Why Rdio's Free Music Streaming Service Is Doomed

Rdio's new free music streaming service launches into an increasingly crowded and unprofitable market that's starting to look like an investment capital bubble on the verge of bursting. Rdio, started by a founder of Skype,* joins Pandora (P), Spotify, Mog, and Rhapsody in the category, which competes against terrestrial radio, Sirius XM (SIRI) and a host of other companies -- iTunes, for instance -- that provide music in one format or another.

Aside from Rhapsody and Sirius, all of these companies offer music streaming for free and are attempting to make money by selling ads next to it. (Rhapsody and Sirius require subscriptions before users can listen to them; Rdio required a subscription until now and is currently promising no ads on its service.)

It is unlikely all these companies will succeed. We know this because Pandora, in its disclosures to the SEC, has given us some excellent information about what it costs to run a music streaming service. The bottom line: The cost of playing music for listeners tends to be more than the money you make from people wanting to advertise to those listeners.

Death by a thousand x 0.0017 cents
Pandora says it currently pays 0.0017 cents for every song it plays for a user. It doesn't sound like much but those fractions add up: Pandora made a loss of $12.3 million on revenues of $67 million in Q2 2011, mostly because of $34 million it had to pay in "content acquisition costs" -- 0.0017 cent royalties on every song played.

All of these companies are trying to convert as many users as possible to paying subscribers. If you divide their monthly subscription costs by the 0.0017 cent royalty fee, and assume that each song is 3 minutes long, you can figure out how many hours each user must listen to the service before the cost of song royalties exceeds the amount they're paying in subscription fees. Here's how it breaks down (I've used the cheapest subscription offering for each company):

• Pandora
  Subscription revenues per listener: $3/month
  Royalties exceed subs revenue after: 22 hours per week
• Spotify
  $4.99/month
  37 hours per week
• Mog
  $4.99/month
  37 hours per week
• Rdio
  $4.99/month
  37 hours per week
• Rhapsody
  $9.99/month
  73 hours per week

Spotify, Mog and Rdio all seem to have the same business model. If they survive -- and there is no reason they should, given that most of their users will not be paying for their songs -- the victor will be the one that has the most pleasing delivery system.

Rhapsody is the Bentley of the bunch: It charges the most and, interestingly, has no free option. Rhapsody will only start to lose money on any given user if that user listens to more than 73 hours a week of music -- an almost impossible feat.

Assuming Rhapsody has enough customers to survive the coming shakeout, it may emerge the winner. The music streaming companies must strike a new royalty agreement with record labels by 2015. On the numbers above, Rhapsody -- like Sirius -- ought to argue for higher royalty costs rather than lower ones, in order to put Pandora et al. out of business.

*Correction: This story originally said Rdio was a unit of Skype. Not!
Related:

• Pandora's Westergren Hints No Solution In Sight for Music Royalty Swamp
• How an Accounting Trick Turned Pandora From a Money-Loser Into a Cash Machine
• SEC: Pandora Is "Unsustainable" Due to Reliance on Legal Strategy
• Pandora Boxed In: Crippling Rise in Music Fees Set Through 2015