The Three Things Spotify Needs to Do

Spotify is certainly the darling of the moment.  In the close to a decade that I’ve been covering the digital music space for Jupiter, and now Forrester, I have seen oh so many services come and go.  I’ve seen far fewer grab the limelight and hold it in the way Spotify is currently doing so.  In fact the only other digital music service that has ever sustained the same pulling power as Spotify is Apple’s iTunes.  And of course there is a lot of talk about whether Spotify is an ‘iTunes Killer’.  (For the record I don’t think the comparison is a valid one, rather that Spotify is a complementary addition to an increasingly complex digital music marketplace.  But I’ll park that discussion for another day.)

The Financial Times today ran a story about Spotify being close to securing substantial extra funding, and I for one hope they secure it: the music industry needs Spotify to get a decent shot at being a success.  It’s no secret that ad-supported music services have numerous challenges, not least a softening ad market.  It’s equally no secret that Spotify needs to make its premium business a success.  But building the ad business and the premium revenues will both take time.  Until those are fixed every new user for Spotify is cost to the bottom line.  So it would be a real shame for Spotify to have to put the brakes on its audience acquisition given that they have that most sought after of dynamics: momentum.

At the same time however, I think it is important to put Spotify’s nascent European adventure into perspective.  Spotify itself is not about to become ‘the future of the music industry’ but it does stand a decent chance of being one of the first truly mass market online services.

As you can see from the chart below, Spotify’s user base growth is impressive.  (It is important to clarify that the current European user number is the 4 million as shown in the chart, not the 6 million reported elsewhere.  Spotify clarified to me that those 6 million numbers are not correct and are ‘unsubstantiated’).

But just what does 4 million really represent?  Well across the 6 European markets Spotify is available in (Sweden, Norway, Finland, the UK, France and Spain) it represents 3 percent of all Internet Users and in the UK it represents 5 percent.  Those may not sound particularly high but are impressive given that the service only launched 9 months ago and only formally came out of invite stage this year.  By way of comparison it took Pandora a year to reach 1.7 million users, representing 1 percent of US Internet users.

So it is clear that Spotify has momentum.  But it is too early to say that it is a success.  Pandora now has 30 million users and its iPhone app users alone out number total Spotify users by more than a million.  Also, there are plenty of streaming music services with many more users, such as imeem (25 million in March),  Last.FM (20 million in March) and iLike (30 million in March).  Spotify has some distance to go before it reaches the levels of those services, none of which are being talked about as the future of the music industry…at least not anymore.

And there lies the rub.  Each of those services had their time in the spotlight.  For a while each was seen as the shape of the future.  They still have plenty to offer, but the attention has shifted elsewhere, due in no small part to the fact that their user growth reached a plateau in the 15-20 million range.

To build upon its great start and be a long-term success Spotify needs to do three things:

1. Break through the 15-20 million user bar like Pandora did
2. Convert roughly 5 percent of its user base to premium offerings
3. Build a sustainable ad business that helps shoulder the cost of its free users

Launching in the US and having its iPhone app approved by Apple would both be great ways of moving towards achieving those three aims.

Spotify has made a great start but it hasn’t even finished the first lap yet.  Here’s hoping that they’ll have made more substantial progress before the backlash begins.  Because one thing my years of market watching have taught me is that the higher a service is built up, the farther it has to fall when it is pushed off the top by many of the very same people that put them there.