Spotify's newest pitch to labels and musicians: Now You Pay Us

Spotify Technology revived the music business. Now it wants the industry to return the favor.

The streaming giant is asking record labels and artists for money to advertise their songs within its app, arguing that they'll reach new fans and increase their popularity. The effort is controversial because it's complicating wider talks over long-term music rights between Spotify and the record companies. The service has already introduced one tool, called Marquee, and is pitching a second, people with knowledge of the matter said.

"They need to diversify their revenue streams, they need to work out ways to drive higher operating margins," said Mark Mulligan, an industry analyst at Midia Research.

Spotify has already convinced a handful of artists to use Marquee, which sends notifications to listeners when artists release new songs or albums. Those participating include Justin Bieber and Lil Wayne. Gaining wider buy-in for what Spotify calls a "two-sided marketplace," connecting artists and fans, is vital.

The Stockholm-based company is under pressure from investors to boost advertising sales and prove it can turn a profit. While Spotify's main streaming business generated $6.1 billion in sales last year - thanks to the more than 120 million paid users - the company loses money because most of its revenue goes right back to the music industry in the form of royalties.

Boosting ad sales has been a struggle. Spotify has more than 270 million total users, but its advertising business trails competitors of similar size. The company generated just $678 million in such revenue last year, less than what Twitter Inc. takes in every quarter.

"They've been apologizing for the underperformance of ads," Mulligan said.

The company has identified two priorities to boost advertising: podcasts and the two-sided marketplace. Both are long-term bets, but the latter could pay more immediate dividends. Selling advertising products and other tools to music companies could yield hundreds of millions of dollars.

Spotify's approach to the two-sided marketplace has changed over the years. The company initially offered tools and services to musicians and independent record companies to help them stand out in a world dominated by major labels. The most high-profile test allowed artists to upload tracks directly to Spotify. That infuriated Universal Music, Warner Music and Sony Music Entertainment - the company's key suppliers - and Spotify canceled the program.

Now its biggest push, music companies say, is paid promotion - getting labels to pay to promote their artists.

Spotify has inserted sponsored songs in listeners' playlists, and has also discussed selling charging artists and labels for data about their habits. With Marquee, artists or their labels can pay a minimum of $5,000 to have fans notified when a new release arrives on the service. Caroline Records, an independent distributor, used it to promote rapper Trippie Redd. Kobalt Music Group has used it for five or six acts, including the Cold War Kids and Lauv.

YouTube has had a similar product, called Premieres, since 2018.

"Partners are seeing how powerful and effective it is," said Beck Kloss, Spotify's vice president of product and strategy for creators. "We're seeing repeat purchases from early customers, and on average, more than a quarter of users who see a Marquee listen to the promoted music, making it one of the most effective digital marketing tools available."

To ensure the new plan improves Spotify's profitability, the company needs support from the music industry. Under current royalty agreements, record companies get a share of all Spotify revenue. That means the labels could theoretically claw back some of the ad money they pay to the company.

Both sides agree that makes no sense - and Spotify is pressing in current talks to create a new revenue pool that major record companies don't get to share, said the people, who asked not to be identified because the matter is highly sensitive.

Yet the music companies fret that this amounts to little more than a cut in their royalty payments and sets a precedent by letting Spotify rope off a pool of money from the industry. They also enjoy a certain amount of free promotion now.

That's dangerous at a time when Spotify is funneling hundreds of millions of dollars into original podcasts that dilute the music industry's share of overall listening. Spotify's long-term plan, according to those familiar with the strategy, is to carve out podcasts from the larger pool as well.

Independent labels, meanwhile, fear that Spotify will create an ecosystem that rewards those companies and artists with the most money. Independents credit the service with boosting their market share in recent years and don't want to see those gains threatened.

"People aren't very happy about it," said Richard James Burgess, the head of A2IM, a body that represents independent labels. "Some labels feel like they'd promote music to people they will reach anyways, and it just reduces the royalty you make." Spotify had told his members the company would never do this, Burgess said.

Another concern for the major labels is that they'll set off a promotional arms race, with every artist wanting want to see their record touted at the top of Spotify's homepage.

Yet for the biggest music companies, this may just be the cost of doing business. Once one big label agrees, the others are certain to follow.

Besides, music companies routinely pay their partners to promote artists - they've long rewarded stores for the best spots on shelves.

"That precedent has been set," said Vickie Nauman, an industry consultant. "If labels are putting out a new release, they are going to get behind that with playlist placement, with billboards, general advertising, marketing everywhere."