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Everyone wants to be the new radio. Streaming music over the Internet is big business with plenty of competition. Pandora, Rdio and Spotify are the established players. Apple and Google joined the fray this year. And there's another one coming from music producer Jimmy Iovine. He's teaming up with rapper and producer Dr. Dre. They are all vying for a slice of an industry that so far is not turning a profit. NPR's Laura Sydell explains why.
LAURA SYDELL, BYLINE: I like Run-D.M.C. So I log into Pandora, enter their name, and the service uses an algorithmic formula to create a personalized stream of music for me by Run-D.M.C. and artists like them.
(SOUNDBITE OF SONG, "HARD TIMES")
RUN-D.M.C.: (Rapping) Hard times spreading just like the flu. Watch out, homeboy. Don't let it catch you.
SYDELL: The idea is to keep me listening as long as possible. The longer I listen, the more ads I hear, and you'd think the more money that Pandora would make. But every time I stream a song, Pandora has to pay, says Mike Herring, Pandora's chief financial officer.
MIKE HERRING: It costs us, essentially, around $20 in licensing fees for every 1,000 hours that we play in music. That means that we have to make $21 in revenue for every 1,000 hours to make a dollar.
SYDELL: It's actually a little more than that. Pandora has 70 million active monthly users who each stream about 18 hours a month. The company estimates it has to pay between $800- and $900,000 in fees every day. Herring says last year, Pandora spent 64 percent of its revenues on music. The service is classified as a pure play Internet radio station, and that means the recording royalties it pays for streaming a song are set by the U.S. Copyright Royalty Board.
Pandora's been lobbying Congress for lower rates, and that's generated a lot of angry press from musicians. The company's competitors don't have the same royalty issues. Such subscription-based services as Rdio and Spotify negotiate directly with the labels. But those services aren't making any money either.
(SOUNDBITE OF SONG, "HARD TIMES")
RUN-D.M.C.: (Rapping) They tell you times are tough. You hear that times are hard. But when you work for the ace, you know you pulled the right card. Hard times.
SYDELL: Rdio won't make its revenue public, but Spotify took in more than half a billion dollars last year. Nevertheless, its losses grew from $60 million to $78 million. Spotify executives say 70 percent of its revenue went to paying licensing fees. These kinds of up-front costs are discouraging investors and innovation, says David Pakman, a venture capitalist who co-founded Apple Music.
DAVID PAKMAN: It's nowhere near as active a space for innovation as, say, social media, mobile apps, where there are literally thousands of companies entering the space. Digital music has been a perilous one where investors have lost a huge amount of money.
SYDELL: Pakman says if there were fewer upfront costs, there would be a lot more new streaming services. But getting involved in the music streaming business is no less attractive than investing in Wal-Mart, says economist Jeff Eisenach, a visiting scholar at the American Enterprise Institute. Eisenach says a retailer like Wal-Mart lays out 65 percent of its revenues to buy the products it sells, almost exactly what Pandora pays in royalties.
JEFF EISENACH: You know everybody who sells more pays more.
SYDELL: The more shirts you sell, the more you pay the supplier to buy those shirts. The more songs users stream, the more a service pays in royalties and licensing fees. Eisenach says companies like Pandora and Spotify are making a lot of money. They're just using it to target new audiences rather than putting it in the bank and calling it a profit.
EISENACH: There is a huge advantage to becoming the largest because there are so many economies of scale. The more listeners you have, the more people value you, the less your cost per listener is. And all firms in these markets lose money initially as they invest in growth.
SYDELL: Though streaming music services have been around for a decade, Eisenach says these are still the early days of the industry. In fact, Pandora CFO Herring says he sees a lot of room for growth.
HERRING: It's important to remember that 80 percent of our listening is done on mobile devices, and the mobile monetization world is very much in its infancy, especially the advertising world.
SYDELL: And Drew Larner, the CEO of the subscription service Rdio, thinks there's a lot of money to be made.
DREW LARNER: With real scale, we will absolutely be profitable - wildly profitable.
SYDELL: Larner defines real scale as 25 to 30 million subscribers. He won't say how many paying subscribers Rdio has now. But its competitor, Spotify, has only 6 million. Larner says most people are still more interested in owning music than paying a monthly fee to listen. But that could be changing. Sales of albums, both physical and digital, are declining, and streaming grew by 24 percent in the first half of the year.
I guess the question is how long until all you guys who've been slogging away are going to get profitable?
LARNER: That, I don't have an answer to. I think it's on the horizon.
SYDELL: And Larner says, like most people, entrepreneurs and investors have an emotional connection to music. So despite the distance of that horizon, they are willing to invest and aim for the day when their efforts will turn a profit. Laura Sydell, NPR news, San Francisco.
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