Taylor Swift being photographed at the ACM music awards in 2014. She removed her music from Spotify, disputing the way in which music is streamed 

Once upon a time, teenagers with questionable 1970s haircuts crowded round dressing rooms, mobbing their favourite band for a scribbled autograph on the cardboard casing of their new vinyl LP. Roll on 40 years and there’s been a fair few changes, and not just in the hairstyles.

Instead of demanding illegible signatures, fans snap selfies from the very device on which they have access to almost every song in the world – the smartphone. Instead of obsessing over one favourite star, they hit festivals where a whole line-up of artists rule the roost.

Those changes have been driven by the digital revolution in the early noughties, with the rise of iTunes and other download platforms. Now, with the increase of subscription-paying and ad-supported streaming services such as Spotify, the industry is undergoing another digital transition – one that is arguably even more dramatic. According to music analysts, streaming services are set to define the future of the industry in a world where fast, on-the-go consumption is the new normal.

But so far they remain unprofitable, while artists are suffering from falling revenue. Total music sales fell 3.3 percent between June 2013 and 2014. If the right business model can be found, however, streaming services could just be the saviour for an industry that has been on the decline financially for more than 10 years. Finding that model, and striking a balance between pleasing artists and making profit, is where the challenge lies.

Dawn of the digital age
The digital download era impacted on physical sales (mainly CDs), replacing them in a number of key markets. It also made piracy via illegal download platforms easier than ever. Music revenues tumbled, plummeting from $15bn in 2003 to just $7bn in 2013 in the US, according to the Recording Industry Association of America (RIAA). A number of music stores collapsed under the pressure. Retailer Tower Records went into liquidation in 2006 after 46 years, and British store HMV followed suit in 2013. The industry had reason to fret.

Since then, digital music has grown to represent 39 percent of global music revenues, according to a report by the International Federation of the Phonographic Industry (IFPI). It accounts for the majority of sales in the world’s 10 biggest markets (representing 60 percent in the US, for example), with global CD sales still on the decline, dropping from 56.1 percent in 2012 to 51.4 percent in 2013, according to the IFPI. Furthermore, those physical sales now have less value; revenues from them plummeted 11.7 percent in 2013.

Sales are likely to continue plunging as Generations X and Y take over. “It’s a product which has been dead for a long period of time,” said Mark Mulligan, an analyst and the founder of Music Industry Blog. According to him, CD sales have another five or so years of strong growth before their demise properly begins.

Now the likes of Spotify, Rdio, Pandora, Beats Music (recently acquired by Apple) and a host of others have started to replace download sales with streaming figures, creating an eerie sense of deja vu for those in the industry (see Fig 1). Revenue from subscription services climbed a staggering 51.3 percent in 2013, reaching more than $1bn, according to IFPI. Streaming is dominant in parts of Europe, including in Italy and France, whereas in Sweden, only 47 percent of internet users said they use streaming services, while only seven percent download. It’s expected to account for 70 percent of total digital revenue in 2019, if forecasts by Music Industry Blog are anything to go by.

The impact on sales is clear: according to a Forbes report, downloads fell 5.7 percent from $1.34bn to $1.26bn in 2013. Although downloads still make up 67 percent of digital revenue globally, revenue from them is expected to drop 39 percent by 2019, according to Mulligan. “Streaming does cannibalise sales, because people stream instead of buying,” he says. Overall, music sales revenue is already falling, dropping 3.9 percent in 2013 to an estimated $15bn according to the IFPI.

Artists are therefore fretting once again (see Fig 2). Taylor Swift recently pulled her music from Spotify, hitting the headlines and sparking widespread debate within the industry. That move seems to mirror the initial reaction to downloads: in 2007, record company Universal Music reportedly threatened to pull its music from the iTunes Store out of concern for lower revenues. “Now you won’t find any artists who will look at iTunes as anything other than one of the most successful revenue streams,” Mulligan told World Finance. He believes we’re likely to see the same thing with streaming over the next five years or so.

Fighting the pirates
Although streaming may well be responsible for declining sales, this new form of music consumption seems to be the only option among consumers hungry for cheap, if not entirely free, music; a culture fuelled by the likes of YouTube and other sites. That’s a reality the industry is going to have to face up to if it is to benefit from the potential that streaming offers.

As Spotify CEO Daniel Ek pointed out in a statement defending his company against Taylor Swift’s move, it’s a choice between free, illegal music (which generates no revenue for the industry) or free, ad-supported streaming services that do make a contribution. An Institute for Policy Research report found that music piracy costs the US economy $12.5bn in revenue and other measures every year. If streaming services can combat that, they could instigate a very real change across the industry. According to Ek, that’s precisely Spotify’s goal: “Our whole reason for existence is to help fans find music and help artists connect with fans through a platform that protects them from piracy.”

The prevalence of piracy is hard to ignore; research by music industry campaign group La Coalición discovered in 2014 that a staggering 84 percent of all digital content being consumed in Spain was illegal. NBC Universal, meanwhile, estimated in a report that nearly 25 percent of total global internet traffic breached copyright laws, according to GlobalPost.

Demand for free entertainment, especially music, isn’t new: in the era of cassettes, recording songs from the radio was common, and in the era of CDs, ripping was rife. What the digital downloads era seems to have done is bring that to light more clearly, and now the likes of Spotify are highlighting it even more.

While there’s a risk that legalising free music amplifies that attitude by sending out the message that music doesn’t have to be paid for – which seems to have angered Swift – streaming services are ultimately obeying, and monetising, a market calling out for cheaper options. Google argued in a report on piracy that the market is partly to blame: “Piracy often arises when consumer demand goes unmet by legitimate supply.” By creating an extremely competitive marketplace, music and video subscription services such as Netflix are giving consumers greater pricing power than ever before. There has to be some benefit, even if it’s not immediately felt by those in the industry.

Subscription services have indeed gone some way to replacing piracy: illegal downloads fell 26 percent between 2011 and 2012 according to NPD Group’s Annual Music Study 2012, and streaming was the motivating factor behind almost 50 percent of those who stopped downloading illegally. “The increased use of legal and licensed streaming services has proven to be an alternative for music fans who formerly used P2P networks to obtain music,” NPD Senior Vice President Russ Crupnick said in a press release. Curbing piracy has been seen to an even greater extent in Norway, where the number of illegally copied songs fell from 1.2 billion in 2008 to just 210 million in 2012, according to The Telegraph.

By legalising and monetising free music, streaming services could start to play a major role in growing the music industry in emerging markets (see Fig 3). IFPI CEO Frances Moore wrote in the Digital Music Report 2014 that “rampant digital piracy” was “the one overriding obstacle to market development”. Streaming services could hold the key to overcoming that. Spotify has already entered Malaysia, Hong Kong and Singapore, while Taiwanese start-up KKBOX is also proving popular, counting 10 million users halfway through 2014.

The power of streaming services to drive growth in the music industry is already being seen in Denmark, Norway and Sweden. The latter’s music market grew 5.7 percent in 2013 to reach $409m. If emerging markets can follow that lead, the likes of Spotify could bring good news to a global music scene already largely reliant on free, mainly illegal music.

Unprofitable model
Some fear subscription services won’t provide enough revenue to offset the fall in physical and download sales. That was a concern voiced by Lucian Grainge, Chairman and CEO of Universal Music Group, at The Wall Street Journal‘s WSJ D.Live conference in October. While that fear is sending shockwaves through the industry, Spotify and other similar services are themselves struggling to create actual profit.

Even with its domination of the music scene in parts of Europe and beyond, Spotify racked up global net losses of $115m in 2012. That marked an increase of $59m from 2011, according to Businessweek, despite the Swedish start-up’s paradoxical growth. In 2013, its revenue exceeded $1bn, but the service was still unprofitable, with net losses of $80m.

“Each user that comes in is basically bringing more losses,” said Andrew Sheehy, Chief Analyst at Generator Research. Spotify recently celebrated news of its first net profits in France and the UK, where it reached £2.6m ($3.2m) in 2013 after an £11m ($14.5m) net loss the previous year. But that’s not necessarily an accurate indicator of Spotify’s total finances, given that its regional arms don’t include the overall costs incurred by the parent company.

Spotify’s losses aren’t surprising given the somewhat risky pay structure on which it operates: the service agrees to pay a sum to the record label and publisher, and is held to that regardless of what the company actually ends up earning.

According to both Sheehy and Mulligan, Spotify’s structure has to change if it is to become profitable on a global scale. Both argue that a tiered model could work. Sheehy noted: “Existing brand positioning in the market wouldn’t be affected, but they’d be able to extract more from users who are less price-sensitive.”

Tiered pricing seems logical given that relatively few Spotify users seem willing to pay the current prices for its ‘premium’ service; three quarters of the 50 million users use the free, ad-supported streams, according to Ek. Different price bands catering to different levels of music interest could expand the paid subscriptions to a wider demographic. Mulligan says 50 to 100 million subscriptions would be needed to achieve profitability.

Ek doesn’t believe a tiered system is necessary, however. “We know if you do [stream free], you’re going to be like, ‘Hey, 10 bucks is nothing’,” he told Businessweek. But if Netflix is anything to go by, consumers are heavily influenced by small shifts in pricing: following a $1 subcription increase in May 2014, Netflix’s growth in the US dropped from 1.3 million customers in 2013 to one million in 2014. Netflix’s total global forecast of 3.7 million customers was undermined by the reality of a confirmed three million.

Even getting people to pay low monthly subscription prices could prove challenging given the availability of completely free services such as YouTube. Sheehy suggests an alternative way of achieving profitability, which is to cut back on the royalties Spotify pays the music industry. He adds that a reduction of around 30 percent would be needed to make a real difference.

That’s likely to anger artists and the rest of the industry even more, however, and it’s highly improbable such terms would be accepted. Mulligan agreed: “There’s been a case for record labels to reduce royalties for 10 years and it hasn’t happened, so what you’d need is probably a market collapse for the record labels to start treating it more seriously.” That’s in spite of the fact that record labels make a fairly substantial amount of money from streaming services, receiving nearly 70 percent of Spotify’s revenue.

Struggling artists
While the record labels might be reaping the rewards, artists stand to lose out, receiving an average cut of around 10 to 15 percent from their labels, according to Mulligan – far lower than the more generous splits seen in the past. “For the really big superstars, [streaming] can be a very real jump, at least in the near term, in terms of revenues declining,” he said. However, it’s perhaps not surprising that some are kicking up a fuss, and in the short term, it appears to be working: Taylor Swift’s album 1989 hit nearly 1.3 million sales globally in its first week after her well-publicised Spotify withdrawal – breaking the record for 2014.

Given the general trend toward streaming, however, shying away from subscription services seems unsustainable in the long term. Furthermore, Swift’s decision to pull her music from Spotify didn’t stop people obtaining it for free: according to Ek, the Pirate Bay found that it topped the list for illegal downloads just after the news broke. That once again demonstrates the reality that a large number of consumers simply aren’t prepared to pay for music.

Swift herself is optimistic that this is not the case. She wrote in an article for The Wall Street Journal: “It’s my opinion that music should not be free, and my prediction is that individual artists and their labels will someday decide what an album’s price point is.” But the sheer number of streamers, and the trend toward consumer-driven pricing that it’s a manifestation of, suggests differently.

It’s true that the legalisation and monetisation of free music through the shift to streaming doesn’t come without a price. By replacing sales, subscription services are arguably spurring on the metaphorical death of the fan devoted to just one or two favourites, as multiple-artist playlists take the place of single-artist albums. Album sales in 2014 fell 8.4 percent from the previous year, according to Forbes. Bar 2011, when there was a slight uptick, this follows part of a consistent downward trend.

That cultural shift and overall change in perception does pose a very real threat to the budgets of artists largely financed by live tours, as Mulligan recognises: “The problem is if people aren’t spending much time with your album because they’ve got all the music of the world in their fingertips, then that also has an impact on how much money you can make live.”

But he believes that if artists can use streaming services as platforms to engage with consumers, they could maintain a strong fan base and counteract the otherwise damaging effects of streaming on music perception. That’s likely to prove challenging given the sheer volume of music available to streamers, but if it can be achieved then there’s every hope that a finance model primarily based on live shows can continue.

Sheehy believes that in the future, artists could potentially bypass the need for record labels completely, by signing up with streaming services directly. “Now they wouldn’t have the advantage of the record label marketing, so that’s a problem, but if Spotify has enough marketing tools, that isn’t a problem,” he said, suggesting that subscription services could act as platforms for free marketing. That would certainly solve the problem of low revenue for artists, but it would also mean an entire restructuring of the industry, which seems highly unlikely – at least in the near future.

According to Sheehy, the industry will change regardless: he predicts a 20 to 30 percent contraction in its size. He also believes that the music heyday is over: “The thought that the music industry is ever going to get back to where it was in the CD days, which was sort of the golden era of recorded music, is just an illusion.”

But if the potential to stem illegal downloads and grow the music industry in both developed and emerging markets can be harnessed, streaming services may well be able to offset the decline in sales, and at least go some way towards reversing the downward trend spurred on by the first phase of the digital era. Even if subscription services don’t succeed in that, what they are likely to achieve is a more balanced market where pricing power is more evenly split between producers and consumers. That’s huge news in itself, and it’s arguably that very shift in power that’s upsetting the industry’s biggest names.