Spotify’s US Launch: First Take

Spotify finally today announced their excessively anticipated US launch. Protracted negotiations with the US labels turned this into one of digital music’s longest running sagas.  And although the $100 million of extra funding for label guarantees and advances seems to have successfully assuaged concerns, the labels weren’t just digging in their heels for the sake of it:  the US digital music market has a lot at risk in the face of Spotify’s arrrival and of course there are growing doubts about the Freemium model.

The label negotiations resulted in the last year in  limits being put on the free element of Spotify so that the full unlimited free offering that got Spotify off to such a great start in Europe will only be available to an initial swathe of invited users in the US.  Once the invite-user phase is over, free users will get 20 hours a month for 6 months, falling to 10 hours thereafter, along with a 5 plays-per-track limit.

When Unlimited Isn’t Actually Unlimited

The 10 hours / 5 plays mix is clearly intended to make people use Spotify as a complement to other services, not as a replacement.  Many listeners simply won’t bump into those restrictions.  Those that do though will be the more engaged music aficionados who will either have the will and means to pay for the unlimited premium offering, or will be young kids and those who can’t pay 9.99 a month and they will look elsewhere i.e. to YouTube and to illegal alternatives.

There is evidence to suggest that both might have happened in Europe: in March Spotify announced it had 1 million paying subscribers (something that no other premium services has yet achieved).  But they also announced that only 6.7 million of their total 10 million subscribers are active.  So a third of Spotify’s users either a) just got tired of the novelty of the service b) don’t use it much c) got fed up of the new restrictions and voted with their feet.  The likelihood is all three play a role.

This all matters because ‘just how free’ Spotify actually is will play a major role in deciding how similar an impact it will have in the US compared to Europe.

Spotify Will Be Net-Positive for the US Digital Music Market

My take is that Spotify will be successful and will also be disruptive but on balance will be net positive for the US digital music market (see figure).

Spotify has that priceless commodity: momentum.  More than that, they have mastered the art of maintaining momentum.  Most other services would have seen their momentum fizzle out in the face of a yearlong delay to a US launch.  Not Spotify. Instead they actually managed to use it to sustain momentum.  How?  Because of another of Spotify’s core strengths: scarcity.  Nothing drives demand like scarcity of supply.  Spotify built its European growth upon a perception of scarcity through its invite-only launch. It is set to do the same in the US, but with additional boon of massive pent up demand from US digital music fans who have had to deal with absolute scarcity this last year.

Can Spotify Afford to Be Successful in the US?

Until Spotify ramps up its US ad sales business every free user will be proportionately more costly than free European users.  But Spotify has learned a lot from its European experience.  It has learned which levers to pull to manage growth.  I expect Spotify to plan and manage US growth on a ratio-target basis, with free users never being allowed to exceed a certain share of total users.  E.g. the 50 million users target touted by an over-zealous Spotify ad sales exec would require 5 million paying subscribers to have signed up.  Spotify can’t afford to screw this up.  Getting the economics right will be crucial to a successful exit, which has surely got to be the next move.

What Do US Music Services Have to Lose?

If Spotify can be successful, to what extent will their gains come at the expense of the incumbent services?

• Rhapsody, Napster, MOG, Rdio et al: the incumbent premium subscription services are right to be nervous: some of them have had years to make the model work yet haven’t managed to reach the 1 million subscriber mark.  Rhapsody has announced that it just hit 800,000 paying subscribers, but despite being 150,000 up from the last tally it is only 25,000 more than Q4 2008 which equates to a net gain of just 833 new subscribers a month. Rhapsody’s position is reflective of the overall stagnant nature of the premium subscription sector in the US.  Prior to Spotify the European subscription market didn’t even get out of the starting blocks, let alone have the chance to become stagnant.  So the US subscription services have good reason to fear Spotify as a premium player.  With the restrictions on free plays I don’t anticipate them losing many subscribers to Spotify Free though.
• Pandora: whatever Pandora’s Tim Westergren says, Pandora will see some of its users defect to Spotify.  Yes it is a different value proposition and yes there are many users for whom Spotify will be no alternative.  But there will be those who simply tolerate not being able to listen to exactly what they want rather than perceiving it as part of the value proposition.  Those users, for whom free is the key driver, will be at risk.  Once again though, the limits on Spotify’s free tier should contain this threat to some degree.
• Apple, Amazon and Goole: none of the big three really have much to fear given their different positioning and products but will watch for new Spotify product features cautiously.  They may even feel the need to accelerate launch of free on-demand streaming in their locker services (i.e. not just of users’ existing music collections)

So it becomes clear that the record labels have a done a decent job of engineering Spotify’s licenses in such a way that the incumbent US services face minimum competitive risk.   One hopes that this doesn’t also mean that Spotify’s wings have been clipped so far that it won’t be able to truly shine in the US.  Because Spotify has done a huge amount in Europe: bringing digital music to the mainstream and freeing it from the chains of the iPod.

I actually hope that Pandora and Rhapsody et al do feel some serious competitive pressure, so that they can focus on what they need to do better and then lean on the labels to give them the licenses to do so.  Because the best way the labels can drive the market is by using licensing to empower services with more functionality rather than using it to restrict disruptive threats.