What does Spotify’s funding say about freemium music fortunes?

Does Spotify’s new VC funding now suggest confidence that ad-supported music service can really work? Depends who you talk to…

Steve Purdham, CEO of ad- and premium-funded streaming site We7, is seeing it as a positive rather than as a victory for a competitor: “We see this as an outstanding announcement given the stage in the maturity of the ad-funded music market, and it is exceptionally positive for We7’s potential valuation going forward.”

But Forrester research director and music analyst Mark Mulligan cautions: “Spotify has made a great start but it hasn’t even finished the first lap yet.” He warns Spotify will find challenges in growing ad income in an ad recession and in attracting premium customers: “Until those are fixed, every new user for Spotify is cost to the bottom line.”

Free streaming music services are growing up to rival pay-for download stores but, just as newspaper publishers in the ad downturn are looking back toward the pay-for model, recent months have seen music streamers wobble. Last.fm has introduced radio subscriptions in some countries, YouTube has pulled premium music in the UK and Germany while baulking at royalty outgoings; We7, too, is experimenting with premium offerings on top of its core free.

But, after a wobbly start when its original aim was to include audio ads inside track downloads, We7 claims to have had its best month to date in July on ad sales, reach (2.5 million UK users) and off-site widget uses (1.5 million). We7 is funded by John Taysom, Peter Gabriel, Purdham himself, Spark Venture and Eden Ventures, and is expected to eye further funding in Spotify’s wake later this year.

But Purdham remains realistic: “Despite the hype, the focus still has to be on sustainability ahead of scalability. Spotify have done a great job hyping up this area but, as I have always said, giving away lots of music has never been the hard bit – sustainability is the real challenge.

“With good companies like Pandora and Hulu, you are starting to see really positive signs of that, and that is our mantra. Once sustainability is covered, then scale becomes a natural step. Imeem have shown that the reverse of that is not true.”

If freemium music streamers can make a success of their own businesses, they will go a long way to helping the music industry itself, which is placing hope in income from these licensing payments as actual retail purchases wane in the face of an online market that’s 95 percent illegal.

Mulligan, though, writes that Spotify needs to hit three triggers if it’s not to be just the latest flash-in-the-pan: “Break through the 15-20 million user bar like Pandora did”, “convert roughly five percent of its user base to premium offerings” and “build a sustainable ad business that helps shoulder the cost of its free users”.

“Spotify itself is not about to become ‘the future of the music industry’,” he says, but “the music industry needs Spotify to get a decent shot at being a success”.