How does Spotify make money?

Spotify makes most of its money off a subscription service, but is in the red due to royalty payouts

There are so many freaking music streaming services now. Too many, if you ask me. There are only so many ears in the world, and minutes that can be spent listening to music. 

Off the top of my head: there's Apple with Apple Music and iTunes Radio, or "iRadio." Google also has two of them, having unveiled Google Play Music All Access in 2013, before it launched a YouTube streaming app in November of last year. There's also Tidal, Deezer, Rdio and iHeartRadio. Did I miss any? I probably did. 

Outside of Pandora, which is the most popular music streaming service with over 80 million listeners, there's no other service that can challenge the supremacy of Spotify.

As of June of this year the company had 75 million active listeners, up from 60 million users in January. If this keeps up, the company could actually surpass Pandora by the end of the year. 

So how does the company make money? The same way that all other music streaming services do: through a combination of free and premium tiers.

For Spotify, its premium tier means its subcription service. Of its 75 million listeners, 20 million of them are paying the $9.99 monthly fee. That equals a total of $199,800,000 a month. Expanded out to a year and that equals $2.4 billion.

From its free tier, Spotify makes money off of advertising. Free users can only play music in “Shuffle mode," meaning that can't play songs on-demand or offline. They also have limited number of song skips and, of course, they have to listen to ads. 

The majority of Spotify's revenue comes from its premium tier. In 2014, Spotify saw $1.3 billion in revenue, a 45% year-to-year increase. Of that, over 90% was said to have come from subcription fees. 

Despite the fact that it has the opposite model of Pandora, which makes almost all of its money off of its advertising model, Spotify is in a similar boat: despite its enormous revenue, it is losing money quickly due to royalties.

The company reported net losses of $197 million in 2014, up from a loss of about $68 million in 2013.

Spotify does not simply pay out per stream, but has formula determining how much it will be giving back.

"Every time somebody listens to a song on Spotify it generates payments, but Spotify does not calculate royalties based upon a fixed 'per play' rate. Although much public discussion of Spotify has speculated about such a rate, our payouts for individual artists have grown tremendously over time as a result of our user growth, and they will continue to do so," the company says on its website. 

It actually works on a country-by-country basis, and depends on a number of variables, including Spotify’s number of paid users as percenatage of total users. The higher percent that pay, the higher “per stream” rate will be.

It also depends on relative premium pricing and currency value in different countries, as well as an artist’s royalty rate.

When it all shakes out, Spotify pays out an average of between $0.006 and $0.0084 per stream, across both tiers of service. That may not sound like much, but it adds up quickly. In all, Spotify says that it gives back 70% of its revenue to right holders. That means labels, publishers, distributors, and, through certain digital distributors, independent artists themselves.

The effective average “per stream” payout generated by Spotify's premium subscribers is "considerably higher," than those paid by its free users.

Considering that Pandora can't make a profit offering music for free, and Spotify can't make a profit charging people for it, I'm starting to think that maybe the music streaming business is simply a doomed model.

(Image source: mashable.com)