Ask the owner of any bar that hosts occasional live music how they make money and they’ll tell you it ain’t from the music. The music is there to draw a crowd to sell more liquor to, which is where the profits are. The cover charge helps defray the cost of the band so it doesn’t all come out of the liquor receipts. These days, the music streaming business is starting to look a lot like those gin joints.
While Spotify, Pandora and Apple are drawing pretty good crowds, none of them are making money from the music. And they’re starting to 
cast about for other ways to make money. Pandora recently plunked down $450 million to buy live-event ticketing service Ticketfly, presumably hoping for some synergy between those who listen to music on Pandora and those who buy tickets to live shows and concerts. Spotify is trying to leverage its music audience to build a business around non-music content, such as online video.
Apple insists it can eventually make money from music streaming, but with Apple it’s always at least as much about finding new users for its devices, where it makes nearly all of its profits, than about any particular service.
All have invested heavily in data and analytics, initially for internal use but almost certainly with an eye toward turning their data into a product in its own right.
In short, some of the leading music streaming services are starting to think of music — implicitly if not expressly — as a loss-leader: a way to draw a crowd to make money off something else.
That may be a reasonable strategy for the music streaming services: whatever it takes to make a buck. But it should set off alarm bells at the record companies. Allowing your product to become someone else’s loss-leader can be a very slippery slope. Inevitably, you end up needing them more than they need you — a position no vendor should want to be in.
The DVD business offers a relevant case in point. The DVD was developed in large measure to provide Hollywood with a home video format that could be sold by a broad range of retailers, rather than rented by a relatively small number of specialty shops, as the business had operated up to that point. DVDs were far-less expensive to manufacture than VHS cassettes and could be stamped out quickly in volume, allowing them to be priced for purchase. Under the purchase model, the studios were able to capture 60-70 percent of the consumer dollar, whereas under under the rental model, retailers kept roughly 70 percent of the consumer dollar, leaving the studios on the short end.
In a short-sighted chase after unit sales, however, the studios allowed DVDs to become a loss-leader for Walmart, Best Buy and a few other big box chains, making it difficult for other retailers to compete. When, as inevitably happens with loss-leaders, DVDs were no longer drawing the same sort of crowds for Walmart the retailer moved on to other traffic-drivers and started eliminating space for DVDs in its stores. With much of the rest of the retail base already chased out of the category, DVD sales began to collapse, taking the studios’ home entertainment revenues with them and dragging down Hollywood’s earnings for years.
Yes, digital would have eventually cannibalized physical media sales anyway. But more far-sighted management of the DVD business would have bought the studios a softer landing and more time to prepare for the digital future.
The reason music streaming services struggle to make money from music is obvious enough. Nearly every dollar they bring in right now, whether through advertising or paid subscriptions, is getting gobbled up by royalties under the industry-standard licensing deals imposed by the record companies, as spelled out starkly in the prospectus prepared last month by French streaming company Deezer as it prepares to go public. The company’s cost of sales last year — essentially its royalty fees as a percent of revenue — was 84 percent. In 2013 it was 91 percent. That doesn’t leave a lot of margin to work with for anything else.
The labels insist the services could make more money by selling more ads or converting more of their free users to paying subscribers. But insisting on a higher cover charge is not the same thing as creating an incentive for streaming services to continue to invest in music.
If the labels believe that streaming is the future of the business then the goal at this stage ought to be to encourage the emergence of as broad and diverse a range of viable customers in the market as possible. To build a business at scale you need other people to invest in it. And if streaming services can’t make a profit because of how their licensing deals are structured then they can’t attract the capital to continue to invest in the streaming music business.
The last thing the record companies should want is a market with only a handful of viable buyers who are making their money off liquor sales.
