The success of Spotify depends on whether users will shell out for its premium version, which will rent them mobile music on demand
Out of all the startups that have tried to reinvent the way we listen to music over the past decade, few have attracted as much attention as free streaming music service Spotify, the latest potential "iTunes killer." As the European company moves to unleash its sleek user interface on the American market, Spotify could prove to be as game-changing as the original Napster, the turn-of-the-millennium file-sharing service that caused music sales to crater as it taught consumers not to pay for songs, or as disappointing as the second-generation, "legal" Napster, a music rental company that failed to win over the mass market before being sold to Best Buy last year.
The success or failure of Spotify largely hinges on its use of the increasingly familiar "freemium" model, in which a basic free service is augmented by a paid one with additional features. In Spotify's case, its free streaming and sharing service is supported by advertisements, while paying users get better sound quality and no ads. But Spotify's ace in the hole is that paid users will also have access to streaming songs via its mobile applications, including a recently approved iPhone app. Add in Spotify's mobile caching function, which will make songs available offline, and the company will essentially fulfill the long-awaited dream of any song, anytime, anyplace, on demand.
The catch? Spotify's paying customers are still just renting songs, for about $13 to $16 per month, depending on the country in which the listener resides. Most discussion of Spotify has centered around a trend toward streaming music rather than owning it, when in fact the more critical question is whether it can persuade a significant percentage of consumers to rent songs rather than just listen for free. (Otherwise, it'd be just another free music site, doomed to face the same struggles as MySpace Music. I doubt many free users will convert to paying customers, for a few reasons:
By and large, consumers aren't all that interested in renting music. When each last revealed its numbers, neither of the two leading music rental services, RealNetworks' Rhapsody and Napster, had more than a million paying subscribers.
If people really cared about sound quality, they probably wouldn't be listening to MP3s.
Unlike most successful freemium models—Flickr, Dropbox, Evernote, et al—Spotify isn't a free "lite" service that power users pay to upgrade after maxing it out. Rather, people will be expected to pay for a superior experience of a service that's already very good. The ad-free upgrade sounds nice enough, but a reasonable price point for that is probably closer to the $3 it costs for Pandora One.
It's expensive. Is the ace in the hole—unlimited access to on-demand mobile music—really worth $10 to $15 per month, especially if consumers won't own their songs if they stop paying?
Spotify may be a very popular free desktop service, but the conversion rate to its premium service will be the make-or-break metric, the one that determines whether it will generate a seismic shift or a minor aftershock. As for the two Napsters, in the end, neither one was a success story. The original company had tens of millions of users but never had a business model and was thwarted by legal problems, while Best Buy acquired the second, publicly traded Napster for $121 million after years of disappointing sales. (They're still working on the mobile experience, too.) Considering that Spotify's venture investors reportedly valued the company at $250 million in a recent round, it's going to take an awful lot of mobile-music lovers to produce an exit that will make them happy.