For the business of recorded music, the first 15 years of this century were the worst of times. Revenue fell by more than half, adjusted for inflation. CD sales plummeted, with the industry under siege first from illegal downloads and then from low-payment sources like Apple’s iTunes. Downloads appeared, but their growth stalled by 2012.

Now sunshine has returned to most of the industry, thanks to a new technology – streaming, the on-demand delivery of music over the Internet to phones, PCs and devices of every sort. Two years ago, with 68 million people paying for recorded music streaming, the industry hoped this technology could halt the declines. Today, subscriber numbers have more than doubled, and music streaming brings in more revenue than digital downloads and CDs combined. This year should be the industry’s third consecutive year of growth.

So now the industry dreams of a streaming-based return to recorded music’s glory days, when the industry was filled not just with songs but with cash. Never mind that revenue is still far below its late-1990s peak; for much of the recorded music industry in 2018 … well, as artist Pharrell Williams puts it, happiness is the truth.

Through the roof?

Streaming revenues might actually be even happier than they look, because streaming delivers music at far lower cost than its predecessors. Goldman Sachs analyst Lisa Yang and colleagues estimated late last year that streaming creates EBITDA (earnings before interest, tax, depreciation and amortisation) per dollar of revenue that is three times higher than physical media like CDs, and twice as high as the download business.

The industry is trying to standardise subscriptions at a price point of around US$9.99 per month, which currently translates to A$11.99 and NZ$14.99. That’s not easy. A hefty slice of the audience gets a discount of some sort: students often pay half price, there are family bundles, and people in poorer countries pay less: in Indonesia, a month of music streaming costs about US$3.60.

These discounts raise a question: might this new well of US$9.99 buyers dry up? Might it take ever lower prices to make future consumers subscribe?

This may already be the story in Sweden, home of Spotify and one of the most developed streaming markets in the world. Streaming now commands 89% of Sweden’s recorded music market. But streaming revenue growth slowed to just 2.8% in the first half of 2017. Only so many people want a US$120-a-year music subscription.

Consumers still have alternatives to paying. Free ad-supported sources of music, such as YouTube and the free version of Spotify, represent an attractive alternative for anyone on a low income. The International Federation of the Phonographic Industry (IFPI) claims, based on recent research in 13 countries including Australia, that YouTube alone accounts for 46% of all time spent listening to on-demand music globally.

Most of the industry hates YouTube’s low payments: IFPI says the site pays less than US$1 per user annually to the music industry, compared to US$20 for Spotify. Yet much of the industry feels it needs free streaming, because removing it could force users back to systems like torrenting, where users simply share illegally copied music between themselves.

Credit Suisse, whose analysts accurately predicted two years ago that streaming would turn the industry around, also predicted that streaming would have limits. It reckoned that streaming would not carry industry revenues above US$17 billion (in 2017 dollars) by 2025 – adjusted for inflation, the same levels they were at in 1988.

The streaming services hope they can keep migrating users from the free service over to the paid versions. If they are right, the new boom could continue instead of petering out. Subscriptions could become the norm in the developed world and then spread into the growing Asian middle class as well.

Happy, happy, happy

Goldman Sachs’ analysts see the recorded music industry pushing revenue through the roof in the next few years – to an all-time high of US$24 billion by 2022, to US$30 billion by 2025 and to US$41 billion by 2030. Of that revenue in 2030, US$34 billion would come from streaming – and paid subscriptions would create US$28 billion of that streaming revenue, with the rest from ad-supported streams. At that point, 14% of six billion global smartphone owners – 850 million people – would subscribe to a music service. Some would have separate subscriptions for their cars and for voice-controlled speakers like Amazon’s Echo. 

All the new predictions of extra revenue have driven a new wave of optimism in the business, emboldening both music creators and the tech firms which now deliver that content to the market.

The industry’s biggest players are among those clapping. Goldman reckons streaming income means Sony Music Entertainment could be worth US$19.8 billion. And the biggest global distributor of them all, Universal Music Group, could be worth US$23.3 billion – three times its 2013 value.

Here comes bad news

The artists who make the music, on the other hand, aren’t all clapping along. Ever since the new digital technologies arrived in 1999 with Napster, artists have complained they get a lousy deal. This doesn’t seem set to change.

Digital analysts like to talk about the “long tail” of lower-profile artists made accessible by the new technology. But in truth the long tail seems as short of money as ever. Estimates vary wildly, but the average stream will be worth well under a cent to those who actually make the music in the first place. That’s okay for huge acts like Drake and the Weeknd and Taylor Swift, whose streams can run into the billions. But it leaves smaller acts still reliant on touring for most of their income. And the minor league stars are not the only ones struggling to make a living in the new stream-driven music industry. So, oddly, are the new breed of tech firms that have rescued the industry over the past half-decade.

Give me all you got

Take the biggest streaming business of them all, Spotify, which wants to go public soon. It has grown revenue by more than 40% per year, has now topped 70 million subscribers, and has revenue closing in on US$5 billion annually. Yet incredibly, it reportedly lost US$568 million in 2016, more than double 2015’s US$258 million loss.

And it’s not just that the company has chosen growth now so as to profit later. Even at US$9.99 monthly, streaming tunes simply costs Spotify too much. So the bigger it gets, the more it loses. Smaller rivals face the same problem.

Analysts like Rohit Kulkarni, head of private investment research for SharesPost and a former RBC Capital Markets analyst, note Spotify’s gross margin was a skinny 22% in the first half of 2017. But Kulkarni points out that Spotify’s ratio of paid subscribers to free users has been rising steadily, from 2012’s 20% to 35% in 2016. He also believes Spotify can win economies of scale as it grows. And he thinks it can cut better deals with the labels: after all, it now contributes almost one-fifth of their recorded music revenues.

Maybe that will happen, maybe not. But with Spotify becoming a stock as well as a service, the music industry’s weird economics is once again apparent. And investors need to prepare for the possibility that it could all end unhappily.

The CA at the head of Maton Guitars talks about the music industry, the family business and success on the world market

David Walker is editor of Acuity and prefers Google Play to Spotify.

Photograph: Brian Bowen Smith / Getty Images