Will Spotify’s Streaming Music Service Dominate in the U.S.?

Spotify is a European digital music service co-founded by 28-year-old Daniel Ek that is just beginning its expansion into the U.S. Ek spent nearly two years in negotiations with record labels, but with less than two days before it planned to open the platform to American users, Ek still hadn’t completed his final major label deal, with Warner Music Group (NYSE:WMG). But Ek pushed the deal through on Wednesday, and it will become available in the U.S. today.

Spotify is a streaming-music service that Ek says makes it “easier to listen” to your favorite music, “Hence, people tend to get more into the experience, and they tend to find new music and build larger collections that they want to take with them. And therefore, they also pay more for music.” In the U.S., Spotify will be closely integrated with Facebook, allowing users to easily share songs and playlists with friends.

Rather than selling individual tracks like Apple‘s (NASDAQ:AAPL) iTunes, Spotify is a monthly subscription service that gives users access to its catalogs of music, allowing them to stream any of Spotify’s songs to their computers and mobile phones. The service will be offered in a three-tier plan, with a free, ad-supported version, a basic ad-free version for $5 a month, and a premium service for $10 a month that comes with mobile phone access, high audio quality, the ability to stream music offline, and more. The free version will begin as an invitation-only service, given to people who have requested it through Twitter or through the Spotify website, while paid subscriptions are available right away.

Spotify began in Sweden in 2008 and has since become the world’s most popular music streaming service, all before becoming available in the U.S. The service has over 1.6 million paid subscribers and 10 million registered users to date. The company as recently valued at $1 billion. However, Spotify had little competition in Europe. As a paid-subscription service, it will now face U.S. companies like Rhapsody, Rdio, MOG, and even programs like Sirius (NASDAQ:SIRI). Its free, ad-supported service will be in competition with Pandora (NYSE:P). One of Spotify’s popular premium features is the ability to listen to streaming music anywhere, including the ability to listen to tracks and playlists on one’s phone or even without an Internet connection. But new cloud services from Google (NASDAQ:GOOG), Amazon (NASDAQ:AMZN), and Apple promise to do the same thing.

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The one advantage Spotify has over its new American competitors is its speed, which allows users to play songs almost instantaneously using a peer-to-peer network. Furthermore, Spotify’s free service can lure in new users who ultimately upgrade to the premium package. However, that same free service that promises users is what worries record labels, as it could steal sales from other sources. So Ek was forced to make concessions in his negotiations with labels, placing restrictions on the amount of time its users could spend on the service. Free users will be allowed 20 hours of listening a month during their first six months, and 10 hours a month after that, and no one song can be listened to more than five times in a month.

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While labels might think that Spotify is stealing business from services like iTunes, but Spotify argues that they are more likely to lure users of piracy sites like BitTorrent who have been largely lost to the industry. Spotify will share advertising revenue with the record labels, which own about 18% of the company, bringing in money where there previously was none. In fact, it was rampant piracy in Ek’s native Sweden that drove him and his partner, Martin Lorentzon, to found the company. “I could steal a file which cost zero, had no restrictions whatsoever and had better sound quality” than legally purchased digital downloads, said Ek. “The illegal, pirated product was actually better than the one you purchased.” How could services like iTunes compete with that?

Another area of concern for labels is the size of Spotify’s royalty payments. While record labels usually receive 70% of the retail cost of a download, which usually costs about $1, they only receive a fraction of a cent per stream through Spotify, meaning the song must be streamed many times over for it to make the same amount of money as one download. However, that can add up. Last year, Spotify paid $60 million in royalties to European record labels, making it their second-largest source of digital revenue, next to iTunes.