The music industry made over $40bn annually from music sales in its heyday. It now makes around $20bn. Digital technology has massively increased reach, convenience, choice and affordability for the consumer. Streaming is now music’s biggest revenue stream, but its growth has come at the expense of physical sales and downloads which yield significantly higher margins for the industry and the artists. Amidst all this turmoil can streaming and the rise of Spotify be the saviour of the music industry?
Disrupted Economics of Music
The launch of Apple’s i-tunes in 2001 was the major kick-off point in the digital disruption of the music industry, with Spotify taking up the baton 7 years later by delivering the first (of many) mass streaming service. Spotify now has 50 million paying subscribers (and another 50m free) across 20 markets. It has raised over $2bn since launch and is valued in excess of $10bn in readiness for an IPO. It has just renegotiated terms with Universal Music, a key supplier and equity holder, which will increase its operating margins to a more acceptable level. What could possibly go wrong?
Spotify’s most pressing issue is that the economics of its business model are against it, not to mention that it operates within a hugely competitive environment against the likes of Google, Amazon and Apple for whom revenues from music is a rounding error!
Around 70% of Spotify’s revenues are paid out as royalties to rights holders based on the number of streams its user base accesses. Add the other costs of operating and Spotify is loss making ($173m loss in 2015 from a revenue of $1.95bn). It finds itself in the grim position of making bigger losses the more it grows. There are three ways out of this situation:
- Increase prices to subscribers
- Generate more advertising and other revenues
- Reduce costs – i.e. royalty rates paid for music
It will come as no surprise that Spotify is working very hard at all three – while at the same time having to raise more finance to keep the ship afloat. Exhausting.
The chosen solution – so often the case when management is strategically challenged – is an IPO. Pass the problem on, in other words, to new shareholders lured in to buy shares from early investors looking to exit. Dangle the carrot of huge numbers of users, seemingly unstoppable growth, more favourable royalty deals, and there will be plenty of buyers.
The problem is that the post-IPO shareholders are unlikely to see their required return because the necessary operating and margin improvements won’t be sufficient to create long-term sustainable success. Three main reasons why:
- The business model is flawed
- Streaming does not deliver the music experience our brains demand
- Spotify does not serve core music fans enough
Flawed Business Model
Spotify streams the world’s music in its most basic form to the masses. Lots of other players are doing the same – Amazon, Apple, YouTube, Tidal, etc etc. To stay ahead of this intensifying competition, Spotify needs to differentiate its offering significantly in order to maintain or increase its pricing. Does anyone know how to meaningfully and permanently differentiate music streaming operators, like Spotify, from one another? Control over the supply of content is what’s needed to provide meaningful differentiation – as Netflix and Amazon are demonstrating In the TV world – but music copyrights are sewn up by the music majors and artists. As a result, the entire music streaming industry is essentially offering identical content and thereby consigning itself to the slippery slope of commodity pricing and a race to the bottom. The suppliers of music have to deliver their content to every platform and outlet, otherwise they are not meeting the demands of their fans, so content differentiation is going to be highly limited – yes, there may be some windowing, some exclusives for a while, some attractive artist-led bundles, but in the end no single platform is going to monopolise music streaming and be in control of subscription pricing.
Advertising is steadily losing its grip on its marriage of convenience with content (eg TV, music, publishing) that the rise of mass media spawned decades ago. The unstoppable trend away from mass media to personal delivery means we are less accepting of advertising messages interrupting the content we consume. With streamed music there is really only one way to consume – by listening. Therefore there is only one way to deliver advertising – by preventing listening! It makes free streaming a painful experience, hence 50% choose to pay for the ad-free version. Contrast this with radio where you tune in because you like the radio station, or the DJ and you get a broader entertainment experience which is more accepting of interruption – is this why radio is growing now it has embraced “digital” delivery? Spotify, unable to increase subscription pricing, will find itself under huge pressure to increase advertising revenues. This can only mean interrupting the music more and more just as consumers are increasingly enjoying ZERO interruptions in other forms of content like TV streaming (no ads on Netflix or Amazon). It’s a vicious cycle that doesn’t end well.
Spotify’s core product problem is that it delivers music as a “single-sense” experience. You can hear, but you can’t touch (CD case, vinyl sleeve), smell (ditto), or otherwise interact with something connected and meaningful (sleeve notes, cover art) while you listen. Music works best when it evokes emotional responses in the listener – the more senses involved, the stronger the emotional responses, and the stronger the resulting bond between the listener and the artist.
The simplicity and convenience of Spotify’s core product is a key reason for impressive user numbers, but is a major barrier to the strategic growth that is now required. Apart from delivering amazing convenience and availability, the streaming experience is second rate compared to other forms like vinyl, CDs and, of course, live. This is of no importance to the mass-market, casual listener, but it matters to the serious music fan. That’s why vinyl is resurging – a format written off by the music industry itself is rapidly emerging as a huge source of growth for many artists. And not just growth in revenues, but growth in an all important factor – core fans. Here’s a piece from last year on vinyl’s resurgence and the core fan.
Flawed Customer Strategy
Every artist from the Stones, Dylan and the Beatles, through to Bieber, Sheeran and Adele attribute their success and growth to their core fans – those early adopters who “discovered” their idols and spread the word to deliver the tipping point across the chasm to mass acceptance. Without the core fan, an artist is nothing – at least not in the long term. Spotify, and the other streaming platforms, are unlikely to create new artists in any meaningful way because the “single-sense” nature of streaming is such that it doesn’t appeal sufficiently to the core fans necessary for new artist growth and acceptance. New artist discovery may happen on Spotify, but the core fan then goes elsewhere for the deeper experience. Early fans discovering new artists are the ones who spread the word, through enthusiasm, passion and genuine “fandom”. These early adopters light the fuse that leads to mass market success – the simple law of “diffusion of innovation” (see diagram below) is at play in new music, just as it is for any new products.
The law of diffusion of innovation is a well-trodden phenomena whereby the early adopters build demand in the mass market through their enthusiasm and word of mouth. But as a mass market product, streaming doesn’t focus sufficiently on the core fans for them to carry the message to the mass market. Without addressing the core fan more effectively, new artist creation will likely remain the preserve of the labels, and increasingly the digital savvy artists themselves now able to roam freely in the digital playground.
So if Spotify, and streaming in general, doesn’t deliver everything the core fans want, where do they go? Core fans are seeking a more immersive music experience, with stronger connections to the artists they love through physical music sources (CDs, Vinyl) and live experiences. They are listening to their favourite music through higher quality sound systems than streaming provides, with the sleeves in their hands, reading the stories of how the album was made, what the songs mean to the artists and so on. And all the time building their enthusiasm and passion ready to tell their friends and the next layer of fans…. This is a problem that Spotify must overcome in order to appeal more to the all important core fans. Trouble is, this strategy is currently at odds with the mass market streaming strategy that Spotify and its founders seem wedded to.
Can Spotify Emerge as the Saviour of Music?
So far, the Spotify story has demonstrably been about “creating value, not music”, that’s why the founders seemingly want an escape route via an IPO. Only by Spotify’s strategic direction being handed over to people who understand music, and what it means to fans and artists, will the necessary changes begin to be made which could result in Spotify being the saviour of the music industry. Key strategic changes Spotify needs to make include:
- Developing Spotify’s overall offering as a “multi-sense” product, more than just a mass streaming service
- Treating the core fan differently to the mass market and giving them the connections they desire to the artists they love and the means and encouragement to “spread the word”
- Revising its business models accordingly in order to reduce reliance on subscriptions and advertising in favour of more transactional opportunities around core fans
The opportunity exists to create an amazing music platform that works for all lovers of music, from the casual listener to the superfan, rewarding artists and fans through more meaningful experiences and connections. It is in Spotify’s gift to do so but I’m not holding my breath…