By BEN SISARIO
Since it emerged in the 1990s, digital music has been hugely popular with fans, but for online music companies and their investors it has almost never been profitable.
And yet the money has again started pouring in.
Pandora, the popular Internet radio service, filed for an initial public offering in February that would raise $100 million. Spotify, a highly lauded European service, is reportedly raising $100 million from private equity firms to help it come to the United States.
And those are just the big fish. Since the end of last year, at least $57 million in venture capital has gone to digital music start-ups, ending a recent financing drought and setting up an array of young companies like Rdio,SoundCloud and RootMusic in an already crowded marketplace.
The heightened interest in a field that has had few winners and a vast graveyard of losers has left some longtime executives and analysts scratching their heads. Faced with thin margins, persistent piracy and expensive licensing deals from record companies, dozens of digital music start-ups have collapsed over the last decade, taking with them hundreds of millions of dollars in investment money. EvenApple, the largest music retailer, has long maintained that it makes little profit from its iTunes store, which has sold more than 10 billion songs since 2003.
“A number of the investors have not invested in digital music before,” said David Pakman, a venture capitalist who is the former chief executive of the download serviceeMusic. “Usually the ones who have, have learned over the decade that it’s an impossibly hard place to make money.”
Even more challenging for start-ups, two very big players are expected to introduce cloud-type music services this year: Apple and Google.
But more bullish investors point to technological developments and shifts in consumer behavior as signs that the business is about to turn a corner. These changes include the migration of digital media libraries from personal computers to the remote storage of the “cloud,” as well as the explosive success of smartphone applications. Pandora’s apps, for example, have been the biggest factor in driving that service to 80 million registered users, up from 46 million a year ago. (A basic, ad-supported service is free; the upgraded version, with no ads and higher-quality audio, is $36 a year.)
“Services like iTunes, Pandora and Spotify have shown that with the right product and the right business model, you can effectively monetize digital music, which is kind of new,” said Doug Barry of Selby Ventures, an early Pandora investor. “The last time around it was mostly about file-sharing and limited monetization.”
Rdio, which streams music by subscription, was founded by Janus Friis and Niklas Zennstrom, the entrepreneurs behind Skype, and the company recently announced that it had raised $17.5 million, some from the founders’ own venture firm, Atomico.
SoundCloud, which distributes user-generated audio content, said in January that it had raised $10 million. Over the last several months Slacker, Songkick, TuneUp, FanBridge, RootMusic and 3G Multimedia have each brought in $2 million to $6 million, according to figures reported by the companies and in the news media.
What most new services do not have yet, however, is a critical mass of paying users, usually defined in the millions. Investors look to the 20 million subscribers at both Netflixand Sirius XM Radio as signs that consumers are willing to pay for streaming content.
Yet those kinds of numbers have remained elusive throughout the history of digital music.Rhapsody, a streaming service begun in 2001, has 750,000 subscribers; eMusic, which sells downloads, has 400,000. Spotify, which has free and paid versions, has 10 million users in Europe, but only 750,000 of them pay (the rate is about $15 a month), a ratio that concerns the record labels.
“Until you get scale, it’s just too hard of a business to work,” said Tom Andrus, who is on the board of Rhapsody.
In another challenge, Apple announced two weeks ago that it would take a 30 percent cut of subscription fees and other purchases through its App Store, a move that digital-media companies of all kinds have criticized as being too steep.
Many investors say that while the labels’ weakened finances have led them to make slightly more friendly deals, they remain tough negotiators. Spotify, for example, recently signed contracts for American distribution with Sony and EMI, but only after more than a year of talks. (Spotify, as well as three of the four major record companies, declined to comment for this article.)
Partly as a way around the record companies, there has been a particular interest among start-ups for services that avoid license negotiations. These include Internet radio — although they still pay royalties set by statute — as well as ancillary businesses like ticketing and concert listings. Yet the focus remains on services that provide music to listeners, and many veterans of the field are skeptical that any of the new models can bring in the revenue to sustain a company.
“People are tantalized by the notion that all music is going to be digital, and that there’s a massive global demand that is not being met,” said Dave Goldberg, a former general manager of Yahoo Music who is now chief executive of SurveyMonkey, an online survey company. “But I don’t know that there’s a good solution out there for anybody who’s rationally looking at this as an investment.”
Pandora’s public offering brings some much-needed market glamour to the digital music business. But even some of the bulls caution that despite hope on the horizon, more music start-ups will inevitably end up in the digital graveyard.
“I think it will get overfunded,” Mr. Barry said. “At the end of the day there is a limit to how many people will pay a hefty subscription.”
“But in that process,” he added, “great services will be built.”