“Oh, okay.” That was how Spotify CEO Daniel Ek responded—in a quickly deleted tweet—to the June announcement of Apple Music, the company’s long-awaited song-streaming and online-radio service (which costs subscribers $9.99 per month). The rest of the music and tech worlds seemed similarly underwhelmed, and Taylor Swift later joined the naysayers, protesting Apple’s plan to withhold royalties on songs streamed during the service’s free trial period. Meanwhile, another music superstar, Jay Z, was pushing his own streaming service, Tidal, and competitors like Rdio, Deezer, Amazon Prime Music, and Google Play were all clawing over a share of the booming music-streaming market (not to mention web-radio giant Pandora, which doesn’t allow user-chosen streams but has signed up some 80 million active users).
If this spectacle were a rock concert, it would be a hell of a show. Yet you’d be excused for feeling like you’ve seen it before. The music business has been in continuous upheaval and internal struggle for the past decade, and all the noise has long threatened to drown out any melody. Still, this moment offers something new, an inflection point of importance—if you know how to deconstruct it.
Steve Jobs believed that fans wanted to own their music, so he focused on selling downloads via iTunes. He was right—until he wasn’t. Last year on-demand music streaming surged 54%, to 164 billion streams, according to Nielsen; the biggest service, Spotify, now has 75 million users. Meanwhile, sales of digital tracks, like the ones on iTunes, are trending firmly downward, sinking nearly 13% in the same period. “The numbers we saw in Q1 of 2015 are almost double what we saw in Q1 of 2014, which was by far a record-setting year for streaming,” says Nielsen senior vice president David Bakula, who tracks music sales. “Consumers go to these services because they provide what people want: Almost all the music, all the time, at a price that isn’t crippling.” Yes, the music business is undergoing yet another fundamental shift. But which service will end up dominating the market—and which business model will prove most sustainable?
It’s no mystery how Spotify has gotten so big so fast: by offering a huge selection of music at no cost. The company’s free tier acts as a feeder for its pay service (which costs $9.99 per month), letting users stream unlimited songs on their desktop computers in return for listening to occasional ads. In the same way record labels have long hoped radio spins would convince fans to buy the full album, Spotify’s “freemium” model is meant to draw in listeners who might otherwise never consider paying. “Our freemium business exists for one reason: It’s the only way to grow paid users,” says Spotify’s chief content officer and boss in the U.S., Ken Parks. And it’s working: Parks says the conversion rate is an impressive 25%. Spotify now has 55 million nonpaying users and 20 million subscribers.
Of course, there’s a catch: Spotify pays a lower royalty rate on free-tier streams than on paid ones, because the ad revenue is far lower than what subscriber fees deliver. Some artists and labels are now pushing back against this two-tier model, arguing that music is worth more than the fraction of a cent per spin they’re getting from freemium. It’s a battle in which they are unlikely to prevail—not because their logic is flawed, but because consumer expectations have now permanently changed. The boom times, when listeners paid en masse to own songs and albums, aren’t coming back. “It’s worth remembering that we account for a significant fraction of the entire record business right now,” says Parks, whose company issued more than $300 million in royalties in the first quarter of 2015.
Pop’s biggest star has also been streaming’s most vocal critic. Last year, Swift removed her music from Spotify to protest freemium, and then there was that open letter to Apple bemoaning the lack of trial-period royalties. Within hours, Apple’s head of software and services, Eddy Cue, called Swift to let her know the company would change its policy, and soon after, Swift announced that her current album, 1989, would be available to stream for the first time anywhere—via Apple Music.
But as powerful as Swift is, there’s only so much she can do given the realities of today’s music business. After all, if Spotify scrapped freemium, users might jump to YouTube (already the most popular destination for on-demand music), which pays artists an even lower rate than Spotify’s free tier; or, worse, they’d switch to one of the many music-piracy sites, which pay nothing. Many artists have stopped depending on revenue from recorded music altogether, focusing on touring and merchandise, which they can control. “How do I feel about streaming?” asks Brittany Howard, lead singer of Alabama Shakes, whose second album, Sound & Color, debuted at No. 1 earlier this year. “I have two answers. One is about my peers. It takes money to make a record, and just because it can be shared doesn’t mean that a lot of hard work and soul didn’t go into it. But for me? I could care less if it’s on Spotify or the Internet. Because as long as we’re touring and people are coming to the shows, I’m going to be okay.”
The rapper-businessman debuted Tidal in March with a surreal, star-studded event that was widely mocked online, and since then the streaming service has failed to get much traction—in June the company lost its second CEO in six months. Co-owned by more than a dozen A-list artists, including Kanye West and Madonna, the subscription-only Tidal is trying to differentiate itself with exclusive music (the Rihanna single “American Oxygen,” for example, was only available there). “If acts want to put out exclusive content, we have a lot of that coming up, almost on a daily basis,” says Tidal senior executive Vania Schlogel. “If artists want to give back to their fans, this is their playground to do so.” As it turned out, though, the Rihanna single failed to connect, peaking at No. 78 on Billboard’s Hot 100 chart. This has reinforced skepticism about the long-term effectiveness of exclusivity as a marketing tool. “It’s fundamentally a bad idea,” says Anthony Bay, CEO of the subscription service Rdio. “Say, if I want Beyoncé I have to subscribe to Tidal, and if I want Taylor Swift I have to subscribe to Rdio. Are people going to subscribe to both?” Bay suggests we will see more “windowing,” where a new album might be available exclusively on iTunes or CD, or on one particular streaming service, for a short period. This allows artists and labels to capture premium revenue from their most devoted fans, without sacrificing the lower per-listen revenue of the mass market.
Despite Spotify’s huge head start, Apple is in a good position to reach fans who are already accustomed to paying for songs via iTunes. The company has access to 800 million users’ credit-card numbers, and new Macs and iPhones will have Apple Music preinstalled. Still, moving forward, the challenge will be converting the next-generation audience, who haven’t grown up with a collection of music that they own. Spotify’s freemium model could have the edge with this rising cohort, which could in turn help its relationships with artists and labels. It’s all about scale: If enough users flock to Spotify, payouts will start to add up.
The most devilish detail in all of this: Neither Spotify nor any of its streaming competitors has ever turned a profit. That’s partly because they’re in furious growth mode, investing heavily. But this raises an uneasy specter of the future. Simply put, selling music subscriptions is a hard way to make money. How many listeners have ever spent $120 per year on music, as Apple Music’s model (and Spotify’s pay tier) requires? Not many. Even at the music business’s historical peak, in 1999, per capita annual U.S. album sales hovered around five, at an average of around $13 apiece, or roughly $65 in total. That year, the industry pulled in $14.6 billion in revenue in the U.S. alone. By 2014, U.S. revenue had fallen by more than 50%, to less than $7 billion. Let’s face it: A return to the head-spinning numbers of the ‘N Sync era is wildly unlikely. On the positive front, the public’s passion for music clearly hasn’t gone away, and streaming is resonating with all market segments. And when it comes to the proliferation of services, maybe there doesn’t have to be just one winner—competition could be good for everyone. “There are a heck of a lot of consumers who still need to be shifted [to streaming],” says Lars Murray, a senior vice president at online-radio site Pandora. “You can’t underestimate Apple [as a competitor], but the history so far has been when more players come into the market, the market becomes bigger.” Streaming could prove to be an iTunes killer that eventually gives way to something else. But it also could be the technology that finally revives the revenue trajectory of the music business after years of decline. Wouldn’t it be a treat if the industry could accept the new reality in a way that makes everyone—consumers, labels, streaming platforms, and, yes, artists—happy? As Swift put it in a newspaper op-ed she wrote last year: “Music is art, and art is important and rare. Valuable things should be paid for.”