I remember how ecstatic I was when I first figured out how Spotify works. It's the "available offline" button on the iPhone app that did it. Up until that point, I'd pick out an artist and listen online before deciding whether to invest my hard-earned $.99 to actually buy a song.

Spotify made all that seem instantly obsolete. I could download an album, any album, as the mood suited me, the only limitation being available storage space. I could make it available offline and listen any time, just as though I "owned" it. And if I got sick of it, I could excise it just as easily. In these days of Zipcars, where sharing trumps ownership, Spotify seemed like a music service for the times.

Until Friday, when the website PrivCo, a sort of WikiLeaks-for-pay of private company financial statements, put what it claimed to be Spotify's financials online for the world to see.

And it wasn't a pretty picture.

According to those documents, Spotify has operated at a loss for the past several years, as one might expect for a start-up, but the amounts are impressive. For instance, in 2011, the company had $59 million losses on about $245 million in revenues. And though the Wall Street Journal had noted these losses months ago, PrivCo displayed an entire balance sheet--revealing just how unsustainable Spotify's model is.

"The biggest concern is that for every dollar of revenue, 98 cents went out in music royalties," Sam Hamadeh, PrivCo's founder and CEO, told Inc. With a business model like this, growing the user base can only lead to bigger losses.

How reliable are these numbers? Hamadeh obviously won't say exactly how PrivCo got them, but he asserts, "They're from a reliable source inside the company." When asked why PrivCo released the figures, Hamadeh explained, "We make a determination on a case-by-case basis. But every time we see a company that looks from the outside like it's minting money, when we know it isn't, and we know the business model is unsustainable, we have to sound the alarm."

CNET reported that Spotify had confirmed the numbers were accurate, yet Spotify told Inc. it would not comment on the numbers, and that it was not commenting on the documents at all.

The question remains: Can Spotify survive?

Its prospects certainly appear doubtful. If it has a prayer, the company must take at least one of the following steps:

1. Raise prices for listeners, perhaps in a tiered system.

This is Hamadeh's immediate prescription. "They have an all-you-can-listen model for $10 a month," he says. "People play it all day at their offices and it may cost them $30 a month in royalties. So they should have the same model cable companies do where they charge more to people who use it a lot."

2. Make more money selling ads.

Hamadeh is highly skeptical this approach can work. "Right now, advertising is less than 10% of their revenue," he says. "What are they going to do--play an ad in between every song?"

Making online advertising, or--worse--mobile advertising into a meaningful revenue stream is, of course, the conundrum that seems to plague practically every company delivering content to consumers online. But just because it's been impossible so far doesn't mean it can't ever be done. Everyone thought online advertising in itself was an impossible business model until Google came along and proved otherwise.

3. Force down royalties.

Will the music industry work with Spotify to decrease royalties and help the service survive? Maybe not, now that they know how precarious Spotify's future is--in which case releasing its financials may turn into a self-fulfilling prophecy.

In years past, Spotify was roundly criticized for low payments to artists, with a British music association claiming 1 million downloads of a Lady Gaga hit earned her only $167. More recently, some independent labels have reported seeing better payments from the service. But with the industry as a whole suffering, it's hard to know how much negotiating room Spotify has on royalties.

4. Get too big to fail.

Think of this as the Kindle strategy. Amazon is willing to take losses on digital book sales, seemingly forever, in order to cement Kindle's market dominance. If Spotify were to grow fast enough to dominate its own market, it may have the clout to force the deals it needs. On the other hand, it may have some imposing competitors soon. Microsoft is rumored to be considering acquisition of Rdio, a San Francisco-based Spotify competitor. And Deezer, a similar service from France recently raised a $130 million funding round.

Which leads me to wonder: If the all-you-can-listen subscription music service model is bankrupt, why are these large, wealthy, and presumably smart players so eager to get into the game?

Maybe they know something that Hamadeh and the rest of us don't.

Published on: Oct 9, 2012
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