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I wonder how they plan to recoup royalty losses from this? Is this just a marketing investment?
It's simply a remote control for the spotify app. They're repaying royalties using subscription payers and ad plays.
Works horribly.

I'm used to:

    1. Click "Play"
    2. Hear music
Now, I get:

    1. Click "Play"
    2. Get to a screen that tells me to download Spotify
It works perfect when you have the Spotify app open. But indeed, when you don't have it installed or open, it's not really as intuitive as it could be!
Strange, for me Spotify just starts and the music begins toplay.
That's because you have to have Spotify installed for this to work.
On the Linux version of Spotify it opens the application but doesn't start to play
Mine started fine, running Mint.
It plays in the background if you have Spotify and a browser which supports CORS.
Lucky, you :)

I get to see only "Sorry, we're not available where you are."

Yes, this is too greedy.

The only way this would've worked was if it played instantly regardless of whether you have spotify, an account or not. While it plays you might of course at the same time (discretely) mention that you can download the spotify app for a better experience.

This could have been a great way to advertise spotify (in theory replacing an extremely popular use of youtube (that youtube is used as a means to discover music is proof that this is an area just waiting to be disrupted)).

No one will use these play-buttons as their main music source so spotify won't loose anything in providing this. Perhaps even a short commercial after the track have been played if you don't already have the client installed would have been an perfectly fair way of recouping whatever "lost" on providing a free listen.

Almost saddens me they didn't realize this.

You forgot step 3: Angrily give up because they require a Facebook account to sign up.
Here is how it "works" for me:

1. Click "Play" 2. Get a message saying that the service is not available where I live.

Can you play songs without a Spotify account?
No. All the button appears to do is open spotify and play the requested song. It does at least sync that playback to the widget though so you can see the song progress and interact with it etc.
No: it doesn't even seem to play back embedded in the page. It launches Spotify and then starts playing the selected track. If you don't have Spotify you're prompted to download it.
OK so it's basically the same as on Facebook then. Not very exciting...
You actually need a Facebook account to use Spotify. Not very exciting at all.
I use Spotify without a Facebook account. You have the option of logging in with your Facebook account, or creating a Spotify account.
It's no longer possible to create a Spotify account, you have to login using a Facebook account.
No, if you don't have Spotify it asks you to download Spotify and log in.
If devs/bloggers start using these everywhere it means people like me in Canada (and other countries where Spotify is not available) won't be able to hear any music on the web. Soundcloud wins here for me - they may not have a huge major label catalog, but they don't have the restrictive licensing problems that Spotify has.
Soundcloud is greatly preferred for the stuff that's on Soundcloud. This is not for that.
Someone should do this with the itunes affiliate API and let people make money as well.

I'm doubtful this will take over the current YouTube/SoundCloud/Grooveshark embeds.

If you have a Spotify player opened the user experience of the play button is similar if not better than a Youtube widget (music does not stop if you close your browser).
The experience isn't better, in fact I'd say it's worse since I'm missing the video and I have to have spotify open AND the song has to be available on spotify.

It also makes no sense for the person embedding this to choose this over YouTube.

Makes more sense as an alternative/backup option for those who do have spotify.

Oh Cool!!! .. a button that works only in 13 countries.
By making their content embeddable, Spotify is finnally filling the gap between them and other Flash-based competitors like Youtube/Deezer/SoundCloud. They are really prooving that the old Desktop App vs Browser Apps schism is no longer valid. Does anyone with a non-premium Spotify account can confirm they still have ads using the embeddable play button ?
Why wouldn't ads play? Isn't it just telling the spotify app to play a song?
Yes I'm thinking it's the way it should work, but having a premium account I can't check how they implemented it, e.g. does the embedded cover is replaced by a ad banner?
This is great, it means I can run a music blog without breaking any laws because without illegally uploaded the tracks to soundcloud / blogger / tumblr.

It also means that you could rigup a Spotify powered muxtape.

Now if only we had a Web API for adding tracks to playlists etc

it also means your blog is useless to any people who aren't in a country that has permission to access spotify.
Which sucks, but how do you accomplish this legally?
Since I moved to Belgium I have being using Spotify again. But It's getting annoying the loads of ads per song played. So, I think I will go back to use Grooveshark on a daily basis. I refuse to pay a premium Spotify at the moment.

I suppose It is gonna be the same for this "Spotify Play Button" button, tons of ads and less music.

The Spotify desktop client is running a server and the play button acts as a remote. It's using regular get requests and seems to require a CORS-compatible browser. It's the same as typing a Spotify URI in your address bar. I think that means non premium users will have ads.