After Coldplay’s Snub, Why Does Spotify Cling to Free Music?

It’s Spotify vs. the world in the debate over free streaming services.

More Musicians Opt Out of Streaming

When Apple Music users opened their apps this morning, they found Coldplay’s new album, A Head Full of Dreams, waiting for them. Spotify subscribers have to do without. The British rock band is the latest big act to hold a new album off the world’s leading streaming service, in the latest rejection of Spotify’s insistence that artists include their music in the free, ad-supported version of its app. “This seems to be more about Spotify clinging to its idea of free and premium being treated the same than about streaming in a broader sense,” said Mark Mulligan, an analyst for Midia Research.

The free tier was also a deal breaker for Taylor Swift, who’s become the de facto spokeswoman for the idea that the model is preying on musicians. Apple Music and, more recently, Pandora are happy to echo that point of view. “Free-to-the-listener on-demand services are driving down music’s intrinsic value by creating a ‘gray market,’” wrote Pandora Chief Executive Officer Brian McAndrews on Business Insider earlier this week. “This gray market is unsustainable.”

With its partners and competitors all piling on, why is Spotify bothering to insist on offering free music? Because its whole business is based on it.

It’s hard to tell whether Spotify has been affected by the changing competitive landscape, because it releases information about its subscriber base erratically. Likewise, it will be essentially impossible to measure the impact of Coldplay spurning the streaming service for its competitors. To be sure, Coldplay is popular among Spotify users. Adventure of a Lifetime, one of the two songs from its new album that’s now on Spotify, has been streamed more than 22 million times. The band said in a statement that it will make the album available on Spotify soon. In the meantime, the roughly 16 million people who use Spotify to listen to Coldplay each month will have to settle for the rest of the band’s discography.

If it’s not clear what Spotify has to lose from sacrificing the occasional high-profile release, it is clear what the service stands to gain by sticking with its free service. Like all digital services that use the so-called freemium model, the free tier is essentially an advertisement for the premium version. In Spotify’s case, it seems to be a pretty effective form of marketing. Mobile games that use freemium models generally persuade fewer than 10 percent of their users to pay. By Spotify’s own account, it converts about a quarter of its nonpaying users into premium subscribers. The company heralds this success, saying it’s the only good way to get more people to pay for streaming services overall.

There are other ways, mainly more aggressive advertising. Spotify has never poured much money into traditional marketing. The reason? It’s expensive. Spotify’s annual revenue is in the billions, but it has to give 70 percent of that away in royalties. Streaming skeptics argue the royalty structure makes it impossible for Spotify to ever turn a profit. A sizable marketing budget on top of that would make it even harder. “The relationship between the cost of acquiring a client and the lifetime value of that client is critical for all these freemium services,” said Max Wolff, chief economist at Manhattan Venture Partners, a firm that’s studied Spotify’s finances. “They can’t afford to move that line any further.”

The difficult economics of a standalone streaming service have inspired Pandora to branch out, through acquisitions of Ticketfly and Rdio. This requires cash, and Pandora’s move this week to borrow $300 million to fund its new ventures has led to a selloff of its stock. Apple, of course, has essentially unlimited resources. But it never has to make a profit from streaming so long as it’s convinced that its service helps it sell phones.

Spotify doesn’t have a phone business. It has reportedly been considering tinkering with its free model to placate its critics at record labels. (It should be noted that these critics also own a significant amount of Spotify, so they have a strong incentive to avoid forcing it to do anything that will harm the company.) But Spotify is going to fight hard to keep its free tier. It doesn’t want to pay for the alternative.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE