Spotify Q4 2018: Solid Growth With a Hint of Profitability But Longer Term Questions

Spotify finished 2018 strongly, overperforming in both subscriber and ad supported MAU additions. This was accompanied by Spotify’s first ever profitable quarter and two major podcast acquisitions early in 2019 hinting at a positive year ahead. However, at the same time premium ARPU continues a long term decline – the price Spotify is paying for maintaining global subscriber market share.

spotify 2018 earnings midia research

Spotify hit just over 96 million subscribers which was an increase of 36% from 71 million in Q4 17. The addition of nine million net new subscribers in Q4 18 was the same amount of subscribers added one year previously. However, while the Q4 17 increase represented 15% growth in Q4 18 the rate was 10%. Relative growth is slowing as the market matures.

Spotify is growing its subscriber base markedly more quickly than it is growing its premium revenue, resulting in declining ARPU. Although subscribers hit 96 million at the end of 2018, premium ARPU declined from €6.20 in 2016 to €4.81 in 2018, a fall of 22%. Over the same period ad supported ARPU followed a mirror opposite trend, growing +22% from €0.96 to €1.17. Spotify routinely explains in its earnings that trials and family plan adoption are driving down ARPU. However, this is not a secular trend but instead a Spotify trend. In retail terms, global music subscriber ARPU actually grew 3.5%. Spotify slightly increased its global subscriber market share in 2018, up to 36.2% from 35.8% in 2017, but it is clearly having to aggressively discount pricing to do so.

Subscriber ARPU continues a downward trend

While ad supported ARPU was up, ad supported revenue grew more slowly in 2018 than 2017 so the increased ARPU is in part a result of users growing more slowly than monetisation. While this is the right balance commercially, Spotify also needs to grow ad revenue more strongly. 

Takeaway: Spotify is maintaining subscriber market share through price discounts while ad ARPU growth owes more to slower ad supported user growth than it does monetisation.

Churn up on an annual basis

Following a peak of 5.8% in Q2 18, Spotify brought quarterly churn rates down, first to 5.6% in Q3 18 and then 5.3% in Q4 18. However, the cumulative impact of churn throughout the year was an annual churn rate of 19.8%, up from 18.1% in 2017. This in part reflects the effectiveness of promotional trials. These trials open the funnel to new subscribers and have strong conversion rates, but because paid trialists are counted in Spotify’s subscriber numbers, any that do not convert become churned subscribers.

Takeaway: Spotify is having to spread its net wider to maintain subscriber growth. 

Profitability has arrived but investment is needed for long term growth

Spotify closed off 2018 in style, adding higher than expected numbers of both subscribers and ad supported users. Also, profitability is on the horizon – Spotify generated a quarterly net operating profit of €94 million in Q4 18 compared to a quarterly loss of €87 one year previously. Spotify is demonstrating that its business can operate profitably even without flicking the switch on new revenue streams, albeit at a modest level. 

Longer term revenue growth will be dependent on a two pronged approach of accelerating subscriber growth in big music markets that are later entrants to streaming – Germany and Japan – while continuing growth in large mid-tier markets like Brazil and Mexico. It also needs to continue its investment in ad infrastructure. Ad revenue is not growing fast enough, nor is Average Advertising Revenue Per User (AARPU), up just $0.15 in Q4 18 compared to Q4 17. This is an increase of just 3% compared to the 26% growth in ad supported MAUs. Spotify understands the importance of building its ad supported business and is investing heavily in ad technology and sales infrastructure. This needs to continue. But it will look to big radio markets  (e.g. the US, Australia and the UK) to drive mid-term growth, not emerging markets as those territories do not have strong enough digital ad markets. So expect AARPU to be hit as free user bases grow in emerging markets.

Takeaway: All in all, a solid quarter for Spotify but with enough softening metrics to suggest that 2019 growth will require more effort than in 2018.

NOTE: these findings form a small portion of MIDiA Spotify Q4 Earnings Report which will be available to MIDiA subscribers next week

Podcasts: a Netflix Moment for Radio But Perhaps not the Future of Spotify

spotify gimlet anchor podcasts midiaWednesday was a busy day for Spotify: it reported above-expected subscriber growthto hit 96 million paid subscribers, strong total user growth to hit 207 million MAUs, improved margins and its first ever profitable quarter, registering an operating profit of €94 million. And the news didn’t stop there, Spotify also announced the acquisition of two podcasting companies, Gimlet and Anchor.Spotify unsurprisingly referenced podcasts in its earnings note, pointing to 185,000 podcast titles available, ‘rapidly’ growing consumption and 14 exclusives to including the 2nd season of Crimetown, The Rewind with Guy Raz, and the Dissect Mini Series hosted by Lauryn Hill. Podcasts is clearly becoming a big part of Spotify’s plans and the rationale is simple: more owned content, and more cheaply licensed content means higher margins than can be generated by record label content. But for all its commitment to the format, Spotify may find the podcast battle harder to win than expected.

An opportunity with many intertwined layers

After many years stuck on the side lines, podcasts are now becoming sought after by everyone from radio companies, streaming services, newspaper publishers to TV companies and many, many more. Media brands of all forms see podcasts as a part of their future, a way to increase and diversify listening time (streaming services); fight back against streaming (radio); reach new audiences (news); and extend audience engagement (TV). To some degree podcasts can probably deliver on all those expectations, and while the creative possibilities are clear, the path ahead is not so straight forward:

  • A Netflix moment for radio: Netflix transformed the TV market not just by giving consumers a cheap, value-for-money way of getting great TV, but by changing forever the way in which TV is made. No longer shackled by the constraints of linear schedules and needing to keep everyone on the sofa happy at the same time, studios and networks started smashing the boundaries of what could be made and what a TV show looks like. We are now in the golden age of TV. Podcasts do the same for radio, allowing every niche topic under the sun to be explored in huge detail and without any constraints on number or length of episodes. Podcasts create even more of a blank canvass for what was once only radio content than Netflix did for what was once only TV content.
  • Apple iTunes stranglehold: Apple is the powerhouse of podcast distribution. In what is otherwise a highly fragmented podcast distribution landscape, Apple is as close as it gets to a unified podcast platform – which is also integrated into Apple Music. During podcasting’s wilderness years, Apple quietly built up a loyal base of podcast users. Given that more than half of Spotify’s subscribers are iOS users, those that are podcast users are most likely also Apple podcast users. Spotify will have to bank on converting those users while simultaneously flicking the ‘market creation’ switch by converting new users to podcasts. A double challenge.
  • Radio:As MIDiA identified early last year, radio is streaming’s next frontier. Spotify has built a sizeable ad supported audience – 11 million as of Q4 2018 – but it has not yet built a viable ad model – ad user ARPU is just $0.28 which is just one cent up on Q4 2017. To persuade radio’s big advertisers to switch, it needs to woo more of radio’s core audience but it currently lacks the content assets (news, weather, sports etc). Podcasts are a step in that direction but radio companies will feel they have a better chance of owning this space than Spotify, and many are currently investing heavily in podcasts. As Apple has been learning with Beats 1, just because you want to do something does not mean you necessarily can, even if you hire many of the industry’s power players.
  • Programmatic ad buying:Spotify is doubling down on its programmatic ad buying and this will be crucial to monetizing podcasts. Spotify reported in its Q4 earnings that programmatic is growing fast and, along with self-serve, now accounts for 25% of all ad sales – though as ad ARPU is flat (up just $0.15 y-o-y), it is not growing fast enough.
  • Use cases:Lastly, but most importantly, the underlying use cases for podcasts potentially limit the market opportunity for podcasts. The addressable audience for podcasts is not all the time spent listening to audio. Listening to music is a lean back experience that we can do while doing other things like work and study. Podcasts tend to require more of our attention and thus the use cases for podcasts are more limited. Also, unlike TV shows, users are less likely to have a large number of podcasts on the go at the same time. Spotify will hope that it will be able to generate appointment-to-listen behaviour, with users tuning in for their favourite podcasts on a specific day. But that necessitates users re-learning how they use Spotify.

The podcast opportunity is undoubtedly strong but there will be many competing to be the owner of podcasting’s future and radio may well do a better job of winning this battle than it has retaining its music listeners. Spotify is betting big on podcasts being part of the future of streaming, but the future of podcasts may lie elsewhere.

Making Free Pay

2018 was a big year for subscriptions, across music (Spotify on target to hit 92 million subscribers), video (global subscriptions passed half a billion), games (98 million Xbox Live and PlayStation Plus subscribers) and news (New York Times 2.5 million digital subscribers). The age of digital subscriptions is inarguably upon us, but subscriptions are part of the equation not the whole answer. They have grown strongly to date, will continue to do so for some time and are clearly most appealing to rights holders. However, subscriptions only have a finite amount of opportunity—higher in some industries than others, but finite nonetheless. The majority of consumers consume content for free, especially so in digital environments. Although the free skew of the web is being rebalanced, most consumers still will not pay. This means ad-supported strategies are going to play a growing role in the digital economy. But set against the backdrop of growing consumer privacy concerns, we will see data become a new battle ground.

Industry fault lines are emerging

Three quotes from leading digital executives illustrate well the fault lines which are emerging in the digital content marketplace:

“[Ad supported] It allows us to reach much, much deeper into the market,” Gustav Söderström, Spotify

“To me it’s creepy when I look at something and all of a sudden it’s chasing me all the way across the web. I don’t like that,” Tim Cook, Apple

“It’s up to us to take [subscribers’] money and turn it into great content for their viewing benefit,”Reed Hastings, Netflix

None of those quotes are any more right or wrong than the other. Instead they reflect the different assets each company has, and thus where they need to seek revenue. Spotify has 200 million users but only half of them pay.  Spotify cannot afford to simply write off the half that won’t subscribe as an expensively maintained marketing list. It needs to monetise them through ads too. Apple is a hardware company pivoting further into services because it needs to increase device margins, so it can afford to snub ad supported models and position around being a trusted keeper of its users’ data. Netflix is a business that has focused solely on subscriptions and so can afford to take pot shots at competitors like Hulu which serve ads. However, Netflix can only hike its prices so many timesbefore it has to start looking elsewhere for more revenue; so ads may be on their way, whatever Reed Hastings may say in public.

The three currencies of digital content

Consumers have three basic currencies with which the can pay:

  1. Attention
  2. Data
  3. Money

Money is the cleanest transaction and usually, but not always, comes with a few strings attached. Data is at the other end of the spectrum, a resource that is harvested with our technical permission but rarely granted by us fully willingly, as the choice is often a trade-off between not sharing data and not getting access to content and services. The weaponisation of consumer data by the likes of Cambridge Analytica only intensifies the mistrust. Finally, attention, the currency that we all expend whether behind paywalls or on ad supported destinations. With the Attention Economy now at peak, attention is becoming fought for with ever fiercer intensity. Paywalls and closed ecosystems are among the best tools for locking in users’ attention. As we enter the next phase of the digital content business, data will become ever more important assets for many content companies, while those who can afford to focus on premium revenue alone (e.g. Apple) will differentiate on not exploiting data.

Privacy as a product

So, expect the next few years to be defined as a tale of two markets, with data protectors on one side and data exploiters on the other. Apple has set out its stall as the defender of consumer privacy as a counter weight to Facebook and Google, whose businesses depend upon selling their consumers’ data to advertisers. The Cambridge Analytica scandal was the start rather than the end. Companies that can — i.e. those that do not depend upon ad revenue — will start to position user privacy as a product differentiator. Amazon is the interesting one as it has a burgeoning ad business but not so big that it could opt to start putting user privacy first. The alternative would be to let Apple be the only tech major to differentiate on privacy, an advantage Amazon may not be willing to grant.

The topics covered in MIDiA’s March 27 event ‘Making Free Pay’.The event will be in central London and is free-to-attend (£20 refundable deposit required). We will be presenting our latest data on streaming ad revenue as well as diving deep into the most important challenges of ad supported business models with a panel featuring executives from Vevo, UK TV and Essence Global. Sign up now as places are going fast. For any more information on the event and for sponsorship opportunities, email dara@midiaresearch.com 

How YouTube’s Domination of Streaming Clips the Market’s Wings

Firstly, happy new year to you all. Now on to the first post of 2019.

The Article 13 debate that shaped so much of the latter part of 2018 will continue to play an important role throughout 2019 while European and then national legislators deliberate on the provision and the wider Digital Copyright Directive of which it forms a part. Regular readers will know that MIDiA first highlighted the risk of unintended consequences of Article 13. Today we present the case for the impact YouTube has on the broader streaming market, driven by the advantages of its unique licensing position. (This is a complex and nuanced topic with compelling evidence on both sides of the debate).

To illustrate YouTube’s impact on the streaming market this post highlights a few of the findings from a new MIDiA report: Music Consumer Behaviour Q3 2018: YouTube Leads the Way But At What Cost?

midia youtube penetration

YouTube is the dominant music streaming platform, with 55% of consumers regularly watching music videos on YouTube, compared to a combined 37% for all free audio streaming services. YouTube usage skews young, peaking at nearly three quarters of consumers under 25. Although YouTube leads audio streaming in all markets — even Spotify’s native Sweden — there are some strong regional variations. For example, emerging streaming markets Brazil and Mexico see much higher YouTube penetration, peaking at close to double the level of even traditional music radio in Mexico. Indeed, radio is feeling the YouTube pinch as much as audio streaming. 68% of those under 45 watch YouTube music videos compared to 41% that listen to music radio. The difference increases with younger audiences and the more emerging the market. For example, in Mexico YouTube music penetration is 84% for 20–24 year olds, compared to 37% for music radio. Streaming may be the future of radio, but right now that streaming future is YouTube.

YouTube’s advantage

While cause and effect are difficult to untangle, the implied causality here is that YouTube’s unique value proposition steals much of the oxygen from the wider streaming market. Due to its unique licensing position – which Article 13 would likely change, YouTube has more catalogue and fully-on-demand free streaming, not to mention standout product features such as complete music video catalogue and social features such as song comments, likes / dislikes. Services that do not use safe harbour protection (i.e. the vast majority of audio streaming services) do not have these assets and so are at a distinct market disadvantage to YouTube. If you are a consumer in the market for a free streaming service, you have the choice between everything that you want, with complete control or constraints and restrictions, with fewer features. It’s not hard to see why consumers from Mexico through to Sweden make the choice they do. With a free proposition this good (especially when you factor in stream ripper apps and ad blockers), who needs a subscription?

A new value gap emerging?

Against this though, must be set two crucial factors:

  1. Audio streaming services would fare better if they had more of the features YouTube and Vevo have
  2. YouTube and Vevo are still the best ad monetisation players in the global market (i.e. discounting Pandora as it is US only). What’s more, (annual) audio ad supported ARPU declined in 2018 to $1.23, while video ad supported ARPU rose to $1.08. Ad-supported users grew faster than revenue while the opposite was true of video. There is a real risk here of an audio ad-supported value gap emerging. Spotify needs to get better at selling ads, fast.

Fully committed to subscriptions?

The final part of the YouTube impact equation is premium conversion. Since appointing Lyor Cohen, YouTube has taken a much more proactive approach to subscriptions, heavily touting its, actually-really-quite-good, YouTube Music premium product. Whether Alphabet’s board is equally exuberant about subscriptions, and whether YouTube Music’s launch lining up with the Article 13 legislative process was coincidental, are both open questions…

But politics and intent aside, YouTube is always going to be far poorer at converting to paid subscriptions because a) its user base is vast, and b) that user base is there for free stuff. So, while 58% of Spotify’s weekly active users (WAUs) are paid, the rate for YouTube Music weekly active usership is in single digit percentage points. That dynamic is not going to change in any meaningful way. In fact, YouTube has a commercial disincentive for pushing subscriptions too hard. It makes its money from advertising, and advertisers pay to reach the best possible consumers. Subscription paywalls lock away your best users, out of the reach of ads, which in turn reduces the value of your inventory to advertisers, which leads to declining revenues. YouTube is not about to swap a large-scale high-margin business for a small-scale low-margin one. Moreover, this issue of advertisers trying to reach paywalled consumers is going become a multi-industry issue in 2019. See my colleague Georgia Meyer’s excellent ‘Marketing to Streaming Subscribers’report for a deep dive on the topic.

Article 13 as a platform for innovation?

The overarching dynamic here is of a leading service that constrains the opportunity for services that are not able to play by the same rules. A levelling of the playing field is needed, but this should not just be legislation (and of course should be careful not to kill music’s ad supported Golden Goose). It should also see labels and publishers finding some common ground between the Spotify and YouTube models, and making those terms available to all parties. Because if YouTube does one thing really well, it shows us how good the streaming music user proposition can be when it is not too tightly constrained by rights holders. Let’s use Article 13 to raise the lowest common denominator, not to bring YouTube down to it.

Streaming music services need a user experience quantum leap in 2019; wouldn’t it be great if Article 13 could be the springboard for transformation and innovation?

Soon to be the Biggest Ever YouTube Channel, T-Series May Also Be About to Reshape Global Culture

pewdiepie tseries

Some time over the next month or so a YouTube landmark will be passed: T-Series will pass PewDiePie as the most subscribed YouTube channel on the planet. As of time of writing T-Series had 75.4 million subscribers compared to PewDiePie’s 76.4 million. (PewDiePie’s lead was narrower but he has mobilised his fan base to delay the inevitable.) But do not mistake this milestone to be a narrow measure of the shifting sands of the YouTube economy. Indeed, it tells us more about the future of streaming as a whole (both music and video) than it does the current status of sweary Swedish gamers.

For those of you who somehow do not yet know who T-Seriesis, it is a leading Indian music label and movie studio – it in fact claims to be ‘the biggest – that is the world’s largest YouTube music channel and before long it will likely be able to drop the ‘music’ qualifier from that title. It is also the label that Spotify just struck a deal with as it preps its protracted launch into India.

A streaming market of contradictions

India is a problematic market for streaming monetization. It has 1.4 billion consumers but just 330 million of those have smartphones. There were 215 million free streaming users in 2018 but just 1 million paid subscribers despite leading indigenous players like Hungama and Saavn having been in market for years. Total streaming revenue was just $130 million in 2017 generating a combined annual ARPU of $0.27. And that number is heavily boosted by unrecouped Minimum Revenue Guarantees (MRGs) due to local streaming services continually failing to meet their projected subscriber numbers (though according to local accounts, perfectly happy to continue to effectively overpay for their streaming royalties). The video side of streaming is more robust with eight million subscribers generating more than three times more revenue than music streaming does. Even still, eight million subscribers is scant return against a base of 330 million smartphone users.

Streaming unlocks the potential of emerging markets

India is exactly the sort of market that streaming business models have the potential to unlock. The old world was defined by commerce, by people paying to own music or for hefty household TV subscriptions that inherently meant owning a TV set. As a direct consequence, the traditional music and TV markets skewed towards western markets with higher levels of disposable income. This was a massive missed opportunity and one that can now be fixed. As Mexico and Brazil are currently in the process of showing us, populations with strong cultural heritage and large, but lower income, populations can have massive impact. Like or loathe Reggaeton, its ability to permeate the global music marketplace is testament to the power of Latin American music fans and the artists they support, as is Colombian J Balvin’s current status as the most streamed artist on Spotify.

The growing influence of second tier markets

Streaming can monetize scale in a way the old model simply could not. What we will see over the coming decades is a steady realignment of the balance of power across the global music and video markets. Western markets – and a handful of others such as Japan – will continue dominate revenues due to a combination of higher subscription penetration and higher subscriber ARPU. But large population, 2ndtier markets will have a growing influence. The BRIC markets (Brazil, Russia, India and China) are obvious candidates but also Mexico, the Philippines, Nigeria, Egypt, Turkey and Thailand all have similar potential.

Large, engaged local audiences can shape global trends

One of the key reasons Latin American artists have become part of the global cultural zeitgeist is that Spotify has a big regional user base – 42 million MAUs as of Q3 18. Because record labels over-prioritise Spotify in terms of marketing and trend spotting, when Latin American artists started blowing up, European and North American labels started paying extra close attention and building up their own rosters of Latin American artists. Latin American users represent 22% of global Spotify MAUs but their influence is amplified by the fact that they stream a lot and they tend to stream individual tracks repeatedly. So, when they put their support behind something it blows up, edging into the global charts which then triggers a whole bunch of actions that see that track being fed into non-Latin playlists and user recommendations, which can then trigger a further escalation of playlist strategy. And so forth. This was Luis Fonsi’s path to global stardom.

Could India ‘do a Mexico’?

So the obvious question is, if T-Series had enjoyed the same sort of success on Spotify that it did on YouTube, would Guru Randhawa be topping Spotify’s global artists instead of J Balvin? Would we be finding Bhangra in every sonic nook and cranny instead of Reggaeton? The answer is – as certain as a counter factual claim can ever be – almost certainly yes. Whereas Latin American emigres are a major demographic in the US, they are less so elsewhere. Also, Latin American culture is divided between Spanish and Portuguese. The Indian diaspora however, is far more global, with large populations in the US, Canada and UK. What is more, though India has many indigenous languages, English is spoken nationally, with many artists releasing in English. Similarly, a growing number of Bollywood movies are being made in English with an eye on the global market.

So when Spotify finally launches in India, expect a series of global cultural aftershocks. Spotify is unlikely to covert that many premium subscribers – except via telco bundles – but it is likely to build a big free user base. And when that happens expect T-Series to take centre stage with Guru Randhawato be the most streamed artist globally by 2020…?

Looking for the Music in Tencent Music

The Tencent Music Entertainment (TME) F1 filingmakes for highly interesting reading, but don’t expect copious amounts of data to give you an inside track in the way that Spotify’s F1 filing did. Instead TME’s F1 bears much closer resemblance to iQyi’s F1, namely a basic level of KPIs, lots of market narrative and even more space assigned to explaining all of the risks associated with investing in a Chinese company. But, perhaps the most significant thing of all is that TME isn’t really a music company or investment opportunity, but is instead a series of social entertainment platforms, of which music – and much of it not even streaming music – is one minor part.

Risk factors – there’s a lot of them

As with iQiYi’s F1 filing, a lot of the document is taken up with outlining the risks associated with investing in a Chinese company, particularly with regard to the various ways in which the Chinese government can potentially put the business out of existence. Evidence of just how real this threat is for Tencent is very close to home. The Chinese authorities are currently refusing to authorise any new Tencent games – and have not done so since March,  while it brings in new restrictions on game playing for kids.Tencent’s shares tumbled as a result. The problem for Chinese companies providing due diligence for overseas investors is that they have to admit that they might not be compliant with all Chinese laws. With the PRC (People’s Republic of China) government not having democratic checks and balances, Chinese companies have to face the real possibility of unpredictable, unchallengeable, draconian intervention, such as is happening with games.

Two particular areas of potential difficulty that the TME F1 highlights are social currency and overseas interests:

  1. TME makes much of its money from social gifting and virtual items. TME argues this does not constitute virtual currency, so should not be subject to tight PRC regulations. The PRC government may disagree.
  2. TME is registered in the Cayman Islands and does not actually own many of its Chinese streaming services but instead has shareholdings in, and contractual relationships with, them. This is a risk-laden approach at the best of times, but is given extra spice by the fact the PRC could determine TME to be a foreign interest, which would put it in breach of a whole bunch of PRC regulations.

Other notable risk factors are:

  • UGC:TME explains: “Under PRC laws and regulations, online service providers, which provide storage space for users to upload works or links to other services or content, may be held liable for copyright infringement”. It goes on to say: “Due to the massive amount of content displayed on our platform, we may not always be able to promptly identify the content that is illegal.” There are two potential outcomes: 1) things carry on as they are 2) rights holders get itchy feet and TME needs to find someone to help it monitor and police copyright infringement.
  • ADS: TME is not offering shares for sale but instead American Depositary Shares (ADS), which in heavily simplified terms means that investors’ money is deposited in US banks in USD and then can in principle be converted into RMB shares at the prevailing currency exchange rate, which may be higher or lower than when the ADS was purchased.

What’s in a number?

Prior to this filing, Tencent had only released one audited music subscriber number – back in Q1 2016 it announced 4.3 million QQ Music subscribers. After that came a succession of press cited numbers that got a lot bigger, but nothing audited. Finally we have a whole collection of numbers to play around with (though see the PS at the end of this post for a health warning on interpreting Chinese company numbers reported in SEC documents).

TME 1

In 2016, TME was very much a music company, with music accounting for nearly half of its RMB 4.4 billion revenues. But by 2017 that picture had changed…and some…with just 29% of its revenues classified as ‘online music services’. Online music revenues grew by 47%, which is impressive enough in isolation, but is much slower growth than the rest of the Chinese paid content market. Video, which parent company Tencent is a key player in, is a major growth area. One sub strand of this is social video, where TME is also market heavyweight. Luckily for TME, it has eggs in many baskets. Social video, which largely comprises live streaming in China, contributed to TME’s social entertainment services revenue growing by 253% (i.e. five times more quickly than online music) in 2017 to reach RMB 7.8 billion – 71% of TME’s total RMB 10.9 billion.

This revenue was driven in large part by live streaming services Kugou Live and Kuwo Liveand by social karaoke app Quanmin K Ge, known as WeSing in the west. WeSing is arguably the biggest ‘music’ app many people don’t know about. Music doesn’t play the same cultural role in China as it does in western markets, thanks in part to the legacy of the oxymoronically named Cultural Revolution, which limits the potential opportunity for music services in China. Karaoke, however, is huge, and WeSing does a fantastic job of converting this demand. By putting social centre stage, TME is able to monetise social in a way that would make Facebook green with envy. As TME explains:

“We provide to our users certain subscription packages, which entitle paying subscribers a fixed amount of non-accumulating downloads per month and unlimited “ad-free” streaming of our full music content offerings with certain privilege features on our music platforms.

We sell virtual gifts to users on our online karaoke and live streaming platforms. The virtual gifts are sold to users at different specified prices as pre-determined by us.” 

Putting social centre stage

But TME’s social skills are not limited to WeSing. Social seeps from virtually every pore of its music services, with features such as likes, comments, shares, ability to create and share lyrics posters from a song, ability to sing along to songs, see local trending tracks, get VIP packages etc. TME has worked out how to bake true social behaviour into the centre of its music services in a way few western companies have (YouTube and Soundcloud are rare exceptions). Both Soundcloud and YouTube built their services without having to play by the record label rule book. Read into that what you will.

The social power of TME’s end-to-end social music offering is illustrated by this case study:

Ada Zhuang (  ). Ada started out as a talented singer on our live streaming platform. A few months later, she released her debut album on Kugou Music. Since then, Ada has released over 200 songs that have won numerous music awards. Her popularity continued to grow through concerts held across China. A single released by Ada in October 2015 has since then been played over three billon times on our platform. 

TME2

Through its acquisition of competitor services Kugo and Kuwou, TME has built a music empire, giving it a 76% music subscriber market share and leaving two key competitors: Apple Music and NetEase Cloud Music. TME pointedly makes no reference to Apple Music, despite it having 2.6 million Chinese subscribers in 2017. NetEase, however, does get a name check.

TME reported its combined (net) mobile music MAUs to be 644 million in Q2 2018, though defining its users as unique devices rather than unique users. (Interestingly, it defines its social users on an individual basis.). What is clear is that TME’s music users and social users are mirror opposites in user tally and the revenue they generate; social users are just 26% of users but account for 71% of revenues. Clearly, TME has identified there is a lot more money to be made from social experiences than streaming music. Few western companies saw this opportunity. Musical.ly, founded by Alex Zhu and Luyu Yang, did, and was predictably bought for $1 billion by Chinese company Bytedance, home to Douyin (known as TikTok in the west).

TME3

TME’s ARPU numbers hammer home the scale of success for its social segment versus its music side. In Q2 2018 TME was earning RMB 122 a month from social users, against a paid user base of 9.5 million, while its paid music base of 23.3 million was generating an ARPU of just RMB 9.

 

Interestingly, international expansion is not mentioned once in the 198,984 words of the TME F1 filing. TME explains exactly how it intends to spend the money from the IPO but international is not spelt out. Our bet though, is that TME is playing its cards close to its chest and will indeed go west.

Wildcard

TME is one of a number of Chinese tech firms listing a portion of their stock on US exchanges. Should the US economy topple into a downward trend at some stage, for example as a resulting of an escalating trade war with China, then stocks like TME could give US investors a seamless way of transferring their holdings out of US companies into Chinese ones, without having to change their portfolio mix (ie one tech stock for another) and without having to change jurisdiction. And with China sitting on $3 trillion of foreign currency reserves – with USD the largest part – China could even hasten things along by flooding US currency into the markets, triggering a tumbling exchange rate.

PS

There is an international jurisdictional loophole between the SEC in the US and the CSRC in China. Which in overly simplified terms means that Chinese companies can falsely report numbers in SEC filings,withtheSEC unable to prosecute Chinese miscreant companies and the CSRC unable to take action over the SEC filing.This has resulted in a significant number of fraudulent filings by Chinese companies reverse listing onto US exchanges via dormant US companies, with SEC filings showing numbers up to 10 times higher than their CSRC filings. The only watertight way to validate Chinese company SEC filed numbers, is to corroborate them with CSRC filings. Unfortunately, TME is not a separate entity in China so has not filed any numbers, and, as stated above, Tencent has rarely reported any numbers for its music division. This does not mean that TME’s should not inherently be taken at face value, but it does suggest extra scrutiny might be wise.

Making Free Pay: Finetuning Freemium

Streaming is transforming music and TV business models, driving growth in both audiences and revenue. A balance between free and paid tiers and services has been key to this success, but, growth is not always balanced, and as we approach maturity in many western markets, more may be needed of free, ad supported options. Likewise, for unlocking longer-term, larger-scale growth in emerging markets.

MIDiA Making Free Pay

We know these issues matter, but we also know it can be hard to plan for the next phase when there is so much activity and resource requirement being delivered by the current phase. Therefore, to help media companies and streaming services alike, we have put together a curated insight event to provide the definitive evidence base for setting the balance between free and paid.

Join us for this free event, to see exclusive, previously unseen MIDiA data presented by our Research Director Tim Mulligan and a panel of industry experts tackle the burning questions. This event will help you understand:

  • Just how big will streaming music and video advertising get?
  • What is the right balance to strike between free and paid?
  • How will this balance vary across different regions across the globe?
  • How many more consumers will make the path from free to paid?
  • Why are streaming audiences so interesting to advertisers and how can they reach them?
  • What impact will the tech majors’ domination of global ad revenues have on streaming services?

The event is free to attend, and will be in central London on the 17thOctober. Places are limited though and going fast, so be sure to sign up soon if you plan to come.

As a sneak peak, here is one snippet from Tim’s presentation:

midia making free pay data

TV and music have a long history in ad supported via broadcast TV and radio. Both also have had the opportunity to convert an unprecedented volume of consumers to subscription relationships through streaming. The focus right now is all on subscriber growth, but the flatten out phase of the s-curve will come and when it does, ad supported can, and should, pick up the baton and run with it. The challenge is how to do that without unravelling subscription revenue.

Both music and video will follow a similarly shaped growth trajectory over the coming years in terms of advertising’s share of total revenue. However, music will lag far behind with just 38% of streaming revenue coming from ad revenue in 2025, compared to 56% for video. This will reflect both the positive and the negative. On the plus side, music will be generating strong subscription revenue in 2025, thus commanding much of the revenue share. However, it will also be generating much less annual ad revenue per user (ARPU) in 2025 than video: $4.69 compared to $20.37. In fact, video will see ad supported ARPU nearly double by 2025 from 2017, while music will add just one dollar.

This reflects multiple factors, including:

  1. Social video (YouTube, Instagram, Snapchat, Facebook) will generate far more ad supported video revenue than it will ad-supported music revenue
  2. Video ads command a higher ad rate than audio ads
  3. TV ad budgets are much bigger than radio ad budgets, and their transition to streaming will accelerate video ad revenue growth
  4. Few music services have scaled their ad sales outside of the US (though some encouraging signs are occurring there)
  5. Emerging markets will be key drivers of ad-supported music audiences, but digital ad markets will take time to get established

Ultimately, streaming ad growth will be shaped in equal measure by traditional ad market dynamics, and the tech and ad sales capabilities of the streaming services in each and every respective market. This means that in many markets we will see free audience growth far outstrip ad revenue growth. Just one of the many challenges posed by a growing ad supported streaming sector.

Join us on the 17thfor this and much more – see you there!

Article 13 – Laws of Unintended Consequences

I do not normally add disclaimers or qualifiers at the start of blog posts, but given how divisive the whole Article 13 debate has become, there is a big risk that some readers will make incorrect assumptions about my position on Article 13. The emerging defining characteristic of popular debate in the late 2010s has been the polarization of opinion e.g. Brexit, Trump, immigration. Article 13 follows a similar model, leaving little tolerance for the middle ground. You are either anti-copyright / pro-big tech or you’re pro-big government / anti-innovation.

Such extremes are the inevitable result of multi-million-dollar lobby campaigns by both sides. Reasoned nuance doesn’t really play so well in the world of political lobbying. My objective, and MIDiA’s, from the outset has been to strike an evidence-based, agenda-free position, that considers the merits of all aspects of both sides’ arguments. So, before I embark on a blog post that will likely be viewed by some of being pro-Google and anti-rights holder (it is not, nor is it the opposite), these are some ‘value gap’ principles that MIDiA holds to be true:

  • YouTube has misused fair use and safe harbour provisions against the legislation’s original intent
  • YouTube’s ‘unique’ licensing model creates an imbalance in the competitive marketplace
  • YouTube’s free offering is so good that it sucks oxygen out of the premium sphere
  • Google has rarely demonstrated an unequivocal commitment to, nor support of current copyright regimes
  • YouTube being able to license post-facto rather than paying for access to repertoire, gives it a competitive advantage over traditional licensed services
  • There is too big a gap between YouTube ad-supported payments and Spotify ad-supported payments, meaning too little gets to rights holders and creators
  • Take down and stay down is a feasible and achievable solution (albeit within margins of error)
  • The current situation needs fixing in order to rebalance the streaming market

Nonetheless, for each one of these positions from the rights holder side of the debate, we also see an equally long and compelling list of points from YouTube’s side. Rather than list them however, I want to explain how ignoring some of the counterpoints could unintentionally create a far bigger problem for the music industry than the one it is trying to fix.

Value gap or control gap?

What really riles labels is that they cannot exercise the same degree of control over YouTube that they can over Spotify and co. This is very understandable, as they rightly want to be able to determine who uses their music, how it is used and how partners pay for usage. However, taking a very simplistic view of the world, the label-licensed approach has created: a few tech major success stories that don’t need to wash their own faces (Apple Music, Amazon Prime Music); a collection of smaller loss-making services (e.g. Deezer, Tidal); and one big break out success story that can’t turn a profit (Spotify). In short, the label-led model has not (yet at least) resulted in the creation of a commercially sustainable marketplace. Rights holders want to pull YouTube into this controlled economy model. YouTube is understandably resistant. After all, YouTube is a crucial margin driver for Alphabet. It cannot afford it to be loss leading. Alphabet’s core ad businesses generate the margin that subsidises Alphabet’s loss-making bets such as space flight, autonomous cars and curing death (I kid you not). Ad revenue has to be profitable.

Fixed costs / variable revenue

As we explained in our recent State of the YouTube Economy 2.0 report, YouTube went double or quits during the last two years, doubling down on music, making music over index across its user base, in order to try to make it an indispensable hit-making partner for labels. That bet now looks to have failed. So, the question is, will YouTube acquiesce to the new command economy approach to streaming or do something else—perhaps even walk away from music?

The fundamental commercial imperative for YouTube is as follows:

  • Spotify pays a fixed minimum fee to rights holders for each ad supported stream, even if it does not sell any advertising against it. The rate is the same for every song, every day of the year.
  • YouTube pays as a share of ad revenue. This means it is always paying rights holders a consistent share of its income, including all the up side on revenue spikes. But ad inventory is not worth the same 365 days a year. There are seasonal variations meaning a song can generate less rights holder income in December say, than January. Also, not all songs are worth the same to advertisers: they are willing to pay much more to advertise against a Drake track than they are for an obscure 1970s album track.

This revenue share approach without minimum per stream rates is why YouTube has a profitable, scalable ad business, but Spotify does not (as recently as Q1 2018 Spotify had a gross margin of -18% for ad supported, compared to a +14% gross margin for premium). Remember, that’s gross margin, imagine how net margin looks…

The walk away scenario

Minimum per-stream rates could break YouTube’s business model, especially in emerging markets where it usage is strong, but digital ad markets are not yet developed. It would also set a precedent that other YouTube rights holders and creators would want the same applied to them.

So, it is not beyond the realms of possibility that YouTube could simply opt to walk away from music, applying take down and stay down its way (i.e. every piece of label content stays down). It could feasibly continue to provide ad sales support and audience to Vevo, but if YouTube gets to this point, then relationships are likely to be fractured beyond repair, meaning Vevo would likely have to decamp to Facebook and build a new audience there, one which is crucially not accessible to under 13s.

A YouTube shaped hole

So, what? you might ask. The so what, is the YouTube shaped hole that would exist in the music landscape. Readers of a certain vintage will remember the long dark years of piracy booming and corroding the recorded music business. It was YouTube that killed piracy, not enforcement. Okay, I’m exaggerating a bit, but the ubiquitous availability of all the world’s music on demand, on any device, nullified the use case for P2P in an instant. Add in stream rippers and ad blockers, and you’ve got a like-for-like replacement. Piracy created and filled a demand vacuum. YouTube (and Spotify, Soundcloud, Deezer etc.) have all since filled that same space, pushing P2P to the margins. YouTube, however, has had by far the biggest impact due to its sheer global scale. If YouTube pulls out from music, that YouTube shaped hole will be filled because the demand has not changed. Kids still want their free music, as in fact so do consumers of just about every age.

Piracy could be the winner

The most likely mid-term effect of YouTube shuttering music videos would be piracy in some form or another raising its head, filling the demand vacuum. Probably a decentralised, end-to-end encrypted, streaming interface built on top of a torrent structure, sort of like a Popcorn Time for music. Then it really would be back to the bad old days.

Is this the most likely scenario? Perhaps not. But perhaps it is. I suppose a just-as-possible outcome is that YouTube sticks up the proverbial middle finger and creates its own parallel music industry, using a unified music right and ‘doing a Netflix’. Yes, YouTube could be a next-generation record label, with more reach and bigger pockets than any major record label. If the labels are worried about Spotify disintermediation, YouTube could make that threat look like a children’s tea party.

As one YouTube executive said to me a couple of years ago: “This is how we are as friends. Imagine how we’d be as enemies.”

Too much to handle?

‘Couldn’t Spotify, Deezer and Soundcloud fill the potential YouTube shaped hole?’ I hear you ask. If these companies did take on YouTube’s 1.5 billion music users on the current financial agreements they have with rights holders, and with their currently far inferior ad sales infrastructure, they would be out of money in no time. It would literally kill their businesses. Based on YouTube’s likely music streams for FY 2018 and, say, a minimum per stream rate of $0.002, Spotify and co would need pay nearly $3 billion in rights revenue, regardless of how much revenue it could generate. Let alone the unprecedented bandwidth costs for delivering all that video. Of course the flip side, is that in the mainstream streaming model, that is how much potential revenue is up for grabs. So, more money would flow back to rights holders. But the extra revenue could come at the expense of the survival of the independent streaming services, ceding more power to the tech majors.

The artist and songwriter value gap

Throughout all of this you’ll have noted I haven’t said much about artists and songwriters. That’s because the value gap isn’t really about how much they get paid, even though they get put front and centre of lobbying efforts. It’s about how much labels, publishers and PROs get paid. And none of them are talking about changing the share they pay their artists and songwriters once Article 13 is put into action. That particular value gap isn’t going to be fixed. Even if Spotify picked up all of YouTube’s traffic, on say a $0.002 minimum per stream rate, a typical major label artist would still only earn $300 for a million streams, while a co-songwriter would earn just $150. The new boss would look pretty much like the old boss.

Be careful what you wish for

The laws of unintended consequences tend to proliferate when legislation tries to fix commercial problems without a clear enough understanding of the complexities of those very commercial problems.

It is of course in the best interests of YouTube and rights holders to carve out a workable commercial compromise, and I truly hope they do. But there is a very real risk this may not happen if Article 13 is successfully enacted into national member state legislation. Perhaps the phrase that rights holders should be considering right now is ‘be careful what you wish for’.

State of the YouTube Music Economy 2.0: A Turning Point for All Parties

YouTube is the most widely used streaming music app globally but it is also the most controversial one, locked in a perpetual struggle with music rights holders, with neither side quite trusting the intent of the other. 2018 has already seen YouTube’s renewed focus on subscriptions as well as a European Parliament vote that could potentially remove YouTube’s safe harbour protection. Meanwhile, oblivious to these struggles, and despite the rise of audio streaming services, consumers are flocking to YouTube in ever greater numbers and, crucially, using it for music more than ever before. Back in 2016, at the height of the value gap / grab debate, MIDiA published its inaugural State of the YouTube Music Economy report. Now two years on we have just released the second edition of this landmark report. MIDiA clients have immediate access to the ‘State of the YouTube Music Economy’ report, which is also available for purchase on our report store. Here are some of the highlights from the report.

state of the youtube music economy midia research

2016 proved to be a pivot point for YouTube. Rights holder relationships were at an all-time low with value gap / value grab lobbying reaching fever pitch. Meanwhile, vlogger hype was also peaking and longer-form gaming videos were beginning to get real traction. If there was ever a point at which YouTube could have walked away from music, this could have been it. The picture though, has transformed, with YouTube doubling down on music and in doing so, making itself an even more important partner for record labels.

With young consumers abandoning radio in favour of streaming, YouTube is the biggest winner among Gen Z and Millennials; penetration for YouTube music viewing peaks at 73% among 16–19 year olds in Brazil. But its reach is even wider: YouTube is the main way that all consumers aged 16 to 44 discover music.

Doubling down on music

YouTube has responded by improving its discovery and recommendation algorithms and gearing them more closely to music. The combined impact of demographic shifts and tech innovation is that YouTube is making hits bigger, faster. Billion-views music videos used to be an exceptional achievement, now they are becoming common place. By end July 2018, Vevo reported that there were already ten 1 billion views music videos for tracks released that year, accounting for 17.2 billion views between them. One billion view music videos that were released in 2010 took an average of 1,841 days to reach the milestone. Videos released five years later took an average of just 462 days, while those from 2017 took an average of just 121 days to get to one billion views. Over the course of eight years, YouTube has become more than ten times faster at creating billion-view hits.

Under indexing

The impact on revenue is less even. Music videos are the single most popular video category on YouTube, accounting for 32% of views but a smaller 21% of revenue. Music is still the leading YouTube revenue driver with $3.0 billion in 2017 but many other genres, gaming especially, over index for revenue. (Many YouTube gamers have multiple video ads placed at chapter markers throughout their videos. Because music videos are shorter they get a smaller share of video ads.) Emerging market audiences are also pulling down ad revenues. The surge in Latin American markets has pushed artists like Louis Fonsi to the fore, but the less-developed nature of the digital ad markets there means less revenue per video. This trend is accentuated with the rise of emerging markets music channels like India’s T-Series becoming some of the most viewed YouTube channels globally.

The net result is that effective per stream rates are going down on a global basis, but are going up in developed markets like the US, where the digital ad market is robust. This brings us to one of the existential challenges for YouTube. What does the music industry want YouTube to be? After years of nudging by labels, YouTube is now embarking on a serious premium strategy, but is that really what YouTube is best at? What YouTube does better than anyone else in the market is monetise free audiences at scale on a truly global basis (China excepted).

A turning point

2018 is a turning point for YouTube. The accelerated success it and Vevo have enjoyed since 2016 over indexes compared to YouTube as a whole, which means that music is a more central component of the YouTube experience than it has ever been. However, driving impressive viewing metrics was never YouTube’s problem, convincing music rights holders that it is a good partner is. The value gap war of words may have died down a little but that is as much a reflection of the rise of audio streaming and a return to growth for record labels than anything else, as the European Parliament’s Article 13 vote highlighted. Safe harbour was never designed to be used the way YouTube does for music, and the fact it does so creates a commercial disincentive for other streaming services to play by music rights holders’ rules. The fact that YouTube can get a greater volume of rights and more cheaply than other services andbe the largest global streaming service unbalances the streaming market. Though against this must be set the fact that YouTube has been able to create a more rounded value proposition without operating within the same confines as other streaming services.

The music industry needs the YouTube-Vevo combination, especially while Spotify scales its global free audience. The road ahead will be rocky, especially if Article 13 is eventually passed and also if rights holders continue to be disappointed by engagement growth out accelerating revenue growth due to the growing role of emerging markets. But it is in the interests of all parties to make the relationship work because neither side wants a YouTube shaped hole in the streaming marketplace, even if a Facebook / Vevo partnership was to try to fill some of it.

Screen Shot 2018-08-24 at 16.54.06Click here to see more details of the 29-page, 6,000 word, 11 chart reporton which this blog post is based. The report is based upon months of extensive research, industry conversations, MIDiA data and proprietary company data and represents the definitive assessment of the YouTube Music Economy.

Facebook Aims To Bring The Fun Back Into Music

Facebook has announced its long mooted move into music. As widely anticipated the service offering focuses on using music to add context to social experiences. The official blog outlines two key use cases:

  1. Adding music to videos
  2. Doing live stream lip syncs in Facebook Live videos

For now the roll out is limited, which will give Facebook the opportunity to hone the service and learn from the behaviour of a relatively narrow user group. A wider roll out will follow.

facebook music midiaIt’s not about subscriptions, nor should it be

Facebook was never going to try be a Spotify clone. Let me rephrase that, just in case anyone in Facebook’s management team is getting tempted to – wrongly – make the wrong move – Facebook should never try be a Spotify clone. Not only is it the wrong fit, it simply doesn’t need to. Streaming music is a low margin business that is being competed over by a number of very well established heavyweights. Facebook may be embarking on a content strategy like the other tech majors, but unlike Apple and Amazon, its core focus will be ad supported, not premium. (MIDiA subscribers – check out our forthcoming inaugural ‘Tech Majors Quarterly Market Shares’ report to see how Facebook’s content strategy stacks up against Apple, Alphabet and Amazon, and where it will be heading.)

YouTube now has a social music competitor worthy of note

For a whole host of reasons which warrant a blog post of their own, streaming music has coalesced around a very functional value proposition. In short, the fun has been taken out of music. Apps like Dubsmash and Musical.ly showed that it doesn’t have to be that way. These apps were small enough to be able to do first and ask forgiveness later. Even though Facebook has all the ingredients to do what those guys did, but at scale, it is far too big to try to get away with that strategy so had to get licenses in place first. YouTube is the only other scale player that really brings a truly social element to streaming. Now it has got a serious challenger that just upped the ante beyond comments, mash ups and likes / dislikes. The music industry so needs this right now. Especially to win over Gen Z.

Is Facebook bottling it when it comes to messaging apps?

For the moment, Facebook’s strategy is squarely focussed around its core platform. There’s no mention of Instagram (surely the best outlet for this kind of functionality). This hints at a degree of strategic wobbles in Facebook towers. By going all in with its messaging app strategy Facebook took a brave move few big companies do: it decided to disrupt itself before someone else did. It realised that the future of social was in messaging apps not traditional social networks. It is now the world’s leading messaging app company, with only Chinese companies truly challenging it (South Koreas’ Kakao Corp, Japan’s Line and Chinese players excepted). But that shift of user time to under monetized ad platforms threatens Facebook’s ad revenue growth. Hence the focus of music to drive usage back to its core platform where it can generate more ad revenue.

Not a Musical.ly killer, at least not yet

Although some have been quick to liken Facebook’s lip sync functionality to Musical.ly and co, in reality it is not competing head on with those apps because it is initially launched as a Facebook Live feature. Betraying Facebook’s strategic imperative of building its Live business. Expect a true Musical.ly ‘killer’ sometime within the next nine months.

Facebook is not here to compete with Spotify, but it is here to compete with YouTube and Snapchat and to steal some of the clothes of Musical.ly and co. The currently announced features just scratch the surface of what Facebook can do. In many respects music has taken a series of retrograde steps socially speaking since the days of imeem, MySpace and Last.FM. Now Facebook has picked up the dropped baton and is running with it.

Finally for anyone at MIDEM, I will be there from Weds PM to Thursday evening, including doing a keynote Q+A with Napster’s new CEO early Thursday evening. Hope to see you there. My colleagues Zach Fuller and Georgia Meyer are there too, both are speaking, so be sure to say hi.