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Spotify is one of the most popular streaming music services in the world, and since its July debut in the U.S. and the recent launch of a deep Facebook integration , it has gained 250,000 U.S. subscribers, bringing the company's worldwide paid subscriber total to "well north" of 2m.

But it's not all good news for the Swedish-based company: while revenue grew from just over £11m in 2009 to just over £63m in 2010, during the same period Spotify's after-tax loss jumped grew by nearly £10m to £26m.

For a company that was supposed to be Sweden's most profitable music export, surpassing even Abba, the company's losses, which are largely attributable to increased administrative costs and expensive music licensing deals, might be worrisome to observers of the streaming music market. Spotify's situation isn't unique in the market; United States-based streaming music provider Pandora has also seen its revenue grow while it continues to lose money.

Spotify and Pandora should remind us of a humorous business anecdote that goes something like this: a middle manager notices that his company is losing money on every widget it sells. He goes to his boss, worried about the company's business model. The boss reassures him, "Don't worry. We'll make it up on volume!"

Of course, while economies of scale can turn transactions that aren't profitable at low volume into profitable transactions at high volume in certain markets, the reality is that you can't necessarily make it up in volume. Selling more stuff doesn't always lead to profit, and some times, selling more stuff makes profitability even more difficult to achieve.

Will this be the case for Spotify and Pandora? Time will tell. In the meantime, both companies provide useful case studies for entrepreneurs and business owners who are often led to believe that profitability necessarily follows scale. That isn't always the case, and it's important not to make assumptions about the relationship between the two, which sadly, is done quite a lot in digital businesses.

Patricio Robles

Published 14 October, 2011 by Patricio Robles

Patricio Robles is a tech reporter at Econsultancy. Follow him on Twitter.

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Stephan

Patricio, what do you think Spotify and Pandora should try to do in order to be more profitable? If increasing volume is not working, and the costs remain high, what strategy should they go with?

almost 5 years ago

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Tom Mangan

Of course the lesson of the Internet is that Amazon was unprofitable for years before it became so huge.

The other lesson is that you have to be able to become Amazon to make this work.

almost 5 years ago

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Zylun

I wonder how these companies can better utilize advertising on their sites in order to make it more effective. They already try to target ads to specific demographics, but it seems that if their advertising was more effective (ie, it generated more revenue for those who advertise on their sites), they would be able to charge more and recoup some losses.

almost 5 years ago

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Tom Arnold

Spotify's model seem extremely unconvincing to me - artists and record companies are unconvinced that the royalties are worth it (given that it is certainly replacing some paid-for downloads), and advertising can only bring in so much money per 1000 - if those economics are working (revenues vs costs) and the costs side is going to be under increasing pressure at low volumes - it can't work a bigger volumes either - since the costs are highly direct - i.e. the track revenues very closely...

almost 5 years ago

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Luke Ashworth

Perhaps I'm being naive, but isn't Spotify simply being groomed to be bought by Facebook either pre or post IPO? If that's the case the investors won't care about losses, when they simply benefit from the spiralling stock of FB?

almost 5 years ago

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Mike

Why don't they just put up their rates? Their service is priced way too cheaply in my opinion. They're obviously more focused on subscriber growth rather than revenue.

almost 5 years ago

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