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Spotify loses itself to music

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How Spotify loses itself to music, and what if it goes public?

 

As Internet and technology has been disrupting all walks of our life in recent years, music inevitably becomes as an important war field of tech startups. Thanks to paid subscription streaming services like Spotify, the music industry is poised to face its third consecutive year of growth in 2017. As the most dominant music App across the world, Spotify seems to be the biggest winner of this hunger game. By continuously playing aggressive user-acquisition strategy, Spotify is expecting a ~40% YOY revenue growth in 2017, and its streaming service now has over 70 million subscribers (as of January 2018) and over 140 million active users (as of June 2017). However, the company still keeps reporting net losses, with 100-200 million euros operating losses in the first half of 2017. Product development costs are still expected to be held steady at ~7% of revenue, same ratio as in year 2015 and 2016.

 

Undoubtedly, Spotify is the winner of bringing enormous value add to the music world. But I’d rather define its business model as a relative loser compared to other tech firms’. Spotify is losing itself to music.

 

The story all starts from the strong historic heritage of the global music industry – singers, musicians and producers are all signed and managed by major music labels. Nielsen SoundScan in their 2011 report named “Big Four” record labels, including Universal Music Group, Sony Music, Warner Music Group and EMI. Just like the rules in Hollywood, major players dominant most resources and talents, and as a result, they bring the best music production to the table, which reinforce their power of dominating the industry. The record labels used to be music distributors as well, until tech firms like Spotify disrupted their distribution arm with providing high quality and user-friendly streaming services to consumers. However, while cassette tapes can be easily replaced by mobiles Apps, music content still plays the most core role in the game. Facing Spotify’s attack, the incumbents chose to defense by leveraging their core asset: “Content is the KING.” they said. Major music labels started to charge high royalty fee of the copyrights of their music contents by asking for 70-75% of Spotify’s revenue per song under on-demand streaming model as return. This leaves extremely thin margin for Spotify to cover its distribution cost and customer acquisition investment but given the core music content assets still belong to the labels’ side, Spotify could do nothing but to compromise this financial model, resulting in consecutive losses under aggressive revenue/user base growth – cause no matter how fast the user base grows or how large the user base is, they are not able to amortize any of Spotify’s cost of goods. There’s barely networking effect created for sake of Spotify’s bottom line through this revenue sharing model.

 

As Spotify approaches its much-anticipated IPO, I am not convinced of the sustainability of its current revenue sharing model. So, what should we expect if Spotify successfully goes public, and wants to turn around its loser trap? First, gaining investors’ financial backup, Spotify would have deeper pockets to sign more artists and producers to compete with major labels. However, building up a heritage of producing successful music content that could create real meaningful competition against major labels is not a mission that could be accomplished in 3 or 5 years. I wonder how long-term would the market be, and how much patience the investors have for Spotify. Second, could Spotify renegotiate the deals with major labels? I highly doubt that. Spotify has not much leverage on the table, given streaming music service market is highly competitive with iTunes, Amazon, Youtube trying to steal Spotify’s pie. All the other competitors are a part of a multi-business tech venture. Now if Spotify goes public by itself, it has to consider the stock price stability when entering the hard negotiation. Lastly, I think the only way out for Spotify is to go disrupt the core music content – what if technology makes the entry barrier of creating good music no longer that high? What if good music becomes a commodity? However, all the above imaginations are hard to achieve, since music is after all a creativity/inspiration-driven business and there’s long lasting blockbuster effect in all creative business. It is art itself that is hard to be disrupted by technology.

 

Source:

“Spotify Records Surging Revenues, Continued Losses in First Half of 2017”, BillBoard

“Inside Spotify’s financials: Is There a Path to Profitability or an IPO?” , BillBoard

“Major music label”, Wikipedia

 

 

 

 

5 thoughts on “Spotify loses itself to music

  1. Great post! One other big factor to consider in the race to winning music streaming is how physical devices (namely, home speakers)will impact the competition. For example, Amazon and Apple both have speaker devices where they can control the music streaming service that launches when you say, “Alexa, play me a song.”

    Without any hardware at this point, will Spotify slowly lose its positioning as smart speakers increase their presence?

  2. Fascinating read! This made me think of two options:
    1. Could Spotify take a Netflix approach and try to create its own content by partnering with artists and going around labels? Instead of established artists who are tied to record labels, perhaps Spotify could try to find fresh talent and create music to at least somewhat decrease their dependence on these labels. Of course, you mentioned the AI-created music idea too, which is probably not too far off.

    2. Could Spotify generate more revenue from ads. Especially as a business with network effects, it should be able to attract advertisers with high willingness to pay. Ad revenue is usually much higher than subscription revenue (ask Facebook), and this could even help them lower subscription fees and attract even more users.

  3. Thanks Rain! Your points seem to call into question the viability of digital music streaming companies in general, and not just Spotify. How do you see the market evolving if not through Spotify’s model? Given that music streaming is here to stay, how could a company win in the market?

  4. Great read, Rain! CEO Daniel Ek insists in being independent from other tech companies, but recent Tencent minority stake exchange (https://www.ft.com/content/b9e301bc-ce5a-3e04-9ed1-ebd6ec2145ca) might point to partnerships with bigger guns. Even if they do end up going public, Spotify is also trying to broaden both its scope (by moving into podcasts, news and political coverage, https://www.bloomberg.com/news/articles/2018-01-18/spotify-has-a-new-plan-to-take-on-radio-and-reinvent-podcasting?cmpid=BBD011818_TECH&utm_medium=email&utm_source=newsletter&utm_term=180118&utm_campaign=tech) and its geographic reach (e.g. China, with the help of Tencent). Maybe these new sources of revenue will help the streaming service clean up their financials in time for the IPO.

  5. Following up on Juan’s comment, your account of Spotify’s story reminds me of some of the incumbents in the Chinese market, namely Xiami Music and QQ Music. Although the sample size is quite small, it seems that music streaming platforms have a higher likelihood to flourish when they position themselves to work with “ecosystem partners” who might subsidize part of their (intrinsically unattractive) business model and serve as organic user acquisition channels. In this regard, Spotify is yet to find her Mr. Right, the Western equivalence of Tencent/QQ, NetEast, etc. to share her growing pains and joys.

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