The New Economics of Online Music: How Listeners Will Pay for Free Streaming in 2016

Digital music services have explored a variety of business models in the quest to attain profitability, with most listeners inclined to ignore industry ups and downs. But whether listeners realize it or not, the era of blissful ignorance has just come screeching to a halt for many digital music fans with a monumental decision by the Copyright Royalty Board to change the way streaming radio royalties are calculated.

The Rising Cost of Doing Business

As of January 1, 2016, non-interactive music streaming services are paying $.0017 in royalties per stream, up from $.0014 during the previous rate term. Simply put, when multiplied out into millions of plays, it just got a lot more expensive for services like Pandora and iTunes Radio to provide streaming radio.

In an industry where profitability has often appeared elusive or even optional, this may not seem like cause for concern. In fact, investors were pleased that mega services like Pandora weren't hit with worse news.

But in the short time since new streaming rates were introduced, changes have already begun reverberating through the industry; numerous small and niche webcasters have closed up shop, there has been talk of Pandora seeking to get acquired, and Apple has terminated free access to iTunes Radio.

Free Streaming Is in the Hot Seat

Until this year, streaming radio services have leveraged a complex array of royalty payment options to make free streaming financially viable. Under the new rate structure, free streaming has become the most costly online music delivery option, putting increased pressure on music services to generate enough advertising revenue to break even.

Regardless of its rising cost, free streaming radio remains a hugely popular listening option. Some companies, such as Apple and Tidal Music, have chosen not to participate in the free music streaming market, and others may follow suit. But many services, both large and small, depend on free streaming as a way to attract and retain users, and are committed to maintaining a free service tier.

In order for free streaming radio to survive in the new online music economy, audiences will be called upon to make some sacrifices and take a more active role in supporting the services they enjoy. There are three significant changes free streaming radio fans can expect to see in 2016 and beyond:

1) The End of Anonymity

The most fundamental change free streaming listeners will start to notice is that anonymous access is going to become harder to come by. As users are increasingly required to provide personal information, they need to understand that this is a necessary tradeoff. The bottom line is that registered users can be much more accurately targeted and effectively monetized through the online advertising that covers the royalty costs associated with free streaming.

The same is true for third-party online radio platforms, which create an identity firewall between music services and listeners. Free streaming listeners will be increasingly steered toward direct engagement with the music services they enjoy. Only the lowest-value advertising models can be applied to anonymous and indirect users, and those ads are just too cheap to cover the cost of royalties.

2) A Push to Paid Subscriptions

Music services with freemium offerings won't expect all their free listeners to step up to premium-level service. But due to the added cost pressures around free streaming radio, more free listeners will be encouraged through direct, targeted engagement to convert to premium subscriptions.

In addition to seeing more targeted marketing of premium services, free listeners can also expect to see the benefits of premium service grow with cutting-edge features, exclusive content and special offers not found at the free service tier.

3) Austerity Measures in Effect

While premium services undergo continual improvement to drive subscription revenues, free listening will increasingly be considered a cost center. As a result, fewer development resources will be dedicated toward the free listening experience. In addition, more resources will be devoted to generating adequate advertising revenues to cover royalty costs.

Not only will free listening lack the bells and whistles of premium offerings, but it will likely be subject to increased limitations, including shorter listening sessions and restrictions on access to exclusive music content as dictated by artist and label agreements.

An Awkward Phase for Free Streaming

Today's free streaming landscape is in an awkward phase; the advertising industry has not caught up with the online music industry's need for the high-value advertising models currently seen in the mobile and online video markets. But with newly intensified pressure to monetize free streaming radio, it's only a matter of time before digital music advertising catches up and fully capitalizes on this need.

In the meantime, online music fans who want to continue enjoying free streaming radio need to be patient and flexible while the market adjusts to user demand. There is still a place for free streaming radio in the new online music economy, but only if business models and listeners are able to adapt to the new financial realities of the online music industry.