Last.fm is paying royalties to the labels and independent artists whose tracks stream on the service. In the past, the royalty for on-demand tracks has been about a penny per play, which is significantly higher than webcasters pay. To cover those costs, Last.fm plans to sell advertisements. That's a business model that CBS, which paid $280 million for Last.fm, understands quite well. Not only is it a commercial TV network, but it's also one of the five largest commercial radio-station groups in the U.S. Not that Last.fm would want to port CBS' broadcast advertising model to its service -- its specialty is understanding each user's tastes based on what he or she chooses to play, so it's well positioned to target advertising to individual listeners. Such targeting commands a higher CPM, which means Last.fm wouldn't have to assault users with so many marketing messages.

When I played with Last.fm this morning, though, I didn't see anything other than Google-powered ads. No commercials in the audio stream, no display ads -- nothing that could cover the royalties I was incurring by playing track after track on demand. So it remains to be seen what Last.fm's strategy is. The free-music-on-demand field has been a tough one, with many announcements but few real entries (consider, for example, the often-delayed Qtrax and vaporous Mashboxx). With CBS' backing, Last.fm might be able to search longer for a workable formula than the typical start-up. But at some point, it has to find a way to pay the bills.

Update: I neglected to mention three advertiser-supported on-demand music services that have been on the market for a while: RealNetworks' Rhapsody 25, which offers 25 free plays per month; Napster's free.napster.com, which offers unlimited listening but restricts the number of times individual tracks can be played; and iMeem, which lets users play the songs posted by other users. IMeem is closest in approach to Last.fm, combining a social network with a media outlet.