After taking a lot of heat from artists like Beck and Thom Yorke, Spotify has finally revealed just how they give back to musicians. In an essay titled "How is Spotify contributing to the music business?" they attempt to explain how artists, from Kings of Leon to little indie bands waiting for discovery, get paid. Here's a very brief summary on how Spotify pays musicians for their music:
1) Advertising - Advertisers pay Spotify for exposure, "and in-turn fund the royalties that Spotify pays out for listening at (the free) tier."
2) Subscriptions - A Spotify subscription costs $9.99 per month. This is direct revenue for Spotify.
Spotify's total revenue is comprised by money received from these two resources.
So, how does Spotify pay musicians from this revenue? Seventy percent of all revenue goes back to the "rights holders" of the music, while Spotify pockets the other thirty percent. The seventy percent for the "rights holders" is given to record labels, publishers, distributors, and sometimes directly to the artists themselves (if they own and distribute their own music). According to Spotify, "that 70% is split amongst the rights holders in accordance with the popularity of their music on the service. The label or publisher then divides these royalties and accounts to each artist depending on their individual deals."
That's pretty much the gist of it, but you can read the full essay for yourself at spotifyartists.com.