10.28.10

Sean Parker Takes on Steve Jobs

Sean Parker all but invented music piracy with Napster. Now he's trying to make it legitimate with an innovative new company, Spotify. The only man who can stop him: Apple's founder.

An upstart called Spotify with an original and appealing business model for distributing digital music has charged successfully into the European market. Now it wants to cross the pond from its headquarters in London and bring a new sort of streaming music to America. But getting the music industry's cooperation is proving a challenge. Part of the reason: Apple's Steve Jobs has acquired outsized power.

“With Spotify, I want to finish what I started with Napster,” said Sean Parker at The Daily Beast’s Innovators Summit in New Orleans last week. In 1999, Parker co-founded the file-sharing service that became synonymous with the music industry’s destruction. After a successful run at Facebook (Justin Timberlake portrays him in The Social Network), he’s now a venture capitalist, he has invested nearly $15 million for a 5 percent stake in Spotify.

Jobs initially won the music industry's cooperation by telling its leaders that Apple’s iTunes would save it. But his deals with the major labels charge them onerous licensing fees that allow them to only earn pennies on the dollar for their songs. As iTunes cornered the market for digital music sales, industry sales overall continue to plunge, even while digital music consumption continues to rise.

While only a few billion digital songs will be purchased this year, estimates for the number downloaded worldwide rise into the trillions. The difference is accounted for by innumerable illegal downloads—the behavior the music industry loves to call "piracy." The record labels badly need a better way to make money. Apple's iTunes has major virtues—especially its elegant design and ease of use. The fact that songs purchased there can only be played on PCs or devices manufactured by Apple is the flip side—the devil's bargain Jobs won in exchange for his appealing integrated system.

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The industry badly needs a viable alternative to Apple. But the record labels are leery of being burned again by licensing their catalogs too cheaply. Every time a new music-delivery service emerges, executives demand upfront payments too large to allow the insurgent a viable business model. The list of startups hailed as music’s next digital savior only to flame out or fail to gain traction with consumers is as long: Lala.com , Qtrax, Spiral Frog, Imeem, iLike, Project Playlist, Grooveshark, Rhapsody, and Napster, among others.

A Spotify launch will finally happen in the U.S. soon.

Spotify may break the cycle. In Europe, it boasts 7 million users, including 500,000 paying subscribers. It crept up on the labels by gradually signing distribution deals with their regional subsidiaries beginning in Sweden, and now has licenses from all the major record labels in several major European countries. But the service’s U.S. launch has been pushed back twice because of delays in signing licensing deals with the major record labels. It remains in talks with EMI, Sony, Universal, and Warner. A major cause of the delays has been Jobs himself, who is known for frequent calls to industry executives arguing that Spotify will cause them even more business pain.

But after seemingly endless wrangling, recent progress suggests a Spotify launch will finally soon happen in the U.S. Whether the service achieves its stated goal of getting started before New Year's is another question. Warner Music Group has been Spotify's biggest opponent, and Chairman Edgar Bronfman Jr. has apparently softened his long-held opposition to Spotify's U.S. debut. At the beginning of this year, Bronfman called it "not the kind of approach to business that we will be supporting in the future." The company has recently said that it is pleased with how negotiations are progressing. That strongly suggests a softening on Bronfman's part. Negotiations continue.

Digital music is essentially divided into four types of businesses: download-to-own services such as those offered by iTunes and Amazon.com ; free streaming services that operate like online radio stations, of which Pandora is the leading example; advertising-supported sites like MySpace Music; and subscription services like Rhapsody. None of the models are generating revenue at rates that please the labels.

Founded in Stockholm in 2006, Spotify is a hybrid. Recently named a “technology pioneer” by the World Economic Forum, it offers both a free service supported by advertising and a paid one with additional features for about $15 per month. Users get access to almost every song ever recorded. Spotify has the kind of sleek easy-to-use interface that made iTunes and Pandora popular, while also incorporating interactive elements such as tradeable playlists and allowing users to buy and own songs.

Critically, unlike almost every other digital music service, Spotify offers a mobile version that gives access to streaming songs through an iPhone or Android app. This is what you get for your $15 monthly. If you don't pay, your songs remain locked on the computer running the Spotify program. That’s the differentiating factor that Parker believes separates Spotify from its competitors and will ultimately hook consumers into a subscription-based model that has thus far failed to catch on en masse.

To put it another way, the conceit behind Spotify is that consumers aren’t going to spend $10,000 to buy 10,000 songs (99 cents per digital song being the average going rate) but they will spend $15 per month for anywhere anytime access to 10 million songs that they merely borrow when they want to hear them.

“You have no choice,” said Parker of the way excited Spotify subscribers on the desktop turn into paying ones on mobile devices. “We’ve got you by the balls. You have to become a subscriber. Consumers are willing to pay for convenience and access... I don’t think there’s a one-size fits all model.”

Spotify also allows a tight integration with Parker’s former company, Facebook, so users can share their musical choices with friends, a compelling way to discover new music.

“The question for Spotify is will they get licensed and, if so, will it be on terms that lets the business survive,” says David Pakman, a partner with venture-capital firm Venrock who formerly served as CEO of rival digital service eMusic. “The music industry’s track record isn’t so great when it comes to that.”

It’s a big bet for both Spotify and the record labels, both of which are banking on the value proposition that it is better to have a steady stream of income from consumers paying for unlimited access to rented music instead of the unpredictable revenue derived from licensing fees resulting from songs they buy on their own.

Consider, for instance, that despite iTunes controlling roughly 80 percent of the digital-download market and raking in an estimated $2.5 billion in annual revenue, Apple CFO Peter Oppenheimer admits the store is barely running above break-even financially.

“Spotify’s model is monetizing access,” said co-founder Daniel Ek in a recent interview with The Wall Street Journal.

Spotify, which has raised more than $50 million in venture capital, must move quickly, however, as its window in the U.S. is closing rapidly. Both Apple and Google are said to be working on streaming-music services that could potentially incorporate a subscription aspect. A recent CNET article suggested that Apple executives would be displeased if a free Spotify service cannibalized paid download sales.

“The clock is ticking for Spotify,” says Ted Cohen, a former EMI executive now serving as a partner with digital consultancy TAG Strategic. “If Apple’s new service or Google comes to market first, then it is going to be a real struggle for Spotify.”

Indeed, as Parker himself noted, “If you operate a music service in the U.S. and you can’t directly port to the iPod, you’re screwed.”

As of right now, Spotify can’t “port,” or transfer files to Apple’s iPod, only its iPhone. Parker’s self-fulfilling prophecy is coupled with skepticism from music-industry executives that the amount of money they make per free stream from Spotify and the number of free users the service actually converts to digital are both too low to generate significant revenue.

Whether Bronfman is simply staking out a tough negotiating position to extract a larger upfront fee from Spotify or really feels like the service is yet another pretender to iTunes remains to be seen. But one thing is for sure, the industry needs to decide soon if Spotify is a savior to be embraced or a sinner to be crushed. The service’s future success depends on the outcome.

Peter Lauria is senior correspondent covering business, media, and entertainment for The Daily Beast. He previously covered music, movies, television, cable, radio, and corporate media as a business reporter for The New York Post. His work has also appeared in Avenue, Blender, and Media Magazine, and he's appeared on CNBC, Bloomberg, BBC Radio, and Reuters TV.