As record labels, digital music stores, and music subscription services continue their struggle to convince music fans to pay for music, Google’s YouTube — itself a major repository of recorded music — claims that giving away music for free generates as much money for copyright holders as charging for it, with profound implications for freemium digital music services such as Spotify and the much-rumored Google music service.

According to what YouTube executives told Evolver.fm this week, YouTube can make as much money for labels as paid services, following a massive, 200-to-300 percent increase in the revenue it generates for copyright holders over the past year.

They said the growth was due to traffic increases, particularly on mobile phones; more profitable, optimized ad formats; the “Ad Word“-ization of video content (through which advertisers make videos that users “opt in” to watching); a new crop of curators who increase free music videos through blogs and social networks; more effective sales teams, particularly as part of Vevo (a joint venture between Google, major labels, and Abu Dhabi); and YouTube’s Content ID system, which allows music copyright holders to profit from infringing use of their songs.

“Our larger music partners on the site are making millions of dollars per month,” YouTube director of content partnerships Chris Maxcy told Evolver.fm. “The other thing that’s astounding is the growth in this. We’ve seen the monetization levels increase two to three times, just in the last year… Our label partners have been pretty pleased with that level, and we expect to see that growth continue. A year from now, I’m hoping we’ll be able to say ‘we increased revenue and RPMs another 2-3x.’”

Even now, says YouTube, its free music pays as well as, well, paid music. And Google could eventually get into that too.

Seven of the ten most popular videos of all time on YouTube are music videos, and another one ("The Evolution of Dance") is music-oriented.

“We’re not tied to any one payment model, per se,” explained Phil Farhi, a product manager from Google’s YouTube monetization team. “We’ve been very focused on advertising so far, but there are users who will pay for content with their money, and users who will pay for content with their time and attention. We’ve been focused on [the latter]. What we’re seeing is that by really optimizing everything, you can make just as much money for a label as the others.”

Some don’t see the value of free music, he says, because they’re too focused on its price.

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“These are the traps that people fall into: They look at price tags for advertising[-supported services] versus price tags for subscription or downloading services,” added Farhi. “But you really need to consider not just the price tag, but the scale of audience and views that you’re reaching with that.”

Offering something for free drastically increases the rate at which people consume it. This is basic micro-economics, and is to be expected. We all want a free lunch. What’s more surprising is YouTube’s claim that a well-optimized free music service generates revenue equivalent to that of paid services like iTunes.

“If you were to look at the numbers for Lady Gaga, the number of views she gets on YouTube versus downloads that she gets on iTunes, obviously, a single download on iTunes will pay her more than a single view on YouTube,” said Farhi. “But when you look at the traffic — the number of people that are coming back and watching her videos over and over again, watching her videos before they download the song, or discovering them on YouTube — you can see how that scale can compete with a paid service.”

The difference between offering music for free and charging for it has a special resonance as music is increasingly delivered by apps running on smartphones, computers and eventually televisions and car stereos. Small developers unable to negotiate their own licenses with the labels, but who nonetheless wish to integrate full-track playback into their apps, face a stark choice. They can either integrate YouTube videos for free (Discovr), or integrate a subscription service that limits non-subscriber listens to 30 seconds (MusicMapper).

Last week, we took YouTube to task for potentially damaging the music industry by providing users and app developers with a free, on-demand alternative to subscription services such as MOG, Rdio, Rhapsody or Spotify.

“You raised some interesting issues with respect to some of these applications out there,” YouTube director of content partnerships Chris Maxcy told Evolver.fm. “Our general philosophy is that we like to make our content as widely available as possible. We want to be the biggest entertainment platform in the world, and we think we are already. We want to make sure that we can get videos to people in a variety of ways… That’s the positive side, but whenever you have a goal like that, and you set your system up that way, there’s always the risk that there will be a small number of people in the world who abuse your good nature and the ability to get access to that content. With our APIs, the vast majority of developers are complying with our terms of service.”

YouTube’s API terms of service specify that developers who add full-track playback from YouTube can only make non-commercial apps, must show the videos, as opposed to stripping them out and only playing the music, and must include YouTube’s ads with those videos.

Songza, Muziic, and other services crossed those lines in years past, after which YouTube denied or threatened to deny them access to its API.

“I think applications integrating music is a great idea, and there are plenty of robust music services out there. I think it’s better for an application developer to… make sure they’re complying properly, versus thinking that they can temporarily and maybe inappropriately access our platform,” said Farhi. “They’re going to get shut down, and it’s going to be a bad user experience because the YouTube videos won’t play anymore one day.”

So, that settles that: If app developers push the YouTube integration too far, they’ll get cut off, and YouTube has shown that it’s willing to take such steps in the past. However, its contention that free music pays as well as paid music indicates that app developers would be wise to include both options: YouTube videos for music fans who don’t want to pay, and Rdio or some other subscription service for those who do.

Ultimately, the real beneficiary of the revelation that free and paid music can generate equivalent revenues could be Spotify, or even Google itself.

Farhi noted Spotify’s success on the Facebook platform in Europe, where users embed Spotify songs within their feeds that anyone can hear (the free version plays up to 20 hours of music per month). In addition, Spotify integrates directly with Facebook as a music sharing network. In the United States, however, Facebook users overwhelmingly prefer YouTube for embedding music, as any U.S. music fan on Facebook has surely noticed.

Spotify has long maintained that its allure lies in being able to monetize the free listening that some people are always going to engage in, through advertising, while those who are eventually willing to pay for extra features (smartphone apps, offline playback, higher sound quality, and no ads) can do so without switching to a new music service and losing all of their playlist, ratings, and friends.

If the lesson of YouTube vs. paid music services should teach the music industry anything, it’s that Spotify — or something like it, which finally joins the equally lucrative sectors of free and paid music — could boost overall revenue to a struggling recorded music industry.

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