We are now one month on from Spotify’s IPO. The IPO was unique – a direct listing whereby the company sold its shares to the public without an intermediary. This is usually an approach taken by smaller, ‘lower profile’ organisations looking to trade publicly. Notably, Spotify was not looking to raise capital as part of the IPO with its co-founder Daniel Ek pointing to business as usual despite the IPO: “Spotify is not raising capital, and our shareholders and employees have been free to buy and sell our stock for years“. The opening market capitalisation of ~$30Bn has since cooled to ~$28Bn as I write this after going as low as $26Bn in the first week after IPO. Analysts believe it is trading lower because of concerns about its business model and the longer term economics of the music industry.
Certainly, Spotify’s IPO now generates greater scrutiny for Spotify’s ‘freemium’ business model – listeners can access a version of the service for free with advertising or a premium service at with a monthly subscription for ~$10/month. This is the same model employed by other music streaming services like Pandora or RDIO (RIP) which have had limited success. As yet, Spotify has not turned a profit despite earning ~$5Bn a year in revenue. It pays out over 75% of this in royalties to labels, producers, songwriters and artists all of which are controlled influenced or controlled by the 3 big labels Universal, Sony and Warner. Also, these payments are linked to its growth – the more listens, the more its pays out.
The other major concern for Spotify is competition for its ~70M paid subscribers and ~159M total listeners . The likes of Apple Music (~30M subscribers), Amazon Prime Music (~16M subscribers) and YouTube Red/Google Play (~7M subscribers) are all reporting growing numbers of subscribers. The problem for Spotify is that these services do not rely on the business of music to make money. Instead music streaming in these businesses is used to generate user ‘stickiness’ or in the case of Google’s service to supplement its advertising and AI businesses.
So what then for Spotify as it stares down uncertainty in its business model and some aggressive competition from rivals who can make money in other ways? This post explores a few options for its core business and considers what the future of music streaming and subscriptions may hold.
Convert ‘free users’ to paying subscribers
The most obvious move Spotify can make. Under its current business model, only 10% of its $5Bn annual revenue is generated by advertising with the rest being generated from its premium subscription service. However, less than 50% of Spotify users are paying for the premium service. On one hand, it is a good sign as there is a large pipeline of potential premium subscribers to be converted, on the other there are barriers to conversion which are not easily overcome. One barrier is price – at ~$120/year a music subscription is still a luxury for many households which in conjunction with the other popular subscriptions like Netflix, cable TV or sports would mean a total of >$300/year on media subscriptions. However, Deloitte’s TMT Predictions 2018 highlights that subscription numbers are growing. It is expected that media subscription numbers will double between now and 2020 in developed countries as people value the quality of the service and subscriptions become a norm. We have not hit ‘peak subscription’ yet.
To remove the barrier for subscribing to Spotify’s streaming service, Spotify could lower its subscription, introduce an intermediate subscription tier or reduce the quality of its ad-funded service. As subscriber growth begins to slow we might expect to see one or two of these tactics or others employed.
Improve advertising revenues for its ‘free service’
There is still ‘money on the table’ in the growing segment of digital audio related advertising. According to IAB, digital audio advertising revenue reached $603 million in the first half of 2017 which was compared to 2016’s total of $1.1 billion. Add to this the growing number of hours that listeners (in the US) are spending on digital audio (32 hours in 2017 compared to 26 hours in 2016 and 24 hours in 2015) according to Nielsen. The opportunity for Spotify is to increase the impact of advertising on its platform without ruining the experience for users. A challenge that YouTube has faced with the introduction of YouTube Red. This may mean, creating search advertising as listeners look for music, adding video content in the stream feed or increasing the pass through rates through new interfaces like voice. For those without the premium service, expect to see Spotify ramp up advertising tactics to take advantage of the growth in digital audio spend.
Introduce a premium-premium offer
What would the iPhone X of Spotify look like? Of the 70M paying subscribers on Spotify’s platform a high portion of these are likely to be ‘music enthusiasts’ who can afford to pay a little more for a differentiated experience. What might this look like? Firstly, Spotify could target this user group based on their listening habits (e.g. more back catalogue vs today’s pop) and offer increased music quality, data/insights into music or new music experiences (e.g. live streaming concerts, ‘first listens’, behind the scenes look at music development process). This is a strategic imperative for Spotify as it considers its ‘how to win’ strategy for the future. It should expect competition from the likes of Apple and Amazon who will be able to offer hardware or cross-product/service experiences in a way Spotify cannot. For example, it is rumoured Apple’s Airpod 2 due for launch this year may offer more ‘integrated experiences’ into Apple Music – stay tuned.
Decouple its revenue model from rights and music labels
The business of legally streaming music requires Spotify to cut deals with record labels to ensure their artists’ music is on their platforms. The interesting thing about music is that back-catalogue (which is owned by the big labels) is as valuable as anything newly produced. Also, music rights are expensive. Since there are only a few major record labels, and a number of competing streaming services Spotify has limited negotiating power. It has been estimated that if it doesn’t cut a deal with the 3 big labels it would lose a third of its library or ~87% of its streams.
Spotify has publicly stated it would like to get to 35% margin for its services but this would mean renegotiating the contracts with major labels. Longer term it has stated its intentions to directly sign artists to its platforms thus cutting out the labels – this would be one form of decoupling the other would be generating revenue from different means outside of streaming music be that concert tickets, live events, merchandise, data services, curation/collaboration or music related products and services. This second form of decoupling would require a move to an aspiration of being a ‘one stop shop’ for all things music – online and offline, a leap it is perhaps not yet ready for.
The future of streaming music – Spotify is the bellwether
The future of streaming music is really exciting (think more explosive heavy metal vs drone of bagpipes :)). The music industry is a poignant example of the change from traditional ‘value chain’ or linear industry thinking to a more ecosystem or value-web approach. Spotify’s rise has been prolific, it has in some ways saved the music labels and given insights into the listeners that were previously not available under physical distribution or iTunes. The big labels have also invested in the streaming service (~15% in total) and cut deals with its competitors as they look to hedge their position in the possible futures that play out. Spotify’s success post IPO will act as a bellwether for the health of the music ‘ecosystem’. If Spotify fails, expect a new era of music dominated by the large aggregators (Amazon and Google) to replace the vacuum it leaves behind.