Is Spotify Making Life Difficult For Sirius XM And Pandora?

Includes: P, SIRI
by: Spencer Osborne

When Spotify launched in the United States, there were many who questioned whether it was too late for another audio entertainment service to enter the market and expressed doubts as to how much traction it would have. After all, the U.S. market has a lot of terrestrial radio stations, satellite radio through Sirius XM (NASDAQ:SIRI), and established Internet radio companies like Slacker, MOG, and Pandora (NYSE:P). Was there room for Spotify? So far, the answer is Yes.

A key to Spotify's successes has been what appears to be a long-term plan aimed at becoming the major player in Internet radio. The company has a pretty cozy relationship with Facebook that has resulted in a massive influx of interest and traffic for Spotify. Essentially, the Spotify timeline, since its U.S. launch, has been patterned by a string of successes that appear aimed at the company's goal of becoming the "OS of Music"

This week, Billboard's Glen Peoples pointed out an interesting factoid about Spotify that may be yet another hint that the company could be a driving force in audio entertainment. All 12 of the new apps introduced this week on the Spotify platform come from or are backed by the record labels. That's right... Those "evil" record lavels that collect massive royalties from services like Spotify, Pandora, and Sirius XM are literally in business and partnership with Spotify. Is a cozy relationship like this healthy for the audio entertainment business? Only time will tell.

One thing we do know is that Sirius XM's Mel Karmazin has stated publicly for about the last year that he is trying to cut direct deals with the labels. One benefit of a direct deal is that restrictions on recording and the number of times an artist is played are lifted. In theory, the company can save some money as well. As yet, Sirius XM has not been successful in such a deal. It is for this reason that its new retail player, called the Lynx seems, neutered when it comes to capability. With no direct deal, many features that the company wants to have on the Lynx simply cannot be accomplished. Perhaps Spotify has navigated a path to work with the record companies that Sirius XM overlooked.

Imagine if the Sirius XM Lynx, which operates on an Android platform, was capable of allowing apps in the same manner as Spotify's! Imagine a radio that allows apps to enhance the service. Imagine a radio that allowed you to integrate social media like Twitter and Facebook. Imagine a radio that has all of the features consumers really want as they experience music. While it may not be the desire of Sirius XM, it may need to open up some doors to the labels, like Spotify did, in order to be able to get the direct deals it wants. In some ways Spotify has changed the landscape for a company like Sirius XM. What might have been a workable deal with the labels a few years ago might not seem so workable today.

How does all of this impact a company like Pandora? Pandora has no direct deals with the labels and shells out a hefty sum in royalties. In fact, the current royalty deal is seen by many as the bane of Pandora's existence, and the one ingredient that is keeping the company business model down. While the labels certainly want their 2 cents, they also do not want to see Pandora fail. They would literally be biting the very hand that feeds them. There needs to be some sort of happy medium, yet month after month pass without an end in sight to the frustrating situation that has been the relationship between artists, labels, and audio entertainment companies.

Three years ago, there was terrestrial radio, Sirius XM, and on the Internet side of the business, Pandora. Those were the big players. Spotify entering the mix last year with its own plans could very well have thrown a proverbial monkey wrench into the workings and plans of Pandora and Sirius XM. It is not that Spotify is gunning to bury everyone else, it is simply that the Spotify agenda may have presented opportunity for labels that previously may not have really existed.

Spotify, Sirius XM, and Pandora can all coexist and enjoy success, in the same manner that Ford, GM, and Chrysler can. These audio entertainment companies each have a niche that carries a core audience. Yes, there is crossover, but at this point it is minimal. The dynamic here is that record labels would rather see a diverse field of suitors for their content as it creates "bidding" competition. To add insult to injury, the labels are now getting into the delivery side of the business themselves, and that is what is scary for companies like Sirius XM and Pandora.

Somehow the newest player (Spotify) in the U.S. market has gone from nothing to something quite substantial in less than a year. While some may not feel that Spotify represents competition, it is now impossible to ignore the fact that Spotify is having an impact on business. It is for this reason that it is prudent to follow the sector as a whole if you are invested in Sirius XM or Pandora.

Disclosure: I am long SIRI.

Additional disclosure: I have no position in Pandora