Right now, music streaming services, such as Spotify and Pandora Media Inc (NYSE:P) are a big hit. New services come online almost monthly, all battling it out for that coveted number one position at the top of the popularity charts. Judging by the take-up figures, music fans like them. They’re convenient and, with a low monthly subscription fee, relatively cheap, compared to buying physical product, or downloads.

Spotify Facing Lawsuits And Musicians Are Pulling Out

But what about the content providers? Big name artists are removing their music from these services, stating that low royalties make it economically unviable to sell their music. At around $0.005 royalty per stream on Spotify (1/140th the revenue gained from an iTunes download), it’s not hard to see why.

Spotify raging against the machine

Pink Floyd is seething at Pandora Media Inc (NYSE:P), Aimee Mann has filed a lawsuit against Medianet, and Thom Yorke of Radiohead fame has pulled his solo album from Spotify, saying:

“Make no mistake. New artists you discover on Spotify will not get paid. Meanwhile shareholders will shortly be rolling in it.”

But the question is: for how long? If bands continue to leave the streaming services, how long will it be until the fans look for their music elsewhere too? As it stands, there’s little left for artists after shareholders recoup their investment and providers cover their costs. Which, in turn, means no funding for new music.

Is Spotify killing the cash cow?

Mark Williamson, director of Artists Services at Spotify says that 70% of their revenues go back to the people who own the rights to the music. But Spotify has steadfastly refused to be transparent with their royalty pricing and, in many cases, it isn’t the artist that owns the music—it’s the record label.  “We have to do deals with tens of thousands of entities to get these rights, but whereas there are specific differences in their deals, across the board, really they’re equitable,” says Williamson. “We’re not massively favoring major artists. We’re providing a level playing field for all artists on the service.”

Spotify say they will have paid out $1 billion in royalties by the end of the year, but considering that most of these royalties will go to record companies who negotiated secret deals for long dead artists with big back catalogues, how much will working artists and songwriters actually see for their efforts?

Don’t give up the day job

Damon Krukowski of the band Galaxie 500 is keeping tabs on his streaming earnings. His song, Tugboat, was played 7,800 times on Pandora Media Inc (NYSE:P) in the first three months of 2012. His revenue? 21 cents! That’s a grand total of 7 cent for each of the three songwriters. They did slightly better with Spotify. For a total of 5,960 plays, they were paid $1.05.

Galaxie 500 can count themselves among the fortunate ones. Their songs aren’t owned by a record label. So they get another royalty for being the owners as well as the musicians. Pandora Media Inc (NYSE:P) had to pay them $64.17 for the quarter for this privilege and isn’t happy about it. The corporation is currently lobbying to have this extra expense removed.

Meanwhile, revenues at Pandora Media Inc (NYSE:P) for the 2012 fiscal year were up 56% at $427 million. The stock currently stands around $18.40. Yet both Pandora and Spotify still managed to report losses of tens of millions. So where is all the money going? One group is making money. Pandora’s executives sold $63 million of personal stock in the company in 2012. Do they know something the rest of us don’t?

Yet Spotify’s CEO, Daniel Ek, says that it isn’t about profit:  ‘The question of when we’ll actually be profitable seems irrelevant. Our focus is all on growth.”

He is, of course, talking about growth of the company, not the music industry. In Spotify’s world, the music is irrelevant. Nothing is being reinvested back into the product they’re selling. With all the money going to shareholders, execs and expansion, there’s nothing left to fund new music. So musicians are giving up and going back to their day jobs. And if this continues, well, there’ll be no profits left for anyone to share.

A self-defeating business model

At best, Pandora Media Inc (NYSE:P) and Spotify are going against one of the fundamental rules of business: you sell something for more than it costs. Pandora and Spotify sell music for much less than it actually costs to make and this is where the streaming model fails. It’s all short-term gain. Something perhaps felt by Chief Executive of Pandora, Joseph Kennedy, when he stepped down earlier this year to ‘get to a recharging station sooner rather than later’.

Sales might be rising, but losses are accelerating year-on-year at both Spotify and Pandora. Profitability looks more distant than ever.

Music is going nowhere

So what happens if and when the streaming bubble bursts? Obviously, people will still want music. CD sales have been falling for years, as witnessed by the demise of many big music retailers, but there’s another trend being ignored – the re-emergence of vinyl. Sales at small independent stores, springing up across the US, show sales of vinyl up 100% year-on-year, and it’s a phenomenon spreading to other countries.

The truth is, music fans are loyal to the artists they love; they’re not fans of corporations looking to make profits for shareholders, especially when those organizations are selling their heroes short. The likes of Spotify and Pandora Media Inc (NYSE:P) would be well advised to take notice of that. The old entertainment industry adage is true: be nice to people on your way up, you’ll meet them on your way down.