."
It can also create ways for artists to make more money, after the online streaming model has come under recurring criticism from musicians for paying poor rates to play their work.
"The two main things that a musician sells nowadays is a song and a ticket, but there's all this time in between that fans want to be interacting with you and spending time and money with you," said J Sider, CEO of Bandpage. A studio recording session that is livestreamed for 15 minutes or a personal meet-and-greet that the artist auctions to the highest bidder are examples of ways musicians can boost their revenue 25 percent to 50 percent, he said. Data from streaming services is helping musicians in this way, providing insights that can help them "target the right fan with the right offer at the right price."
A Nielsen study determined that fans who are already responsible for 75 percent of music spending could spend an additional $450 million to $2.6 billion annually for behind-the-scenes access or exclusive content. And PricewaterhouseCoopers estimates that between 2013 and 2017, digital content will account for 40 percent of the market and 87 percent of the growth in consumer spending on entertainment and media.
Streaming heats up
Greg Boyer, managing director of PricewaterhouseCoopers' media and entertainment division, said streaming has a direct correlation with paying for more music. "Consumers are slowing down on digital downloads but there's significantly higher growth on the streaming side," he said. "If that reads as an inflection point, then you'll see streaming revenues gain steam."
But it's still unclear whether the gains in streaming revenues mean a bigger pie for the music industry or just that streaming is taking bites out of downloading's sales slice, he said.
Pandora's Conrad noted that big spenders on music are rare in the US. Data indicates most of the country doesn't pay anything for music, the second biggest chunk pay a pittance, and the remaining sliver are the ones who push up the average by spending a lot, he said.
With subscription services generally priced around $10 a month, there's the possibility that those high spenders are going to get a great deal. "Are you going to take all the people who spend $300 a year, and move them to $120 a year, and get none of the people who spend $15?" he asked.
Pandora, of course, would be skeptical of the subscription streaming model, since it has taken an ad-based route. According to Conrad, Pandora doesn't see itself as part of the question about the future of music sales. Its job, like traditional radio, is to help consumers discover music they love and, as a result, may eventually buy. And Pandora collects ad dollars along the way.
But that tack has put Pandora on the music industry's bad side. Sure, terrestrial radio doesn't pay anything to rights holders to broadcast music, but labels and publishers have relied on radio's massive reach to publicize their artists and rack up sales for decades. The system worked pretty well in the 20th century.
In its pursuit of 21st century radio, Pandora eschewed direct dealings with rights holders, who in turn resented the low rate Pandora pays them through a statutory license. Labels' antipathy over the service compelled them to derail a bill that would have lowered the royalty rate Webcasters pay, and music publishers have singled out Pandora in an effort to withhold their catalogs.
Despite the discord, a confluence of positive factors are coming together for Pandora next year. It has built out its mobile ad capabilities and reached an audience size -- Pandora is the No. 1 radio station in 12 of the top 15 local radio ad markets in the US -- that will start to bring local advertisers on board in larger crowds. Pandora has posted only a couple of quarters of slim profit since going public in 2011, but investors are giddy about its profit prospects -- the company's shares have risen more than 180 percent this year.
If 2014 is the year streaming music creates a profit powerhouse, it may just be the service the recording music industry loves to hate.