If you have read anything about digital music recently, you have probably encountered two names over and over: Spotify and Pandora. Both offer an abundance of free listening on easy-to-use interfaces, and music fans have embraced them. At least 33 million people have tried Spotify, more than 150 million have registered for Pandora.
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Those are extraordinary numbers for any online service. But even at their level of scale and hype — and despite having very different business models — Spotify and Pandora exemplify the business challenges for digital-music companies. Both are losing money, and for largely the same reason: the cost of music royalties.
Pandora, which went public last summer, has never had a profitable year, and in its most recently reported quarter lost $20 million on $81 million in revenue. (Its next earnings announcement is Wednesday.) Spotify’s accounts for the last year, recently filed in Luxembourg, show that it lost $57 million in 2011, despite a big increase in revenue, to $236 million.
The companies license music differently, but both wind up paying a majority of their revenue to music companies. Pandora does not negotiate with record labels to use their songs. Instead, it operates under the compulsory licensing provision of federal copyright law, which allows it to use any song — with some restrictions — and sets royalty rates by federal statute.
For its revenue, Pandora, which has free and paid tiers, relies almost entirely on advertising. Yet it has been unable to sell enough advertising to offset its royalty costs. Last year, Pandora paid $149 million, or 54 percent of its revenue, for “content acquisition,” otherwise known as royalties. No wonder the company has been active in Washington lately to try to push for lower rates.