Spotify, the American Dream, and why freemium is a broken record

There’s a certain irony that just two days after the who’s-who of the London startup scene were out toasting Spotify as the Telegraph newspaper’s inaugural #startup100 winner, the music streaming service announces an about turn and all but begins ditching its non-paying users. It looks like free music doesn’t pay after all. Then again, it’s not like the UK startup community hasn’t got drunk on the kool-aid before.

But actually, Spotify’s announcement today that it’s drastically reducing the amount of free music that its non-paying users can consume as well as the freedom that comes with it, isn’t all that surprising. The dirty little secret that no one likes to talk about is this: free, ad-supported, unlimited, unrestricted music streaming doesn’t pay. It’s that simple. Worse still, even when the model is off-set with a paid-for version, the sums still don’t add up. When it’s applied to music streaming, the freemium model is clearly broken.

The economies of scale that support a freemium model doesn’t apply to music steaming. Costs don’t come down per-user in the same way as a classic Software-as-a-Service, which after upfront and varying ongoing development costs, can keep adding more users at a fraction of the cost. Therefore, a service that fits the freemium model can potentially support a high ratio of free vs paying customers.

However, in the music streaming business, in theory each user or, more specifically, each track streamed costs the same because of the royalties charged by record companies. Put simply, it doesn’t become any cheaper the more you scale, so supporting non-paying customers comes at a substantially higher cost compared to other types of Internet services. It’s no wonder then that Spotify is weaning its users off of the “free” in freemium.

But what about Spotify’s competitors? It’s not like they are the only music streaming service in town. Well, in the UK at least, has pretty much stopped offering free music after huge losses, while Pandora pulled out a long time ago. Also notice earlier that I used the words ‘unlimited’ and ‘unrestricted’ when I said free music doesn’t pay. That’s because so-called Internet radio services in which the user has less control over what is played and can’t play tracks from the same artist one track after another, for example, actually cost less to run as they have a different royalty rate to a pure on-demand service. Another Spotify competitor, we7, has just switched to the Internet radio model, claiming that’s how mainstream users want to consume music, although it’s convenient that it also reduces costs not insubstantially.

Perhaps the oddest thing about Spotify’s new terms for non-paying users, however, is that after 6 months they’ll only be able to play each track up to a total of 5 times. This, of course, produces artificial scarcity and therefore it could be argued that it will push more users to pay for a subscription. But it also feels arbitrary. Why five plays? Is the sixth play more expensive to serve than the previous five? Not as far as we know and certainly not if we simply apply the on-demand vs Internet radio test. So where did the idea come from and why now?

The answer, I suspect, lies in Spotify’s pursuit of the American Dream. As the company gets closer to those licensing deals it needs to launch across the pond, something had to give. So idiosyncratic is the five plays-only rule it could only have come at the request of the US record labels. My guess is that Spotify is putting this in place now as a prerequisite to a US launch. Unsurprisingly, the company denies this.