Joining the Dots: How Wixen’s Suit Impacts Spotify’s DPO

While many are still recovering from their festive exertions, Spotify hits the news twice –though for two very different reasons: the long-awaited confirmation of its DPO date and, less expected, a new lawsuit from a music publisher. While they’re totally different developments, their timing is not coincidental. (Note, Spotify is doing a Direct Public Offering (DPO) not an Initial Public Offering (IPO) as many outlets have mistakenly reported – though its SEC filing does mean it could still opt to do an IPO should it decide to).

Spotify has been talking about going public for years and many column inches have been expended on trying (and failing) to guess the date. The one bit that everyone got right was that Spotify could not afford to delay the move for much longer, because its debt was becoming increasingly expensive to service. Those debt costs were the main reason Spotify’s losses grew in 2016. I have written extensively about Spotify’s need to create a new narrative for Wall Street and how it will need to diversify its revenue base to drive profitability. But, it should have a fairly easy ride for its first 12 months—certainly easier than Snap Inc. has had. This is because demand far outstrips supply. The big institutional investors (investment banks, hedge funds, pension funds etc.) that now want a ‘position’ in the music business effectively only have Vivendi and Spotify as options (Sony Music is too small a portion of Sony Corp, while WMG is considered too small by bigger institutions).

Investor demand exceeds supply

The imbalance between supply and demand has been reflected in the grey market of private trading of Spotify stock. So, even if it has some weak earnings Spotify should hold onto much of its value, unless some big hedge funds decide to bet against Spotify, and decided to do so in a big way. In the longer term, if Spotify can execute well, three to five years from now we won’t be thinking of Spotify as a streaming company, but instead as a music platform. It will be a conduit for the plethora of music services and tools – ranging from data services, through e-commerce to services, that we currently largely identify with labels (artist promotion, label services, rights exploitation etc.). Streaming will generate more revenue than any of these, but all of these higher-margin revenue streams will help deliver Spotify profitability.

Wixen puts risk back on the table

Before its transmutation, Spotify has to make sure its DPO is a success and another hurdle just emerged: music publisher Wixen Music filed a lawsuit against Spotify for $1.6 billion. The background to the suit is complex and rooted in an effective loophole in US music publishing practice, which sees music services assume the right to stream songs rather than explicitly requesting it. The NMPA brokered a Spotify settlement for songwriters and publishers (following a David Lowery class action suit) and also helped shape a new piece of legislation aimed at closing the loophole, and crucially for Spotify, making it harder for publishers to file suit. Investors hate risk factors, and the double whammy threat of class action suits and uncapped statutory damages was a risk factor too far. This is why so much effort was put into creating a pragmatic solution that delivered results for all sides, in time for Spotify’s DPO. Only, Wixen doesn’t see things that way.

Wixen’s suit argues that the new legislation and the settlement do not provide enough in terms of compensation, guarantees nor safe guards. By filing before the legislation’s January 1 deadline, Wixen is hoping to be able to set new, improved terms for publishers. Whether the case has merit or not is almost inconsequential with regards to its potential impact on Spotify’s DPO. The mere presence of the suit could spook investors. In practice however, the sheer level of demand for Spotify stock is likely to win the day.

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MIDiA Research Predictions 2018: Post-Peak Economics

With 2017 drawing to a close and 2018 on the horizon, it is time for MIDiA’s 2018 predictions.

But first, on how we did last year, our 2017 predictions had a 94% success rate. See bottom of this post for a run down.

Music

  • Post-catalogue – pressing reset on the recorded music business model: Revenues from catalogue sales have long underpinned the major record label model, representing the growth fund with which labels invested in future talent, often at a loss. Streaming consumption is changing this and we’ll see the first effects of lower catalogue in 2018. Smaller artist advances from bigger labels will follow.
  • Spotify will need new metrics: Up until now Spotify has been able to choose what metrics to report and pretty much when (annual financial reports aside). Once public, increased investor scrutiny on will see it focus on new metrics (APRU, Life Time Value etc) and concentrate more heavily on its free user numbers. 2018 will be the year that free streaming takes centre stage – watch out radio.
  • Apple will launch an Apple Music bundle for Home Pod: We’ve been burnt before predicting Apple Music hardware bundles, but Amazon has set the precedent and we think a $3.99 Home Pod Apple Music subscription (available annually) is on the cards. (Though we’re prepared to be burnt once again on this prediction!) 

Video

  • Savvy switchers – SVOD’s Achilles’ heel: Churn will become a big deal for leading video subscription services in 2018, with savvy users switching tactically to get access to the new shows they want. Of course, Netflix and co don’t report churn so the indicators will be slowing growth in many markets.
  • Subscriptions lose their stranglehold on streaming: 2018 will see the rise of new streaming offerings from traditional TV companies and new entrants that will deliver free-to-view, often ad-supported, on-demand streaming TV.

Media

  • Beyond the peak: We are nearing peak in the attention economy. 2018 will be the year casualties start to mount, as audience attention becomes a scarce commodity. Smart players will tap into ‘kinetic capital’ – the value users give to experiences that involve their context and location.
  • The rise of the new gate keepers part II: In 2018 Amazon and Facebook will pursue ever more ambitious strategies aimed at making them the leading next generation media companies, the conduits for the digital economy.

Games

  • The rise of the unaffiliated eSports: eSports leagues emulate the structure of traditional sports, but they may have missed the point. In 2018, we’ll see more eSports fans actually seeking games competition elsewhere, driving a surge in unaffiliated eSports.
  • Mobile games are the canary in the coal mine for peak attention: Mobile games will be the first big losers as we approach peak in the attention economy – there simply aren’t enough free hours left in the day. Mobile gaming activity is declining as mainstream consumers, who became mobile gamers to fill dead time, now have plenty of digital options that more closely match their needs. All media companies need to learn from mobile games’ experience.

Technology

  • The fall of tech major ROI: Growth will come less cheaply for the tech majors (Alphabet, Apple, Amazon, Facebook) in 2018. They will have to overspend to maintain revenue momentum so margins will be hit.
  • Regulation catches up with the tech majors: Each of the tech majors is a monopoly or monopsony in their respective markets, staying one step ahead of regulation but this will change. The EU’s forced unbundling of Windows Media Player in the early 2000s triggered the end of Microsoft’s digital dominance. 2018 could see the start of a Microsoft moment for at least one of the tech majors. 

2017 Predictions

For the record, here are some of our correct 2017 predictions:

  • Digital will finally account for more than 50% of revenue
  • Spotify will still be the leading subscription service
  • eSports to reach $1 billion
  • Streaming holdouts will trickle not flood
  • AR will have hype but not a killer device.
  • VR players will double down on content spend
  • Google doubles down on its hardware ecosystem plays
  • 2017 will not be the year of Peak TV
  • Original video content to arrive on messaging apps

Here are some that we got wrong or were inconclusive:

  • Tidal finally sells ($300 million stake from Softbank was a partial sale – full sale likely in 2018)
  • Apple will launch an Apple Music iPhone – didn’t happen but the Home Pod may be the bundled music device in 2018 (see below)
  • Spotify will be disrupted – it actually went from strength to strength with no meaningful new competitor, yet

Disney, Netflix and the Squeezed Middle: The Real Story Behind Net Neutrality

Unless you have been hiding under a rock this last couple of weeks you’ll have heard at least something about the build up to the decision over turning net neutrality in the US, a decision that was confirmed yesterday. See Zach Fuller’s post for a great summary of what it means. In highly simplistic terms, the implications are that telcos will be able to prioritize access to their networks, which could mean that any digital service will only be able to guarantee their US users a high quality of service if they broker a deal with each and every telco. As Zach explains, we could see similar moves in Europe and elsewhere. If you are a media company or a digital content provider your world just got turned upside down. But this ruling is in many ways an inevitable result of a fundamental shift in value across digital value chains.

net neutrality value chains

Although the ruling effectively only overturns a 2015 ruling that had previously guaranteeing net neutrality, the world has moved on a lot since then, not least with regards to the emergence of the streaming economy across video, music and games. In short, there is a lot more bandwidth being taken up by streaming services and little or no extra value reverting to the upgraded networks.

Value is shifting from rights to distribution

Although the exact timing with the Disney / Fox deal (see Tim Mulligan’s take here) was coincidental the broad timing was not. The last few years have seen a major shift in value from rights companies (eg Disney, Universal Music, EA Games) through to distribution companies (eg Facebook, Amazon, Netflix, Spotify) with the value shift largely bypassing the infrastructure companies (ie the telcos).

The accelerating revenue growth and valuations of the tech majors and the streaming giants have left media companies trailing in their wake. The Disney / Fox deal was two of the world’s biggest media companies realising that consolidation was the only way to even get on the same lap as the tech majors. They needed to do so because those tech majors are all either already or about to become content companies too, using their vast financial fire power to outbid traditional media companies for content.

The value shift has bypassed infrastructure companies

Meanwhile telcos have been left stranded between rock and a hard place. Telcos have long been concerned about becoming relegated to the role of dumb pipes and most had given up any real hope of being content companies themselves (other than the TV companies who also have telco divisions). They see regulatory support for better monetizing their networks by levying access fees to tech companies as their last resort.

In its most basic form, this regulatory decision will allow telcos to throttle the bandwidth available to streaming services either in favour of their favoured partners or until an access fee is paid. The common thought is that telcos are becoming the new gatekeepers. In most instances they are more likely to become toll booths. But in some instances they may well shy away from any semblance of neutrality. For example, Sprint might well decide that it wants to give its part-owned streaming service Tidal a leg up, and throttle access for Spotify and Apple Music for Sprint users. Eventually Spotify and Apple Music users will realise they either need to switch streaming service or mobile provider. Given that one is a need-to-have, contract-based utility and the other is nice-to-have and no contract and is fundamentally the same underlying proposition, a streaming music switch is the more likely option. Similarly, AT&T could opt to throttle access for Netflix in order to give its DirecTV Now service a leg up. Those telcos without strong content plays could find themselves in the market for acquisitions. For example, Verizon could make a bid for Spotify pre-listing, or even post-listing.

The FCC ruling still needs congressional approval and is subject to legal challenges from a bunch of states so it could yet be blocked. If it is not, then the above is how the world will look. Make no mistake, this is the biggest growing pain the streaming economy has yet faced, even if it just ends up with those services having to carve out an extra slice of their wafer-thin margins in order reach their customers.

Spotify, Tencent And The Laws Of Unintended Consequences

spotify tencent midia

News has emerged that Spotify and Tencent Holdings could be swapping 10% holdings in each other’s companies ahead of Spotify’s public listing. There are some obvious implications for both enterprises, as well as some less immediately obvious, but even more interesting permutations:

  • Spotify gets a foothold in China: Tencent is the leading music subscription company in China with QQ Music, Kugou and Kuwo accounting for 14.7 million subscribers in 2016. Apple Music has got a strong head start over Spotify with 3.5 million Chinese music subscribers. Tencent, with its billing relationships, social reach (WeChat, QQ Messenger) and rights holders relationships (Tencent sub-licenses label rights) provides a potential China launch pad for Spotify. So, the obvious implication is that Spotify could use Tencent as an entry point into the market. But this is where things get complicated. Tencent is planning a $10 billion flotation of Tencent Music. How would this valuation be impacted by Tencent aiding the entry of a direct competitor – which is a leader in virtually every market it is currently in, into the market of? A joint venture could be the way to square the circle.
  • Spotify continues its narrative building: As I have long argued, Spotify needs to construct a compelling narrative for Wall Street. It needs to be able to show that it is making strong progress on many of its weak points. Getting better deals from the labels was one such move. Now it has ticked the ‘what about China’ box too.
  • Tencent gets a foothold in the US: Earlier this year the Chinese government put in place restrictions on Chinese companies investing in overseas companies, in order to slow the outflow of Chinese capital. (It slowed a potential investment by Alibaba in UMG). Swapping equity is a way to get round this restriction. It also builds on Tencent’s move extending its stake in Snap to 12%. Tencent is pushing the rules to the limit in order to become a key player in US digital consumer businesses (Spotify of course will become, in part at least, a US company when public). The intriguing question is whether Tencent will get any access to Spotify’s western billing relationships.
  • Valuation disparities: Tencent Music has around a 3rd of Spotify’s subscriber base, a fraction of its revenue and half of its market valuation. Yet a 10% swap deal is on the table. Which suggests that Spotify really, really feels that it needs that entry point into China….

If this deal pans out the way it has been slated, it will potentially save Spotify and Tencent from a resource-draining clash of Titans for when (not if) Spotify would enter the Chinese market. It also provides Spotify with a potential long-term insurance asset. When Yahoo acquired a stake in Alibaba it was very much the senior partner. But, as Yahoo’s business imploded its Alibaba stake became its core asset.

Spotify obviously won’t be thinking that way but history shows us to never say never.

UPDATED: This post has been updated to reflect that the 10% equity swap is with Tencent  Music, not Tencent Holdings Ltd

This Is What Post-IPO Life Will Look Like For Spotify

With a fair wind, Spotify’s long-anticipated public offering should happen before the end of Q2 2018 (and yes, probably a direct listing rather than an IPO but ‘IPO’ worked better in the title!) . The music industry will be watching with keen interest as it is going to be the bellwether for the streaming music sector. Posting three or four successive quarters of well-received earnings will be key to Spotify’s life as a public company. Note my careful use of words, ‘well-received earnings’, not ‘strong earnings’. Spotify’s currently challenged underlying financials are not going to change in any fundamental sense over the course of nine to 12 months, so it will need to construct a series of narratives and targets that Wall Street will buy into. The only problem is, Wall Street often has very high expectations for growth stage tech stocks, and falling short of those expectations can result in a tumbling stock price, even if the growth trend is actually solid.

When narratives alone will not be enough

I’ve written before about how Spotify will need to construct a number of new narratives for life as a public company. They will need to demonstrate:

  • Sustained strong growth in subscribers, users and revenue
  • Improved profitability metrics
  • Diversification of revenue streams
  • Reduction of risk factors

All except the first could prove contentious, as many of the solutions will be inherently challenging for record label partners. Netflix has set a strong precedent for how to drive net margin with a 70% rights cost case (like Spotify’s) by creating its own content and using accounting technique,  such as amortization of costs, to turn cost into profit on the books. Netflix can get away with this because there are many TV networks so no single one can kill the service by removing its content. For example, Disney recently announced it was pulling its content, but Netflix continues to go from strength-to-strength. Spotify without Universal Music would swiftly wither on the vine. Spotify ‘becoming a label’ will be highly disruptive so it will have to do it slowly and in non-obvious ways. The news today that Spotify has acquired online music and audio recording studio Soundtrap – reportedly for $30 million – fits this thinking. In effect, subtly reversing into becoming a label. Meanwhile, it will need to have other new less disruptive revenue streams to spin narratives around, such as selling data to music industry stakeholders.

The upshot of all this is that during its first year as a public company, those narratives are unlikely to be enough. Instead, investors will be applying forensic scrutiny to Spotify’s user and revenue metrics. More than that, investors will set their own targets and if Spotify misses the consensus of these third-party targets, the share price will go down. Apple tried to distract investors from its slowing core metrics in 2016 by releasing a supplemental information document that focused on new metrics such as revenue per user. But investors refused to have their fixed gaze moved away from iPhone shipments.

spotify netflix users growth and stock price

So, Spotify will live or die by meeting investor-set subscriber growth targets? This means it will have to tread a delicate line between being bullish about its prospects to get investors’ interest piqued, but not so bullish as to raise their expectations too much. What complicates matters further though is the relationship between user growth and stock price. Pandora and Netflix have had very different journeys in the last 24 months, but both have endured ‘4 Quarter Kill Zones’ during which period stock prices struggled:

  • Pandora: Pandora’s post-earnings closing stock price declined at ever-greater rates than its monthly active user (MAU) count did. In Q1 2017 Pandora’s stock price fell by $0.11 for every million MAUs lost. By Q3 2017 this rate was $0.79.
  • Netflix: Between Q4 2015 and Q4 2016, Netflix added 12 million memberships (subscribers and trialists), yet its share price fell from $107.89 to $99.80. Investors, quite simply, expected even stronger growth. The irony is that since that time Netflix has continued to add memberships at a similar rate but its stock price has rocketed to $202.68 in Q3 2017.

Growth at what cost?

The lesson from these two cautionary tales is that it is not so much user metrics that is essential, but meeting user metric expectations. And Spotify will need to be careful about how it meets those targets. Growth stimuli like $1 for three-month super-trials can spike growth but hit profitability, which will be there for all to see in SEC filings. Therefore growth cannot come at any cost. In a similar vein, with market maturity approaching in many major western markets, Spotify will need to rely on a combination emerging markets for subscriber growth, and total free users (everywhere) to drive its user numbers, both of which will dent ARPU and margin. It is yet another balancing act for Spotify to manage and navigate.

Music market IQ

Spotify has one major advantage and one major disadvantage going into its flotation:

  1. Disadvantage: Since large investors have steered clear of the recorded music business for so long, the level of institutional market IQ is relatively low. The music business is notorious for being highly nuanced. This means that although big investment companies have been busy getting up to speed over the last 18 months, their expertise in music still lags massively behind the other sectors they invest in. Pandora learned the hard way that investors did not have the market IQ to differentiate between its ad supported radio model and Spotify’s subscription Similar things will happen to Spotify.
  2. Advantage: There are very few places truly big investors can put their money. Spotify’s IPO and a potential UMG sale or listing are about it. Big institutions see WMG as too small, and Sony Music as too small a part of Sony Corp. It’s no coincidence perhaps that UMG is reported to have been valued at between $30-$40 billion by Vivendi, conveniently keeping it well north of Spotify’s likely flotation valuation of $15-$20 billion.

So, with institutional investor demand massively exceeding supply, Spotify – and potentially UMG – could be very well placed to benefit. But a strong start can soon falter, as in the case of Snap Inc., which has fallen from an opening $24.48 to $12.56 now. The beauty of being a privately held company is that you can chose what metrics to report, and when. If you’ve had a tough quarter you can keep quiet until you have a good one. When you’re public you have no such luxury. It is warts and all, every quarter. Spotify’s life as a public company will be as much about managing expectations as it will be about driving growth.

Is Hip Hop Keeping Female Artists Out Of The Charts?

There is a gender divide in the upper echelons of popular music. In the US, Taylor Swift is the first woman to top the Hot 100 in 2017, with hits by women accounting for just 14% of all top 10 hits throughout the course of the year. But this is not just a US thing; it is a global trend, with female artists in the distinct minority in streaming too. There are various contributing factors, including unintended consequences of label A&R strategy and streaming service curation techniques.females in spotify

Looking at the global top tracks on Spotify, just 18% of the tracks from the top 30 streams are from solo female artists. In terms of chart positions the male dominance is even more pronounced with female artists making up 13%, or just four, of the top 30 slots.

So how did we get here? Part of the reason is that big female acts like Beyoncé, Rihanna and Katy Perry are out of cycle, but there are other factors too:

  • Hip hop A+R strategy: Hip-hop has replaced EDM as the record labels’ second favoured genre (after pop). When streaming exclusives were a thing, Apple Music and Tidal were fighting it out over hip hop and urban exclusives such as Frank Ocean and Beyoncé. Meanwhile, Drake was the most streamed artist of 2016. In 2014 and 2015, labels were falling over themselves to sign EDM artists. In 2016 and 2017, hip hop and urban artists have become the sought-after commodity. EDM is a male dominated genre but hip hop is even more so. Thus of the 11 hip hop artists in the top 30 most streamed tracks on Spotify globally for the week ending 8/11/17, all of them are male. You have to go down to position 33 to find the first and only solo female hip hop artist (Cardi B) in the top 50 streamed tracks.
  • Streaming algorithms: Playlists are at the heart of streaming consumption and their relevance is determined by a combination of user-data learning and human curation. As a result, a vicious circle emerges, whereby playlists end up full of the music labels are pushing, and because people tend not to skip that much when listening, the user data suggests that this is the music they want to listen to. To quote Paul Weller’s lyrics: the public wants what the public gets. With hip hop now de rigueur, it essentially self-accelerates on streaming. And with most of the big artists being male, females end up becoming side lined. It is a classic case of the law of unintended consequences.

In truth, many genres have a strong male bias. Rock, now a shadow of its former self (just two artists in the top 30 Spotify tracks are rock) is similarly male dominated. Pop and vocal music have long been the genres where female artists have done best. However, right now, the hip hop-defined picture of popular music is particularly skewed. When you get further down the tail, things even out a little. Within the top 50, female artists generate 23% of streams, and the full year numbers will be better balanced when seasonal skews, such as big female artist release cycles, are balanced out. Nonetheless, the inescapable takeaway is that the combination of label A+R strategy and streaming curation have, unintentionally, created a distorted picture of the top of the music pile.

Announcing MIDiA’s Streaming Services Market Shares Report

coverAs the streaming music market matures, the bar is continually raised for the quality of data required, both in terms of granularity and accuracy. At MIDiA we have worked hard to earn a reputation for high-quality, reliable datasets that go far beyond what is available elsewhere. This gives our clients a competitive edge. We are now taking this approach a major step forward with the launch of MIDiA’s Streaming Services Market Shares report. This is our most comprehensive streaming dataset yet, and there is, quite simply, nothing else like it out there. Knowing the size of streaming revenues, or the global subscriber counts of music services is useful, but it isn’t enough. Nor even, is knowing country level streaming revenue figures. So, we built a global market shares model that breaks out subscription revenues (trade and retail), subscribers, and subscription market shares for more than 30 music services at country level, across 30 countries and regions. You want to know how much subscription revenue Spotify is generating in Canada? How many subscribers Apple Music has in Germany? How much subscription revenue QQ Music is generating China? This is the report for you. Here are some highlights:

promo slide2 

  • At the end of 2016 there were 132.6 million music subscribers, up from 76.8 million in 2015
  • In Q4 2016 Spotify’s subscriber market share was 35% and it had $2,766 million in retail revenue
  • Apple Music was second with 21 million subscribers at the end of 2016, a 15.6% market share and it had $912 million in retail revenue
  • In 2016 Apple was the largest driver of digital music revenue across Apple Music and iTunes
  • The US is the largest music subscription market, which Spotify leads with 38% subscriber market share
  • The UK is Europe’s largest streaming market, which Spotify also leads
  • China’s subscriber base is the second largest globally, but it ranks just 13th in revenue terms
  • Japan is the world’s third largest subscription market, in which Amazon has the largest subscriber market share
  • Brazil is Latin America’s largest music subscription market

The report contains 23 pages and 13 charts with full country detail as well as audience engagement metrics. The dataset includes four worksheets and a comprehensive methodology statement.

Streaming Services Market Shares is available right now to MIDiA premium subscribers. If you would like to learn more about how to access MIDiA’s analysis and data, email Stephen@midiaresearch.com.

The report and data is also available as a standalone purchase on MIDiA’s report store as part of our ‘Streaming Music Metrics Bundle’. This bundle additionally includes MIDiA’s ‘State of The Streaming Nation 2.1’. This is our mid-year 2017 update to the exhaustive assessment of the streaming music market first published in May. It includes data on revenue, forecasts, consumer attitudes and behaviour, YouTube, app usage and audience trends.

Examples of country graphics (data labels removed in this preview)

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Quick Take: Spotify And Hulu Partner In The US

Spotify just announced it is bundling in the Hulu No Commercials plan into its $4.99 student offering in the US. Given that the Hulu product retails at $7.99 and Spotify at $9.99, this is unmistakably a good value for money deal – even compared to the standard $4.99 student Spotify tariff. In the Spotify blog post announcing the tie up, it is made clear that this is the start of something bigger: “This is the first step the companies are taking to bundle their services together, with offerings targeted at the broader market to follow.”

Putting aside for a moment how the economics of this bundle might work for Spotify, this partnership gives us a clear pointer as to Spotify’s video strategy going forward. The other part of the puzzle is the news that Spotify is hiring former Maker Studios exec, Courtney Holt, to head up its original video and podcast strategy.

Spotify knows that it needs to have a video play of some kind, despite the failure of its previous attempt. Unfortunately, everyone else is thinking the same – with Snap Inc, Facebook and Apple now committing billions to original content, in an already inflated market for video. Hulu will spend $2.25 billion on original content in 2017, matching Amazon’s original content budget for the year. This is the barrier to entry for video, and its simply too high for Spotify to justify.

Instead, it has focused on working with one of the leading streaming video services in the US, and is building complimentary music-orientated video in house. Thus, through this Spotify bundle a user gets their scripted drama hit from Hulu and their music video hit from Spotify.

Spotify’s Hulu partnership is a smart way to get into the video market without getting in over its head. While for Hulu, Spotify gives it clear differentiation from Netflix and Amazon. Which is given extra significance by the announcement that T-Mobile Netflix for free for its premium customers. Whether the economics of this deal add up for either party is another question entirely.

Spotify Earnings: Growth Comes At A Cost

spotify metrics

Spotify has published its much anticipated 2016 revenues. Because the company is under so much analytical scrutiny, there is little that is particularly surprising but there is still plenty we can learn from the results:

  • Growth maintains momentum: Spotify recorded revenues of €2.9 billion in 2016, up 51% from €1.9 billion in 2015. Although that was a lower growth rate in % terms (80% for 14/15), it was a bigger net add in revenue terms (€989 million net new revenue in 2016 compared to €863 million in 2015). Spotify still has some way to go before it challenges Netflix’s $8.2 billion streaming revenue, but it is making clear progress.
  • Spotify is getting ready for public reporting: The 2016 accounts featured heavy restating of previous year figures and many line items from last year’s accounts were no longer reported. All of which points to an organization getting its reporting structures in place for a public listing of some kind.
  • ARPU is a mixed story: Spotify’s total monthly user ARPU increased from €1.82 in 2015 to €1.94, driven by a small increase in ad supported user APRU and, more importantly, a higher share of paid users (38% in 2016 compared to 31% in 2015). However, that increased paid conversion has come at the price of lower paid ARPU, with $1 for 3-month trials etc., pushing down paid ARPU from €5.16 in 2015 to €4.58 which in turn is more than an entire dollar a month less than the €5.85 paid ARPU figure Spotify enjoyed in 2014.
  • Losses are widening again: Spotify reported losses before tax of €539 million against revenues of €2.9 billion (i.e. 18% of revenue). This was up from 12% in 2015 although it had been as high as 17% in 2014. In order to keep up with the market, Spotify is having to spend heavily, and this is all without any major product or territory launch in 2016. You need deep pockets to play at streaming’s top table.
  • Rights costs may be on a positive trajectory: Spotify’s Cost of Sales (previously reported as Royalty Distribution and Other Costs) were €2.5 billion, or 84.6% of revenue, down slightly from 85.5% in 2015. The shrinking share of the loss-making ad supported user base is most likely the key contributor here. Though the new UMG and Merlin deals will help sustain this path.

In Search Of A Margin

So, what do Spotify’s results say about the economics that we didn’t already know. In truth, not much. The market has lots of growth in it yet; competing is expensive, growth has to be incentivized and rights are the main cost component.

As Spotify nears a public listing or an acquisition by Alibaba or Tencent, it remains the benchmark for the health of the streaming economy. With the underlying fundamentals remaining largely unchanged in 2016 despite stellar growth, here are a few thoughts on how the economics of streaming might change:

An often repeated argument from record labels is that streaming services will hit profitability when they reach scale. So, when does that happen? 48 million subscribers can lay a good claim to being ‘scale’, but it isn’t driving profit. While the market establishes itself, streaming services have to overspend on product innovation and marketing (and then, later, on user retention). So, these costs will likely rise in relative terms. Meanwhile, rights are always going to remain largely in line with revenue (though the UMG and Merlin deals reward growth with some discounting, which is a welcome innovation). But even these deals will not change the fact that rights will be large enough to challenge margins and will largely scale with growth. Which means no truly meaningful scale benefits. So here are a few alternative ways in which streaming margins might be improved:

  • Doing a Netflix: Because Netflix owns much of its own content, it is able to use its recommendation algorithms to ensure that content over-indexes, improving margin. It also amortizes costs against those content assets to help it register a profit. Spotify could do the same but is unlikely to do so anytime soon. It cannot afford to antagonize its major label partners, each of whom has a UN Security Council type power of veto (Spotify would falter if any one of them pulled out). Someday, Spotify probably will become a label, though not in the way most people would understand the term. However, it will wait for more scale and confidence before flicking the switch on that strategy.
  • Ecosystems: Apple has long demonstrated the value of competing right across value chains. Now Amazon is following suit (e.g. Amazon Video covers rights, infrastructure and distribution). Exercising control across the value chain gives a company more places to extract margin. Perhaps Alibaba or Tencent (or some other Chinese giant) could buy a major label and a streaming service? Access Industries is already on this path, wholly owning WMG and more than half of Deezer (though there doesn’t seem to be much in the way of dots being joined yet). And then the wildcard is a streaming service becoming so big that it can buy a major or a collection of big indies. Or of course Apple deciding to any of the above. Should this feel like wild conjecture, do not forget that it was not so long ago when an ISP (AOL) bought WMG, and a water and sewage conglomerate (Vivendi) went on a media company acquisition spree and bought UMG.
  • Ancillary revenue streams: The most pragmatic solution though is not a silver bullet, but instead a blended strategy of new revenue streams. These can range from B2B (e.g. Spotify selling its data to live companies like Live Nation and AEG to help them get more cost effective with better targeting), through premium user add-ons to new formats such as limited capacity, pay-per-view artist live streams.

Spotify played the starring role in streaming’s biggest year yet and looks well on track to do the same in 2017. But at some stage, the losses need to narrow. The industry needs to help ensure this happens, unless it wants the market to end up being dominated by companies that simply do not have to have streaming turn a profit because they are making money elsewhere.