Can You Offer Free Digital Music and Be Profitable?

Digital music sites like Pandora and Spotify are extremely popular with music fans because they offer free or low-cost music on a variety of different devices from computers to smartphones. However, despite their growing number of users, these digital music companies are still losing money.

As detailed in a recent New York Times article, the primary roadblock is the cost of music royalties. Even though Spotify and Pandora have adopted different business models, both companies devote a substantial amount of their revenue to securing music licenses. As a result, Pandora lost $20 million on $81 million in revenue in the first quarter of 2012, and Spotify lost $57 million in 2011, despite a significant jump in revenue.

In order to gain the rights to stream music, Pandora relies on compulsory licenses under the U.S. Copyright Act and pays the royalty rates established under the law. Spotify, on the other hand, negotiates directly with the copyright owner.

Both ways are costly. Pandora devoted 54 percent of its revenue, for “content acquisition,” according to the Times. While exact figures are not available for Spotify, its chief executive has stated that it returns 70 percent of its income “back to the record industry.”

These two companies illustrate the high costs often associated with securing intellectual property rights. Even for successful enterprises, IP expenses can eat into a substantial portion of your revenue.

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