The leading online music streaming service in Europe, Spotify, is reportedly in line to get an injection of $100 million in venture funding as it seeks to launch its service in the US. If the funding materializes, Spotify would be valued at more than $1 billion. Investors include Russian investment firm DST Global, which also has made large investments in Facebook and Groupon, and one of Silicon Valley’s premier investment firms, Kleiner Perkins Caulfield & Byers.

If the deal goes through, Spotify will have the ammunition to compete with streaming services Pandora, which has filed for a US IPO, and Rhapsody. Spotify has already signed licensing deals with two of the four largest music companies, Sony Corp. (NYSE: SNE) and EMI Group Inc., the music firm recently taken over by Citigroup, Inc. (NYSE: C). Spotify is negotiating a deal with Vivendi’s Universal Music Group, the largest, and the new money could help seal the deal.

Music industry revenues are sinking fast. The collapse in CD sales is not being made up with digital sales from online stores like the iTunes store from Apple Inc. (NASDAQ: AAPL) or the digital downloads available from Amazon.com Inc. (NASDAQ: AMZN). Here’s a chart from Bain Capital that illustrates the carnage:

Warner Music Group Corp. (NYSE: WMG) recently announced that it would stop licensing its content to free services, and the company’s CEO said that “free streaming services are clearly not net positive for the industry … [and are] not the kind of approach to business that we will be supporting in the future.”  Apparently Warner Music thinks it can promote its own music subscriptions and apps, and make up more of the lost revenue from dwindling CD sales. Warner Music already has a licensing deal with Spotify, and that deal is expected to be left in place.

That’s probably delusional. In the first place, a presence at the iTunes store is a must for companies wanting to sell music. The catch is that Apple’s new subscription pricing plan means that the music company must pay Apple 30% of all subscription revenues. Spotify, too, is likely to run afoul of the Apple requirement, as are the other free streaming services.

In the second place, Warner Music appears to believe that people listen to music in order to enrich music companies. Therefore, music fans will continue to buy over-priced CDs with 11 songs they couldn’t care less about and 1 song they really like. That isn’t happening now, and won’t happen in the future. That model is dead, and nothing Warner Music does will bring it back to life.

The one company that could come out a winner here is Sirius XM Radio Inc. (NASDAQ: SIRI), which licenses its music following the traditional radio station model. The bad news for Sirius is that its current subscription fee price of $12.95/month will almost certainly have to go up or the service will have to start taking advertising.  Either way, subscribers could desert the station, especially for a paid streaming service that’s cheaper — like Spotify or Pandora or Rhapsody.

Free streaming over the internet to a desktop PC is not where Spotify will make money. The company has build an app that allows users to stream music directly to their smartphones. No iPod, no Sirius XM radio required. Anywhere there’s cell coverage, there’s Spotify.

For the music companies to make money they need to charge a healthy licensing fee to the streaming services, and the music guys want all the money up front. That’s what’s been holding Spotify back from a US launch. But now the company is about to get its hands on big money. And even if the investors won’t allow the cash to go straight through to the music companies, a stake of $100 million for marketing and promotion might be enough to make Vivendi soften its stance on an all-cash, up-front deal.

If Spotify and the other streaming services can get the licenses they need from the music companies, and can figure out a way around Apple’s new subscription requirements, the way people listen to and buy music will change in a big way. And not in ways that are good for the music business as it has existed for the past couple of decades.

Sirius is on the bubble here — if streaming takes off, Sirius could struggle; if streaming fails or is only a modest success, Sirius is well-positioned. The outcome may well depend on where the music industry sees its future. Right now, most of the industry is making a bet on streaming.

Paul Ausick

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