Spotify Turns Up the Volume on Pandora

Spotify is getting serious about building its audience in the U.S. The London-based music-streaming service said today it’s introducing an online-radio feature to its music offerings, a move that competes directly with Pandora. Spotify’s initiative is likely to push the crowded market of streaming-music providers – which also includes Rhapsody, MOG, Rdio and offerings from giants like Apple, Google and Amazon – into a period of consolidation.

As popular as cloud-based music is becoming among consumers, it’s proving to be a good way for companies to lose money. In its last five fiscal years, Pandora has had an aggregate operating loss of $69 million. Spotify showed a $68 million operating loss in two fiscal years through 2010.

The biggest expenses, of course, are royalties, usually paid through a performance-rights organization like SoundExchange. Some digital music executives have argued that the royalties and other demands of content owners are so onerous that Spotify and other companies will never be profitable.

That’s not stopping Spotify from spending more money. The company updated its iPhone and iPad apps to allow free access to its 16-million-song database, letting users create instant Pandora-like radio stations tailored from songs, artists, albums and playlists. Spotify pays a royalty every time it streams a song, so more users listening to more free songs on their mobile phones is bound to rack up more costs.

Spotify is covering some of the outlays with ads from big advertisers like Chevrolet, McDonald’s, Taco Bell, Verizon Wireless and Warner Bros. U.S. listeners who tune into the new radio stations will hear two or three minutes of commercials per hour. Premium users can listen commercial-free.

The news is being greeted as bad news for Pandora, which also relies on ads but continues to struggle with operating losses. Pandora has a large share of the U.S. online music market, although it’s increasingly facing competition not just from Spotify but also from challengers like streaming upstart Songza and e-tail giant Amazon.

Pandora has 150 million registered users and 52 million active users, with 87% of its revenue coming from ads and the rest from premium accounts. Spotify claims 10 million users worldwide and three million paying subscribers, and aims to increase those numbers by poaching Pandora listeners.

As the business of cloud-based music evolves, companies are adopting each other’s features, making it harder for consumers to distinguish between them. Pandora’s radio stations generate playlists according to algorithms, while Spotify relies on the social graph of its users, many of whom log in through their Facebook accounts.

But as the differences separating online music companies erode, and as the losses continue to mount, the industry will tend toward consolidation. Smaller companies will merge or be bought out by a deep-pocketed giant that wants to beef up its customer base. For the rest, it will be a matter of time before the music stops playing.

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