More Money, No Profit: Is the “Free For All” Ethos of the Internet Killing Streaming?

Stephen Carlisle April 16, 2015

What do YouTube, Pandora and Spotify have in common? Yes, they are all streaming services, but what links them together is that none of them earn a profit. Wait, let’s go further. They have never earned an annual profit in all the years they have been in business.

Google purchased YouTube in 2006 for $1.6 billion dollars. ¹ Despite having one of the world’s most cash rich businesses as their owner, and despite $4 billion in revenue, YouTube in the nine years since its purchase has never turned a profit. ²

And then there’s Pandora. In 2011, it lost $9 million. In 2012, it lost $36 million, and in 2013, it lost $41 million. ³

Not to be outdone by its main competitor, Spotify is winning the race to the bottom. According to this article in The Trichordist, ⁴ citing this article in The Wall Street Journal, ⁵ Spotify is going back to its investors and asking for another $400 million in funding. This is the seventh time it has had to ask investors for more money. ⁶ In 2010, Spotify lost $38 million. In 2011, it lost $59 million. In 2012, it lost $78 million. ⁷

What is truly incredible is the losses are getting bigger while the revenue increases. During the period noted above, Spotify increased its revenue from $98 million to $575 million. ⁸ For Pandora, its revenue increased from $267 million to $638 million.

And here’s the kicker. At the same time that Pandora was losing $41 million, it paid its top 20 executives $57 million in compensation. ⁹ In the same period that Pandora’s annual loss quadrupled, it increased executive compensation 383.2%. ¹⁰ (N.B. This site is updated daily so the numbers may change.) As noted previously on this blog, Pandora’s solution for its mounting losses is to petition the government to lower the rate that it pays to musical artists, ¹¹ instead of figuring out that, just maybe, they have a bunch of bungling executives who are vastly overpaid.

This leads some observers to conclude that the “free streaming” model simply does not work. As this article from The Motley Fool points out:

“[A] report published by Generator Research last year concluded that the streaming business in its current state was ‘inherently unprofitable’ and that ‘no current music subscription service — including marquee brands like Pandora, Spotify, and Rhapsody — can ever be profitable, even if they execute perfectly.’” ¹²

Yes, both Spotify and Pandora have pay tiers. But the majority of the subscribers are on free tiers. For example, Spotify has 15 million paid users against 45 million free users. ¹³ The fundamentals simply are not there. It’s the pay sites that make the real money. According to the April 15, 2015 issue of Bloomberg BNA’s Patent Trademark and Copyright Law Daily, “per-song rates are much lower [on free services]. While the record industry made $1.6 billion in revenue from companies that run paid subscription services, it brought in just over half that-$641 million-from companies that offer only free music.”

Let’s compare these facts against some of their competitors. Sirius XM makes a profit ($65 million in 4Q 2013) ¹⁴ and is actively buying back its stock on the open market. ¹⁵ Netflix, a YouTube competitor, made $350 million in 2013 ¹⁶ and is on track to achieve a 32% U.S. profit margin by 2016. ¹⁷

How are Netflix and Sirius XM succeeding where YouTube, Pandora and Spotify are failing? Simple. They charge everyone for their services. You don’t pay, you don’t get. Netflix has 50 million paid users. ¹⁸ Spotify has 45 million free users. It’s not hard to see where the problem is.

Beginning with Napster, the Internet has promoted the idea of “everything has to be free.” With its corollary “and if it’s not free I will feel no remorse about simply taking it.”

Whatever happened to the notion of requiring people to pay for something that has value?

Lots of newspapers are putting content behind “paywalls,” where you have to pay to read the content. Fair enough. It costs money to generate that content. But of course, this is the internet where everything has to be free. I did a Google search for “how to get around paywalls” and Google spit back what it said were 56,000 results on how to do exactly that. Yet is seems that demanding that you be paid for your creative work does get positive results.

“Although the [New York Times] paywall is extremely easy to circumvent, subscription rates have exceeded expectations. While some predicted that users would be unlikely to begin paying for content that previously had been free, the New York Times reported that it had more than 100,000 subscribers in just the first month. This not only defied expectations, but also made a powerful case for the argument that users are willing to pay for content that could be accessed freely in other ways.” ¹⁹

So, Pandora and Spotify, it seems you need to forget the “everything must be free” ethos of the internet if you want to stay in business. Yes, it does seem that your business plan is DOA unless you switch to an all pay tier like Sirius XM and Netflix. Your problem is not, as the Wall Street Journal hinted, that the payouts to the artists are too large. A grocery store can make a profit with a razor sharp margin of only 1% on the goods they sell. ²⁰ The difference is, they expect you to pay for everything you take from the store. And since the grocery store is not the Internet, taking something without paying for it gets you a nice ride in a police car.