Not only is Union Square Ventures partner Fred Wilson the godfather of the New York startup scene, he also loves music. So who better than this self-proclaimed music nut to talk about the future of music and technology, and how companies straddling both have a shot at making money.
At the Billboard FutureSound conference in San Francisco this week, Wilson laid out four guiding principals for would-be music moguls. All you Russell Simmons wannabes, here you go.
1. It’s more expensive than you think, and it takes longer than you want.
Unlike a typical software startup that can get up and running with $500,000, music startups often need at least $5 million and up to $20 million just to get started, says Wilson. Much of that money goes towards licensing music content from the copyright holder, which is usually a record label. “The startup costs for a legal and legitimate music service are extremely high relative to any other sector,” he says. Translation: VCs have plenty of other cheap sectors to go hunting for promising startups, so funding for music startups is hard to come by.
Union Square Ventures‘ two music plays are group listening service Turntable.fm and social MP3 sharing site SoundCloud, both of which received sizable rounds from the firm. Turntable.fm has raised $7 million from Union Square and others, and SoundCloud banked $10 million in its Wilson-led second round of funding.
Unlike many web-based startups (mobile and otherwise), which latch on to massive distribution platforms offered by Facebook, Google and Apple, music streaming or discovery services can’t go global on day one because of copyright protections and country-specific licensing contracts.
Turntable.fm learned that lesson the hard way. When the service launched in 2011 it blew up thanks to its slick design and mobile-friendly approach. But the startup quickly learned that it was illegally offering music to overseas listeners. It immediately shut off service to international customers, and two-thirds of its users disappeared. The company is now hammering agreements with individual countries and record labels to stream music legally, but it’s going to be a long and tedious process, says Wilson.
2. No matter how many users you have, massive valuations are fleeting if you can’t make money – even if you are Spotify and Pandora.
Spotify recently banked $100 million from Goldman Sachs, valuing the company at $3 billion. Even though Pandora has been trading down 46 percent from its 2011 debut, the company still has a $1.21 billion market cap. But those valuations will disappear if neither company can stem their operating losses, and fast, says Wilson.
A PrivCo report shows that while Spotify earned $244 million in revenue during 2011, the company lost $60 million in the same period. Even though a leaked report says that Spotify’s revenue could double in 2012, if the company losses keep climbing, Wilson says Spotify’s value won’t stay in the billions forever. “Spotify is probably not worth $3 billion,” he says. “It might be worth something, someday to someone, but if they still can’t figure how to make money, they’ll lose.”
Pandora faces the same struggle as Spotify, trying to get users, not advertisers, to pay for its service. For the second quarter of its 2013 fiscal year, the company booked $101.3 million in revenue, but lost $5.4 million. Though its advertising revenue remains strong at $89.4 million, it is having a hard time converting freeloading listeners into paid subscribers, despite its own ad attempts. “Pandora will not be worth billions for long if they are losing money,” Wilson says.
3. That said, Pandora has the right idea. Advertising dollars will move increasingly to internet radio, and artists will start to make money from their music.
FM radio advertising is a $17 billion market, and Wilson believes that as Internet radio services like Pandora, Songza, and Rdio take the place of traditional broadcast, those ad dollars will move online. That’s good for online radio streaming startups, but even better for the artists whose music is played over these apps and websites.
When a song is played on the radio, the artists gets a royalty. But to play a song over Rdio or Pandora, those companies must pay licensing costs and higher royalties, which go right back to the artists. Pandora has said that it pays out $1 million to Adele, Coldplay, and others.
Wilson is optimistic that as more music enthusiasts ditch radios for apps, more money will find its way to artists. That might be the case for radio apps now, but that could easily change as Pandora has been looking for ways to reduce its royalty costs. The company recently sued the American Society for Composers, Authors and Publishers, a major royalty collection agency, seeking lower licensing fees. Pandora is also lobbying Congress to pass the Internet Radio Fairness Act to bring down it’s licensing costs, a piece of legislation that many artists oppose.
4. Selling virtual goods might be a better business than selling music.
Wilson would be remiss to not plug his own investment in Turntable.fm during his keynote. If you’re not familiar with the service, users create themed music rooms, like “I Love the 80s” or “Indiescribable,” which they join as a virtual DJ. Others join the room as listeners, and influence which songs are played based on a thumbs-up/thumbs-down voting system. Too many down-votes will force the song to skip to a new one on the playlist, but up-votes earn you “DJ points,” credits you can use to unlock new avatars.
Turntable.fm doesn’t charge its users for a subscription and doesn’t serve ads. Though it’s not bringing in revenue right now, there is talk of charging for DJ points, so anyone can get a little bit of cred without getting up on the virtual DJ platform.
While that will surely vex some current Turntable.fm users, charging for virtual goods might be the next big revenue-earning tool for music businesses. “Ads can carry a lot of the load, but not all,” says Wilson. “Turntable.fm’s virtual goods model could work well as a new revenue stream for other music businesses.”
So You Want in on the Music Biz? Fred Wilson Has 4 Things to Tell You
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