Spotify set for the big time as regulators scuttle the pirates

Sweden's Spotify is about to take its music business global. Nick Clark reports

Spotify is at the forefront of a music revolution. Less than a year after launching it has an audience running into the millions, and offers the music industry a viable chance to take on the pirates. The only problem is making it pay in the long term.

This week could prove extremely significant in its evolution. Apple approved one its application for the iPhone, a core part of the development of taking the service portable. At the same time the rescue of rival Pirate Bay looks to have run aground.

Apple's approval surprised the industry, as the service will be a direct competitor to its iTunes service, which currently dominates the digital music business. The application will allow Spotify users to take their music away from their desktop computers for the first time.

Spotify allows listeners to stream songs to their desktop almost instantly without actually downloading them. They can choose from an eve- expanding list of tunes that hit six million earlier this year and is expanding by 10,000 songs a day, create playlists and share them with friends. The group itself says: "Our dream is to let everyone listen to whatever they want, whenever and wherever they want. Instant, simple and free."

The rise of Spotify – the name is an amalgamation of spot and identify, "to help you spot and identify the favourites you forgot about" – is extraordinary as it has existed for just three years and went live in October.

It was set up by 25-year-old Daniel Ek, who started his first company at the age of 14. He started the company with Martin Lorentzon, who co-founded the online advertising group TradeDoubler. It now has 75 employees, with headquarters in London and its research and development facilities in Sweden. The founders say they have invested €8m (£7m) and received a further €15m in funding from Scandinavian groups.

Beyond its home country and the UK, Spotify is available to users in Norway, Finland and Spain. "We hope to launch in more countries in the future," it said. The big one is the US, and the group is currently fundraising. It has also held talks about taking the service to China.

Spotify this year secured investments from the charitable foundation of Li Ka-shing, the Hong Kong tycoon who invested in Facebook, and the venture capital group Wellington Partners. The $50m investment is understood to value the group at $250m.

It seems to have shrugged off the first issue facing such sites in Europe; they haven't proved popular. Dan Cryan, analyst at Screen Digest, said: "The track record of music 'rental' services in Europe is terrible," but he added: "This is a service of convenience." Two million have signed up already, and most use it for free.

The free version is funded by 30-second adverts about every half an hour. But analysts have cast doubts on how effective the model will be if it remains the overwhelming choice of consumers. "The advertising model has significant question marks over it," Mr Cryan said. He asked how much the ads were generating, and added that the company has to pay royalties every time it plays a song.

To remedy this, the group is pushing Spotify Premium, part of the growing trend of services described as "Freemium". Spotify says this is the service in its purest form.

Listeners willing to pay £9.99 a month will gain access to the library without the imposition of advertising. They will be offered exclusive material – in February users had access to U2's new album a week before it was released – and have the ability to stream at a higher bit rate of 320kb/s, double the free service. It has also tied up with the online retailer 7digital to boost revenues. It will allow users to download the tracks as they listen to them. Spotify will take a commission from each track sold.

Mr Cryan said: "Music is increasingly becoming a commodity. Our understanding is that the premium model has to take off for the business to take off. Whether the Freemium model is enough remains to be seen."

The market is also filling with rivals including Last.fm, Deezer and TuneArea.

Mr Cryan said the company would have to have more cards up its sleeve like the iPhone application, "which is undoubtedly an important piece of the puzzle to flesh out its pay-for model. Like pay TV, it has to convince the users there is something worth paying for, like the application and the exclusive content".

The music industry sees Spotify as a shining light in its battle to bring those unwilling to pay for music away from the illegal downloading sites. Sony BMG, Universal, EMI Music and Warner Music have signed up to support it. Mr Cryan said: "Does it bail out the music business? No. Does it help? Undoubtedly yes."

The most visible was Pirate Bay, which the music and film companies took to court earlier this year. It was found guilty of infringing copyright law in offering free file-sharing, and has appealed. Despite services like Spotify and the UK Government proposing legislation to cut off illegal downloaders, the International Federation of the Phonographic Industry estimates that 95 per cent of music downloaded is done so illegally. However, Pirate Bay's future is unclear after talk that its proposed takeover, and incidentally one that will make it legitimate, by Global Gaming Factory X has hit the rocks.

From recent studies it seems that youth attitudes towards streaming aren't great, with many putting a premium on owning the content. "Spotify has enjoyed huge success but it has a few things to iron out to secure long-term growth," Mr Cryan said.

Northern lights: The country 'democratising' digital media

Sweden is rapidly becoming the standard bearer for free media and communications in the digital age. Some have suggested that the country's social democracy mindset drives it towards this "democratisation of culture".

Spotify is just the latest in a string of successes. In 2003, the Swede Niklas Zennstrom launched Skype with a team of Estonian developers and Dane Janus Friis. The software allows its more than 405 million users to communicate via their computers for nothing. Like Spotify's deal with Apple, Skype has also gone portable following a deal with the mobile phone company 3 this year. It was bought by eBay in 2005 for $2.6bn, but the acquisition has proved problematic as the parent was forced to write the value down and announced plans to spin it off.

Skype's founders had previously launched Kazaa to share video and music files and Joost, a service that provides broadcast-quality television on demand. Other successes include TradeDoubler, the online marketing site, and the legal film downloading service Headweb.

Most notorious is The Pirate Bay, launched in 2003, which forced the music and film industries to take up arms. The website soared to 25 million users before running into legal difficulties. The group agreed to a takeover approach from Global Gaming Factory X, which now appears to be in doubt.