Spotify: five big challenges looming for the streaming music service

Winning over artists, going mainstream, turning a profit, facing big-tech competition and (perhaps) going beyond music

Its critics include Thom Yorke and Johnny Marr, but music streaming service Spotify has become an established industry fixture that poses a competitive threat to headline technology acts like Apple.

The announcement by the Swedish music streaming service that it has 10 million paying subscribers and 40 million active monthly users will further excite US investors who are anticipating a flotation this year.

Despite its detractors, Spotify’s growth confirms that the music-listening public likes the model of paying a monthly subscription – of £10, $10 or €10 – for unlimited access to tens of millions of tracks. The company has leapt from 24 million active users and 6 million paying subscribers in March last year and is the world’s biggest music subscription service.

“We’ve had an amazing year, growing from 20 markets to 56 as people from around the world embrace streaming music,” said chief executive Daniel Ek in a statement. “Ten million subscribers is an important milestone for both Spotify and the entire music industry. We’re widening our lead in the digital music space and will continue to focus on getting everyone in the world to listen to more music.”

Spotify also announced that its users have created 1.5bn music playlists; that Avicii’s Wake Me Up is its most-streamed song with 235m plays; and that David Guetta is its most-followed artist, with 5m fans subscribed to his updates on the service.

The service now has a clear lead ahead of fellow music upstarts. Its rivals in the streaming music market include Deezer, which has 12 million active users and 5 million paying subscribers, and Rhapsody, which has 1.7 million paying subscribers around the world, split between its Rhapsody and Napster brands.

But it is the bigger rivals, which have noted Spotify’s success, that pose the main threat. Beats Music in the US is not bigger – it launched in January – but its likely new parent is a problem. Beats Music’s owner, headphones firm Beats Electronic, is close to being acquired by Apple for $3.2bn (£1.9bn). Apple’s streaming music ambitions represent one of the biggest challenges to Spotify. Its iTunes Radio service – which streams personalised “stations” but does not allow users to choose individual songs unlike Spotify – is already available in the US and Australia with more countries, including the UK, expected to follow later this year.

Meanwhile, YouTube is also expected to launch a subscription music service in the near future, although it is already the biggest online source of free streaming music. So Spotify may look good money for its mooted $4bn valuation in the wake of Wednesday’s figures, but it faces several key challenges to its business in the months and years ahead:

1. Winning over musician sceptics in the musician 

Some prominent musicians don't like Spotify at all. Thom Yorke called the company "the last desperate fart of a dying corpse" in 2013, telling his peers that "I feel like as musicians we need to fight the Spotify thing", suggesting that the company is just another (unwanted) middleman in the music industry.

"All these fuckers get in a way, like Spotify suddenly trying to become the gatekeepers to the whole process. We don't need you to do it. No artists needs you to do it. We can build the shit ourselves, so fuck off."

David Byrne was more measured, but just as critical in an article for The Guardian shortly afterwards. "It seems to me that the whole model is unsustainable as a means of supporting creative work of any kind," he wrote. "What's at stake is not so much the survival of artists like me, but that of emerging artists and those who have only a few records under their belts."

There are various reasons some musicians don't like Spotify, although the company is something of a lightning rod for criticism of all streaming services. Some criticise the size of per-stream payouts compared to the money they receive for sales of CDs and downloads, or plays of their music on the radio.

Others think that streaming funnels money towards the biggest stars and doesn't support emerging acts. And others simply distrust Spotify because major labels own a chunk of the business, and they don't think they'll get a fair share of advance payments made to those labels, as well as any profits if and when the company is either bought or floats on the stock market.

Others are taking a more pragmatic – but still problematic for Spotify – approach of withholding their new albums until they've had a few months of sales on CD and download stores like Apple's iTunes. Coldplay, the Black Keys and Beyoncé are the three latest high-profile artists to adopt this approach, following Adele and Taylor Swift in previous years.

Spotify has tried to tackle all this in several ways. It launched a Spotify Artists website in December 2013 to explain how it calculates its payouts – including making it clear that it pays labels and publishers but can't make them more transparent about how they pass that money on to creators.

It has also highlighted the success (in terms of streams and sales) of big artists like One Direction and Bruno Mars, whose last albums launched day-and-date on iTunes and Spotify, while launching new features to help artists sell merchandise and tickets from within its service.

Spotify also has its supporters within the musician community. Billy Bragg launched his own "talking playlists" show on Spotify in February, and defended the company from attacks by artists. "Let’s not attack the platform: they’re making a lot of money, but they’re paying out a lot of money too," he said. "It’s where the money is going to: the people who are collectively referred to as the rightsholders."

Meanwhile, Metallica and Pink Floyd – both formerly streaming music holdouts – have added their back catalogue to Spotify in recent times.

2. Turning a profit from streaming music

Streaming music is a tough business, to say the least. Companies like Spotify pay out 70% of their revenues in royalties, spending the rest (and a lot more) on running their services, expanding globally and the other costs involved in a modern digital business.

Spotify sees the $1bn that it has paid out to rightsholders since 2008 as a positive thing: a sign that it's adding value to the music industry. But that also means the company remains heavily lossmaking: €45.4m of net losses in 2011, €58.7m in 2012 and possibly more in 2013 – those figures haven't been announced yet.

The argument in point one about whether Spotify is sustainable for artists is important, but so is the question of whether it is sustainable for itself. Thus far, the company has been fuelled by massive venture capital funding rounds – $537.8m so far, including a $250m round in November 2013. That valued Spotify at $4bn, with rumours of an IPO this autumn continuing to bubble away.

Investors may not expect Spotify to be making a profit yet, but with no existing business in hardware (Apple, Beats, Sony, Microsoft) or advertising (Google, YouTube) to prop it up, the company's future depends on figuring out how to reach a much bigger scale with many more paying subscribers, managing its royalty commitments, running costs and investment in new features and countries.

Note: renegotiating contracts to lower those royalties is one tactic, but a risky one given the artist-payouts controversies. In the US, streaming radio firm Pandora has been attracting even more heated criticism than Spotify, partly because it has been publicly lobbying to reduce the percentage of its revenues it has to pay out in royalties.

3. Appealing to a more mainstream audience

40m active users is a decent number, but it's not what Spotify needs. When the company launched its Spotify Artists website, it set out a target of sorts: 40m paying subscribers – which at its current conversion rate of 25%, would mean 160m active users. Four times its current size, in other words.

Spotify has done a good job of appealing to early adopters: tech-savvy music fans. Its bigger long-term challenge is how to attract a much more mainstream audience to first use its service, then pay for it – this is a challenge facing every streaming service, obviously. Spotify and streaming is already truly mainstream in its native Sweden and nearby Norway, but there's lots of work to do to make this happen elsewhere in the world.

It's likely to be a mixture of marketing and partnerships – the latter particularly focused on mobile operators and ISPs (often the same company, obviously) to promote Spotify to their customers, and perhaps to bundle its premium service in with monthly contracts, so it feels cheaper. Vodafone 4G in the UK is one example, and a recent deal with Sprint in the US another.

Spotify and its rivals are all pursuing such partnerships aggressively, because they see them as an important way to both reduce the price (or perceived price) of a subscription music service, while raising awareness that they even exist in the first place.

Appealing to a more mainstream audience is also about the product itself. Log on to Spotify (or, again, most of its rivals) and you'll see more than the "search box" that they've been accused of being in the past. Carefully-curated playlists based on genres, themes or moods, and recommendations of artists or songs you may like based on your listening habits, are to the fore.

Spotify has made big strides in becoming a more accessible way to find music for people who don't want to spend that much time actually findingmusic. Those efforts – fuelled by competition from Beats Music, Deezer, Apple and others – will continue.

4. Taking on bigger beasts: Apple and YouTube

Spotify is bigger than Deezer, bigger than Rdio, bigger than Beats Music and the rest of its direct rivals. But it has bigger 900lb gorillas to battle in the coming months and years.

Spotify isn't the biggest on-demand streaming music service in the world: YouTube is, particularly among younger internet users. And YouTube is expected to launch its own streaming music subscription service this year.

Then there's Apple. For now, the iTunes Store is mainly about buying downloads rather than playing streams. Mainly? Some albums are available to stream on iTunes before their official release, as an incentive to pre-order the download versions.

There's also iTunes Radio, which is only available in the US and Australia so far, but is expected to launch elsewhere in the next few months. It's more about personalised "stations" of music based on your tastes, favourite genres or specific artists than Spotify's fully on-demand – play anything you like – service. But if Apple does buy Beats Music, the two will finally be head-to-head.

Apple and YouTube (well, Google) are massive companies with deep pockets: formidable foes for a company like Spotify. Apple in particular already has proven clout in negotiating exclusives with big artists – Coldplay, the Black Keys and Beyoncé's latest albums aren't on Spotify but they all got big promotion on iTunes.

If the streaming music world turns into a flurry of chequebook exclusive deals, Spotify could be at a disadvantage to these bigger beasts. Who, don't forget, own the two big platforms – iOS and Android – that have been such an important part of Spotify's growth so far.

5. Moving beyond music if necessary

Every so often, Spotify is rumoured to be preparing to make a move into Netflix-style streaming video: TV shows and films. It hasn't happened yet, and it's fair to say the company has plenty on its plate expanding its music service around the world without trying to get into a different entertainment industry that has its own dominant players.

Even so... there's an argument that the future of digital entertainment may move more towards people getting their content from fewer companies. Apple, Google, Amazon, Microsoft and Sony being the five that immediately spring to mind: all able to offer music, TV, films, e-books and games to customers from one place.

Where does that leave Spotify – and for that matter Netflix too? This is a longer-term challenge, but Spotify's management team will already be thinking hard about what life might be like for a pureplay streaming music service in 5-10 years time.

This doesn't necessarily mean Spotify should pile into video (and books, and gaming) as quickly as possible. It's about at least preparing the arguments for why people should still subscribe to a specialist music service in a potential world of digital jack-of-all-trades.