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.

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Spotify Earnings: Growth Comes At A Cost

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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.

 

Announcing MIDiA’s State Of The Streaming Nation 2 Report

2016 was the year that streaming turned the recorded music business into a good news story, with revenue growth so strong that it drove nearly a billion dollars of total growth. Leading streaming services spent the year competing with ever more impressive metrics while playlisting and streaming exclusives became cornerstones of the wider music market both culturally and commercially. 2017 is set to be another year of growth and the coming decade will see the music industry become a streaming industry in all but name. In this, MIDiA’s 2nd annual benchmark of the global streaming business, we present a definitive assessment of the global market, combining an unprecedented breadth and depth of supply side, demand side and market level data, as well as revenue and user forecasts out to 2025. This is quite simply the most comprehensive of assessment of the streaming music market available. If your business is involved in the streaming music market this is the report you need.

Key features for the report:

  • 32 pages
  • 4,650 words
  • 17 charts
  • 9,000+ data point dataset

At the bottom of this post is a full list of the figures included in the report. The report is immediately available to all paid MIDiA music subscribers.

To find out how to become a MIDiA client or to find out more about the report email Stephen@midiaresearch.com

Selected Key Findings

  • YouTube and Spotify lead Weekly Active User penetration with 25.1% and 16.3%
  • There were 106.4 million paid subscribers in 2016, rising to 336 million in 2025
  • Global streaming music revenue was $7.6 billion in 2016 in retail terms
  • 55% of subscribers create streaming music playlists
  • Universal music had 44% of major label streaming revenue in Q1 2017
  • 79% of streaming services globally have standard pricing as their lead price point

Companies And Brands Mentioned In The Report: 7Digital, Alibaba, Amazon, Anghami, Apple, Apple Music, CDiscount, Cstream, CÜR Media, Deezer, Echo, Google, Google Play Music All Acccess, Hitster, IFPI, KKBox, KuGou, Kuwo, MelON, Merlin, Mixcloud, MTV Trax, Napster, Pandora, QQ Music, Radionomy, Saavn, Slacker, Société Générale, So Music, Sony Music, Soundcloud, Tencent, The Echo Nest, Tidal, TIM Music, Universal Music, Vivo Musica, Warner Music, Worldwide Independent Network, YouTube, Vevo

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List of Figures In The Report

  • Figure 1: Penetration Of Key Streaming Music Segments (Subscriptions, Ad Supported Audio, YouTube/Vevo), April 2017
  • Figure 2: Overlap Of Key Streaming Music Consumer Segments (Subscriptions, Ad Supported Audio, YouTube/Vevo), April 2017
  • Figure 3: Key Streaming Adoption Behaviours Of All Consumers, Paid Streamers And Free Streamers (Including, family plans, trials, telco bundles), April 2017
  • Figure 4: Key Streaming Adoption Behaviours Of All Consumers, Paid Streamers And Free Streamers (Including playlist creation, curated playlists, radio impact, spending impact), April 2017
  • Figure 5: Weekly Time Spent Listening To Music And To Streaming Music (Streamers, Overall Consumers), April 2017
  • Figure 6: Age And Gender Distribution Of Streaming Music Consumers By Category (Subscriptions, Ad Supported Audio, YouTube/Vevo), April 2017
  • Figure 7: Average Number Of Tracks Streamed Per Week By Segment (All Consumers, Spotify, Apple Music, Subscribers)
  • Figure 8: End Subscriber Numbers For Individual Streaming Subscription Services, 2014 – 2016, Global
  • Figure 9: Weekly Active User Penetration For Selected Streaming Music Services, Q4 2016
  • Figure 10: Quarterly Major Label Streaming Music Revenue, Q1 15, Q1 16, Q1 17, Global (Millions USD)
  • Figure 11: Number Of Streaming Subscription Services Available By Country, April 2017
  • Figure 12: Key Pricing, Product And Trial Features For Music Subscription Services Across 22 Markets, April 2017
  • Figure 13: Streaming Music Revenue And Streaming Share Of Total Recorded Music Revenue, 2008-2025, Global
  • Figure 14: Global Streaming Music Revenue Split By Subscriptions And Ad Supported, 2008 to 2025
  • Figure 15: Streaming Music Revenue For 10 Largest Streaming Markets And Top 10 Share Of All Streaming Revenue, 2016 And 2025
  • Figure 16: Music Subscribers By Region (North America, Latin America, Europe, Asia Pacific, Rest Of World), 2013-2016
  • State Of The Streaming Nation 2 Infographic

Universal And Spotify’s Deal Is An Even Bigger Deal Than It Looks

 

Universal Music and Spotify have finally agreed on terms for the streaming service’s new licensing deal which reportedly includes better rates tied to growth targets and premium windowing. Check out Tim Ingham’s piece for detail on the deal. Although the big focus across the industry so far is, understandably, on what this means for Spotify, it is also part of a bigger story, namely that of the maturation of the streaming market and its associated business models.

What It Means For Spotify And UMG

Firstly, what it means for Spotify. As I have written previously, Spotify needs to create a strong narrative for Wall Street if it is going to IPO successfully. Within that narrative it needs to demonstrate that it is embarking on a journey of change even if the destination is some way off yet. Its relationship with the labels is central to that. Paying out more than 80% of revenue for ‘royalty distribution and other costs’ on a cash flow basis is not something potential investors exactly look upon with unbound enthusiasm. In pure commercial terms Spotify actually pays out round about the same amount (c70%) of revenues to rights holders as Netflix does, but because Netflix owns so much of its own rights it can amortize the costs of them to help generate a net profit while Spotify cannot.

The 2 ways of fixing that are 1) owning copyrights, 2) reducing rates to rights holders (which really means labels as publishers are pushing for higher rates). It is probably too early to flick the switch on the ‘Spotify as a label’ strategy as that would antagonize labels at exactly the wrong time. So reducing rates is the main lever left to pull.

However, the labels feel the rates are fair value, in fact many think the rates undervalue their content assets. So Spotify was never going to achieve a dramatic change in rates at this stage. Also, labels are wary of granting better terms to Spotify because Apple and co will immediately demand the same. Hence UMG has tied Spotify’s lower rates to growth targets, which you can rest assured will be ambitious. Why? Firstly the labels need continued big growth. The global music business grew by around 1 billion dollars last year, with streaming growing by 2 billion dollars. Thus without streaming’s growth the music business would have declined by 1 billion dollars instead of growing by that much. The labels cannot afford for streaming growth to be smaller than the amount by which legacy formats decline.

Secondly, Spotify needs better deals more than many of its competitors, so is more willing to agree to ambitious growth targets. Apple and Amazon (who both make their money elsewhere and aren’t prepping for an IPO) are less concerned about better rates and are less likely to be willing to be tied to strong growth targets. So UMG has a win win here. It gets Spotify tied into ambitious growth without a major risk of having to also give lower rates to Apple and Amazon.

What It Means For The Wider Market

With $5.8 billion in revenue in 2016, streaming has more than come of age, it is the beating heart of the recorded music business. But just as young companies have to transition from scrappy start ups to mature companies, this is the stage at which the streaming market as a whole needs to move from a cool emerging technology to a more nuanced and complex marketplace. It needs to develop the sort of sophistication that $5.8 billion market merits. Adding the ability to window new release albums is part of this process. And to be clear, the windowing does not mean that UMG’s new music is suddenly going to disappear off Spotify’s free tier. Instead UMG has the ability to choose to put selected albums behind the pay wall for 2 weeks as Daniel Ek’s press release quote makes clear:

“[This is a] new flexible release policy. Starting today, Universal artists can choose to release new albums on premium only for two weeks, offering subscribers an earlier chance to explore the complete creative work.”

While there is a risk that windowing may give piracy a little boost, those consumers that choose to Torrent rather than upgrade or simply wait 2 weeks were never realistic targets for the 9.99 tier anyway. What we may well see is a spike in uptake of free trials and the ‘$1 for 3 months’ super trials.

Getting The Right Kind Of Growth

The UMG – Spotify deal is more than just an agreement between 2 parties. It is the start of the next chapter in relationships between streaming services and labels. A deepening and strengthening of links. It is of course a unique product of its time (ie Spotify needing to get its house in order ahead of the IPO) but market defining precedents are often born out of such circumstances. Such as the time when AOL Time Warner wanted to ‘get smart with music’ following its recent merger and promptly sent off Warner Music’s CEO Roger Ames with Paul Vidich to carve out the iTunes deal with Steve Jobs.

Back then Apple was focused on trying to jump start iPod sales. Now though the labels need Spotify to start building a sustainable business. It is not enough for Spotify to simply clear the IPO hurdle, it needs to land on its feet and maintain speed. So while it’s great to see that UMG and Spotify have hit upon a framework for delivering better rates in return for better growth, Spotify must be careful to ensure that it grows sustainably and not pursue growth at any cost.

2016 was inarguably a great year for both streaming and the labels. This deal has the potential to lay the foundations for an even better 2017 and beyond.

Four Companies That Could Buy Spotify

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For much of 2016 it looked nailed on that Spotify would IPO in 2017 and that the recorded music industry would move onto its next chapter, for better or for worse. The terms of Spotify’s $1 billion debt raise (which mean that Spotify pays an extra 1% on its 5% annual interest payments every six months beyond its previously agreed IPO date) suggest that Spotify was thinking the same way too. But now, word emerges that Spotify is looking to renegotiate terms with its lenders and there are whispers that Spotify might not even IPO. It would be a major strategic pivot if Spotify was to abort its IPO efforts and it begs the question: what next?

The World Has Changed

When Daniel Ek and Martin Lorentzon were drawing up the Spotify business plan in the 2000’s, the music and tech worlds were dramatically different from what they are now. The ‘Potential Exits’ powerpoint slide in Ek’s investor pitch deck would have listed companies such as Nokia, Microsoft, Sony and HTC. Over the subsequent decade, those companies have fallen on harder times (though Microsoft is now experiencing a turnaround) and all of them have moved away from digital music, which is why an IPO seemed like a much better option for being able to get a large enough return on investment for Spotify’s investors.

The only problem is that the IPO market has changed too. IPOs were once the best way for tech companies to raise capital but with the current VC bubble (and its recycled cash in the form of exited-founders reinvesting as Angels) equity and debt investment is much easier to come by. In 1997, there were 9,113 public companies in the U.S. At the end of 2016, there were fewer than 6,000. 2016 was the slowest year for IPOs since 2009. And of course, Deezer aborted its IPO in 2015. Snapchat’s forthcoming IPO will be a Spotify bellwether. If it does well it will set up Spotify, but if Facebook’s continued aggressive feature-cloning on Instagram continues, it could underperform, which could change the entire environment for tech IPOs in 2017. The fact that only 15.4% of Snapchat’s stock is being listed may also push its price down. No fault of Spotify of course, but it is Spotify that could pay the price.

$8 Billion Valuation Narrows Options

Because Spotify has had to load itself with so much debt and equity investment it has needed to hike its valuation to ensure investors and founders still have meaningful enough equity for an exit. Spotify’s revenues will be near $3 billion for 2016 but its $8 billion valuation is half the value of the entire recorded music market in 2015 and more than double the value of the entire streaming music market that year. However, benchmarked against comparable companies, the valuation has clearer reference points. For example, Supercell had revenues of $2.1 billion and was bought by Tencent for $8.6 billion in 2016. King had revenues of $2.6 billion and was bought for $5.9 billion by Activision Blizzard, also in 2016.

The complication is that both of those companies own the rights to their content, while Spotify merely rents its content. Which means that in a worst case scenario Spotify could find itself as an empty vessel if it had a catastrophic fall out with its rights holder partners. King and Supercell would both still have their games catalogue whatever happened with their partners.

Western Companies Are Not Likely Buyers

So, in the event that Spotify does not IPO, it either needs to raise more capital until it can get to profitability (which could be 3+ years away) or it needs someone to meet its $8 billion asking price. Of the current crop of tech majors, Apple, Google and Amazon are all deeply vested in their own streaming plays (Apple Music, YouTube and Prime) so the odds of one of those becoming a buyer is, while not impossible, unlikely and for what it’s worth, ill advised. Though there could be a case for Apple buying Spotify for accounting purposes as buying a European company would be a way to use some of its offshore domiciled $231.5 billion cash reserves. Reserves that the Trump administration is, at some stage, likely to make efforts to repatriate to the US in one way or another. Facebook is the wild card, but it’s unlikely to want to saddle itself with such a cost-inefficient way of engaging users with music. A distribution partnership with Vevo or launching its own music video offering are much better fits.

Go East: Four Potential Suitors For Spotify

So much for Western companies. Cast your gaze eastwards though and suddenly a whole crop of potential suitors comes into focus:

imgres-2Tencent: With a market cap of more than $200 billion and a bulging roster of consumer propositions (including WeChat) and 3 music services, Tencent is arguably the most viable eastern suitor for Spotify. The fact that the company recently reported inflated subscriber numbers for QQ Music (which were in fact a repetition of the same inflated numbers given to Mashable in July last year) hints at Tencent’s eagerness to court the western media and to be judged on similar terms. A Spotify acquisition, especially an expensive one, would be both a major statement of intent and an immediate entry point into the west. It would also transform Spotify into a truly global player.

imgres-4Alibaba:
Another Chinese giant with a market cap north of $200 billion (although it has lost value in recent years), Alibaba has a strong retail focus but has been diversifying in recent years. Acquisitions include the South China Morning Post, Guangzhou Football Club and the Roewe RX5 ‘internet car’. Spotify would be a less obvious fit for Alibaba but could be a platform for building reach and presence in the west.

imgres-1Dalian Wanda: With assets of over $90 billion, revenue of more than $40 billion, a heavy focus on media and an insatiable appetite for acquisitions, Dalian Wanda is a strong contender. The company has built a global cinema empire in its AMC Theatres division, most recently picking up a Scandinavian cinema chain for a little under a billion dollars late January. Dalian Wanda’s strong US presence and long experience in that market, along with its bold global vision make its fit at least as good as Tencent’s. The fact that it is currently mulling a €6 billion acquisition of the German bank Postbank indicates it can buy big.

imgresBaidu: Baidu’s $10 billion revenues make it a markedly smaller player than Dalian Wanda but its $66 billion market cap and strong music focus (e.g. Baidu Music) make Spotify a good strategic fit. Spotify could help Baidu to both counter the domestic threat of Apple Music and to build out to the west, which could act as a platform for building out Baidu’s other brands.

imgres-3Other runners: A host of telcos could be contenders, including the $78 billion SoftBank and India’s Reliance Communications. However, most telcos will surely realise that emerging markets will soon hit the same music bundle speed bumps that are cropping up in western markets. One other outsider is the $29 billion 21st Century Fox. Perhaps less of a wildcard than it might at first appear, considering that News Corp was a major shareholder in the now defunct Beyond Oblivion. And of course, don’t rule out Liberty Global.

An IPO, albeit a delayed one, still remains the most likely outcome for Spotify, but if it proves unfeasible there is a healthy collection of potential buyers or at the very least, companies that could buy into Spotify to give it enough runway to get towards profitability.

Why Netflix Can Turn A Profit But Spotify Cannot (Yet)

Having just celebrated its 10th (streaming) birthday, Netflix followed up with a strong earnings release, announcing 5.8 million net new paid subscribers in Q4, sending its share price up by 9%. This wraps up a stellar year for Netflix, one in which it doubled down on original programming and delivered acclaimed hits such as Stranger Things and The OA, shows that don’t fit the traditional TV mould. In fact, Stranger Things was turned down by 15 TV networks before finding a home at Netflix and The OA’s oscillating episode lengths (from 1 hour 11 mins to 31 mins) would have played havoc with a linear TV schedule (not even considering its mind bending plot).

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Netflix closed 2016 with 89.1 million subscribers and the temptation to benchmark against Spotify’s equally strong year is too strong to resist. Spotify (which celebrated its decade in June 2016) closed the year with around 43 million subscribers, 48% the size of Netflix. But a closer look at the numbers tells another growth story.

Read the full post on the MIDiA blog by clicking here.

Music Subscriptions Passed 100 Million In December. Has The World Changed?

In streaming’s earlier years, when doubts prevailed across the artist, songwriter and label communities, one of the arguments put forward by enthusiasts was that when streaming reached scale everything would make sense. When asked what ‘scale’ meant, the common reply was ‘100 million subscribers’. In December, the streaming market finally hit and passed that milestone, notching up 100.4 million subscribers by the stroke of midnight on the 31st December. It was an impressive end to an impressive year for streaming, but does it mark a change in the music industry, a fundamental change in the way in which streaming works for the music industry’s numerous stakeholders?

Streaming Has Piqued Investors’ Interest

The streaming market was always going to hit the 100 million subscriber mark sometime around now, but by closing out the year with the milestone it was ahead of schedule. This was not however entirely surprising as the previous 12 months had witnessed a succession of achievements and new records. Not least of which was the major labels registering a 10% growth in overall revenue in Q2, driven by a 52% increase in streaming revenue. This, coupled with Spotify and Apple’s continual out doing of each other with subscriber growth figures, Spotify’s impending IPO and Vevo’s $500 million financing round, have triggered a level of interest in the music business from financial institutions not seen in well over a decade. The recorded music business looks like it might finally be starting the long, slow recovery from its generation-long recession.

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Spotify Continues To Set The Pace

Spotify has consistently led the streaming charge and despite a continually changing competitive marketplace it has held determinedly onto pole position since it first acquired it. Even more impressively, it has also maintained market share. According to data from MIDiA’s Music Streamer Tracker, in Q2 2015 Spotify’s share of global music subscribers was 42%, H2 15 41%, H1 16 44%, H2 16 43%. Not bad for a service facing its fiercest competitor yet in Apple, a resurgent Deezer and an increasingly significant Amazon. Spotify closed out the year with around 43 million subscribers, Apple with around 21 million and Deezer with nearly 7 million. 2nd place is thus less than half the scale of 1st, while 3rd is a third of 2nd place. Meanwhile Apple and Spotify account for 64% of the entire subscriber base. It is a market with many players but only 2 standout global winners. Amazon could change that in 2017, largely because it is prioritising a different, more mainstream market (as long as it doesn’t get too distracted by Echo-driven Music Unlimited success). Meanwhile YouTube has seen its music streaming market share decline, which means more higher paying audio streams, which means more income for rights holders and creators.

A Brave New World?

So far so good. But does 100 million represent a brave new world? In truth, there was never going to be a sudden step change but instead a steady but clear evolution. That much has indeed transpired. The music market now is a dramatically different one than that which existed 12 months ago when there were 67.5 million subscribers. Revenues are growing, artist and songwriter discontent is on the wane and label business models are changing. But 100 million subscribers does not by any means signify that the model is now fixed and set. Smaller and mid tier artists are still struggling to make streaming cents add up to their lost sales dollars, download sales are in freefall, many smaller indie labels are set to have a streaming-driven cash flow crisis, and subscriber growth, while very strong, is not exceptional. In fact, the global streaming subscriber base has been growing by the same amount for 18 months now: (16.5 million in H2 2016, 16.5 million in H1 2016 and 16.4 million in H2 2016). Also, for some context, video subscriptions passed the 100 million mark in the US alone in Q3 2016. And streaming music had a head start on that market.

At some stage, perhaps in 2017, we will see streaming in many markets hit the glass ceiling of demand that exists for the 9.99 price point. Additionally the streaming-driven download collapse and the impending CD collapses in Germany and Japan all mean that it would be unwise to expect recorded music revenues to register uninterrupted growth over the next 3 to 5 years. But growth will be the dominant narrative and streaming will be the leading voice. 100 million subscribers might not mean the world changes in an instant, but it does reflect a changing world.

Spotify May Be Buying Soundcloud, But Who Wins?

spotify-pac-manThe Financial Times has reported that Spotify is in advanced talks to buy Soundcloud. Soundcloud has been shopping itself around for some time, while Spotify needs to continue outpacing Apple as it heads towards an IPO. Which is why the deal has been rumoured for some time. But who would do best out of the deal (if indeed it goes ahead)?

  • Soundcloud has peaked: Throughout the 2010’s Soundcloud’s growth was impressive, growing from 1 million registered users in May 2010 to 150 million by December 2014. But registered user numbers only ever tell part of the story. The most telling statistic is Soundcloud’s Monthly Active User (MAU) number: 175 million. Impressive enough, and 50 million more than Spotify’s 125 million. But Soundcloud hit that number in August 2014 and it hasn’t reported a bigger number since. In fact, it could well be that Soundcloud hasn’t actually issued a new number since, but instead has simply being restating that number. If it had grown, you can be sure we’d have heard about it. If it had fallen, perhaps not. On top of this, in October 2013 CEO Alexander Ljung stated that Soundcloud had hit 250 million MAUs. A number that has not since been repeated. So best case, Soundcloud usage has peaked, worst case it is in decline. DEAL WINNER: Soundcloud
  • Soundcloud users are male super fans: According to MIDiA’s consumer data 7% of consumers are Weekly Active Users (WAU) of Soundcloud, about half the rate of Spotify (again suggesting that Soundcloud’s headline user numbers aren’t all they appear). But crucially 60% of its WAUs are male while Spotify’s are 50/50 male/female. Spotify has spent the last few years diversifying its user base away from this male super fan skew. All that work would be undone if the Soundcloud user base is absorbed. DEAL WINNER: Evens
  • Soundcloud users are a funnel: Spotify’s model relies upon giving new audiences a taste of its offering via its free tier, super trials and telco bundles, before converting to paid. To keep ahead of Apple, Spotify has to keep filling up its funnel. So Soundcloud’s user base will be a welcome boost to Spotify’s user acquisition as it seeks to maintain momentum as it heads towards IPO. DEAL WINNER: Spotify
  • Many Soundcloud users are already subscribers: 28% of Soundcloud users already have a music subscription, with the majority of those already paying for Spotify rather than Soundcloud Go. So many of the low hanging fruit users have already been converted, weakening the value of the audience. DEAL WINNER: Soundcloud
  • Soundcloud has a unique catalogue: A key reason so many Soundcloud users also use Spotify is that so much Soundcloud catalogue can only be found there. This is a rich asset for Spotify but as much of it is not licensed so it could prove to be a licensing quagmire for Spotify. DEAL WINNER: Spotify, if it can sort out the licensing
  • Soundcloud’s valuation is high: Reported valuations for Soundcloud have ranged from $700 million to $2 billion. Even if it comes in at $500 million, unless the deal is heavily skewed towards stock, Spotify will burn through a massive chunk of its latest $1 billion debt round. DEAL WINNER: Soundcloud

There is an additional wild card, that Spotify could use Soundcloud as vehicle for becoming a serious player in ad supported in its own right (which will delight Apple’s Jimmy Iovine, not). The deal of course may not even happen, but if it does, it is far from a guaranteed winner for Spotify. It will help Spotify build a bullish growth story for Wall Street but Spotify will have to IPO before the shine starts to come off if Soundcloud’s user base turns out to be smaller and less valuable pickings than at first appears.

 

Have Spotify and Apple Music Just Won The Streaming Wars?

Spotify has just delivered 2 landmark data points: 40 million subscribers and $5 billion paid to rights holders to date. Although the 3 million added in Q3 was down on the 7 million added in Q2 (boosted by a summer pricing promo) there is no escaping the fact that Spotify’s momentum has accelerated rather than declined since the emergence of Apple Music. 2016 is proving to be Spotify’s year. The question is how well the rest of the market is performing beyond the 2 market leaders?

The streaming music market as a whole is experiencing unprecedented growth, with the major labels collectively reporting a 52% increase in streaming revenue in Q2 2016 compared to the same period 12 months ago. Given that total streaming revenues (including YouTube etc. but not Pandora) grew by 44% in 2015 (according to the IFPI) the picture that is emerging is one of, at worst, sustained growth, at best, accelerating growth.

Although the major label numbers have to be interpreted with caution due to factors such as Minimum Revenue Guarantees (MRGs) – see my previous post for much more detail on this – the headline trend is growth. However, headline growth is not necessarily a reflection of how most of the market is actually performing. In fact, a forensic examination of these numbers cross referenced against reported Apple Music and Spotify numbers reveals that the outlook for the rest of the pack is very different indeed.

streaming-market-share-q2-16

At the end of 2015 there were 67.5 million subscribers, by the end of June 2016 that had increased to 83.2 million – a 23% increase from the end of 2015 and a 63% increase on Q2 2015. Spotify’s subscriber count for Q2 2016 was 37 million (including super trialists) while Apple Music was just under 16 million. This gives them a combined market share of 56%, which in itself is not particularly surprising. However, when we look at what has happened to the rest of the pack that things start to get really interesting…

The Rest Of The Pack Is Getting Left Behind

By end Q2 2015 Spotify had 20 million subscribers and Apple Music none. This meant that the rest had 31 million between them. By Q2 2016 this ‘remainder’ had shrunk to 30.5 million. Among this chasing pack there is a diverse mix of stories, with some services showing solid growth, some losing lots of paid subscribers and some disappearing all together. Meanwhile Spotify and Apple Music added 32.7 million to the global subscriber base. Thus over the same 12 month period these two players combined, became bigger then the entire rest of the market in subscriber terms with a 63% combined market share. An interesting side note: Tidal’s reported revenues of $47 million in 2015 mean that it can’t have had more than around 800,000 commercially active subscribers by year end, which means that the reported and ‘implied’ 4.2 million current subscriber count is probably closer to half that.

Streaming revenue followed a similar trend with Apple and Spotify dominating and the rest falling slightly (by 1 percentage point year on year). Spotify paid around $1.6 billion in royalties in 2015 and a cumulative $6 billion by September 2016, implying about $1.1 billion in 2016 already. The amount that Spotify paid to record labels in Q2 was somewhere between $479 million and $622 million, depending on when and how Spotify paid for those 7 million new super trialists it acquired that quarter. Towards the lower end of that range is probably the safer bet. Apple by comparison paid around $220 million. And as with subscriber numbers, the rest of the pack lost revenue.

It’s A 2 Horse Race

When Apple launched Apple Music some less informed observers suggested that it was too late to the party and that there was only room for one big player. The numbers from Q2 2016 show that Apple was far from too late (fashionably late perhaps) and that the rather than being a winner takes all scenario, the streaming market is a 2 horse race. Unfortunately for the rest of the pack it does look like there is only space for 2 leading global players, with Apple clearly having played a key role in knocking Deezer out of 2nd place and racing on ahead.

Still A Place For Regional Leaders

This does not mean that there is not space for other players, there is. Especially regional leaders like QQ Music, KKBox, Anghami and MelOn. But the consumer marketplace only has so much appetite for global scale $9.99 AYCE services. Which is why pricing and product innovation are so crucial if the recorded music business wants a vibrant streaming sector. Compare and contrast with the streaming video market where there is immense innovation with niche services and a diverse range of price points. Music streaming needs the same approach. Tidal may have (very successfully) differentiated on brand and content but it remains fundamentally an also-ran, $9.99 AYCE service. As things stand, the only really serious attempt to play by different rules is Amazon’s steadily emerging streaming strategy. Expect that dark horse to make up ground by playing by different rules. Perhaps even Pandora may be able to break the mould too.

But it is only through differentiated strategies that serious inroads can be made and unless pricing and product innovation occurs (and the labels and publishers need to enable it) expect the streaming race to continue to be a tale of 2 horses.

Just How Well Is Streaming Really Doing?

All of the three major record labels announced strong streaming music revenue growth in the 2nd quarter of 2016. On the surface it is a clear cut success story, but as is so often the case with music industry statistics, all is not quite how it seems.

The Global Streaming Market

First of all, let’s look at the global picture. According to the IFPI’s Recording Industry in Numbers (RIN) 2016 edition record label streaming revenue grew by 45% in 2015 reaching $2.9 billion, up from $1.9 billion in 2014. But even that number requires a little due diligence. The IFPI restates its historical numbers every year to reflect the current year’s exchange rates, which can, and does, overstate things. Indeed, a quick look at the 2015 edition of RIN shows that streaming revenue was reported as $2.2 billion for 2014. So on a non-adjusted basis (i.e. without restating the numbers) streaming revenue actually grew by 31%.

Spotify’s Contribution

31% is still impressive growth but the plot thickens when we factor in Spotify’s contribution to those label revenues. Spotify’s total royalty payments were $1.9 billion in 2015, of which around $1.4bn were label payments, and of those around $1.1 billion were royalty payments (i.e. minus advance payments such as Minimum Revenue Guarantees (MRGs) paid in anticipation of future growth). That $1.1 billion was up 85% from $610 million in 2014. As the IFPI numbers only represent payments in respect of actual royalties (i.e. minus advance payments) the Spotify label royalty payments can be considered as a share of that global total. That share was 39% of all label streaming revenue in 2015, up from 28% in 2014.

This results in 2 interesting points:

  1. Spotify’s share of the global music subscriber total was 35% in 2014 and 37% in 2015. So the label royalty payments over indexed in 2014 and under indexed in 2015. The fact that 2015 was a big year for heavily discounted promotional offers such as $1 for 3 months most probably plays a key role here.
  2. If we remove the Spotify label royalty payments from the equation, label payments from other streaming services grew by just 10% from $1.6 billion in 2014 to $1.8 billion in 2015. Not exactly the most robust of pictures for the wider streaming market place.

major label streaming

So much for 2015, let’s look at where we are now. All three major labels reported strong streaming growth in Q2 2016. Together they reported $918 million, up 51% from $607 in Q2 2015. That growth generated $311 million of new digital revenue. At the same time, and as a direct consequence, download revenue fell by 24% from $925 in Q2 2015 to $705 million. So streaming is now nearly as big as downloads were 12 months ago. The net increase in combined digital music revenue was $91 million, or a combined digital growth rate of 6%. Solid growth, but not far from treading water. This is a transition process, not a transformative growth process.

Universal Is The Big Streaming Winner

Each of the 3 majors had differing streaming experiences. Universal was the big winner, growing its share of major label streaming revenue from 38% in Q2 2015 to 42% in Q2 2016 (boosted more than other majors by ‘embedded’ independent label revenue). UMG’s streaming revenue grew by more than 60% while Sony and Warner grew by an average of 42%. However, it is important to note that UMG’s reported streaming numbers may be skewed more by currency restating than the other majors, so this share increase might be slightly on the high side.

Sony Music meanwhile lost share from 35% to 33% while Warner Music, which was most coy about its streaming revenue in its reporting, also saw a fall from 26% to 25%. Warner’s and Sony’s loss was Universal’s gain. An interesting side note: Sony was the only major that saw growth in physical music sales over the period. Yet more evidence of the Adele effect?

The Role Of Advanced Payments

But perhaps the most important element of the majors’ streaming reports is the difference between royalty payments (i.e. money earned for music streamed) and total streaming revenue (i.e. including advanced payments such as MRGs). Spotify states rights payments are 70% of its revenue though its 2015 accounts show royalty payments as 82% of revenue due in large part to advanced payments. Using this benchmark advanced payments represent around 16% of all label payments. Applying this to the label reported numbers we can extrapolate that $145 million of all major label streaming revenue is advanced payments.

Why does this matter? Because this is the major record label’s streaming reality distortion field. They get streaming revenue regardless of how well the marketplace actually performs. If a streaming service pays an MRG of $30 million but only earns $10 million the label still gets $30 million. So in that scenario the label’s view of that part of the streaming music market is 3 times better than it actually is. If the music service wins, the label wins, if the music service loses, the label still wins. This disconnect between how the market performs and how the label performs is one of the festering wounds of the streaming music market. And its revenue impact is massive. In fact, advanced label streaming payments were 158% of the $91 million that digital music revenue grew by in Q2 2016. Yes, that’s right, advanced streaming payments accounted for all of the digital music growth, and more.

Streaming Will Continue To Grow, But Haunted By Advanced Payments

So where does all this leave us? The streaming market is without doubt entering a phase of accelerating growth and is doing enough to counter the resulting decline in downloads to contribute to a combined total recorded music revenue growth of 4% for major labels in Q2 2016. But growth is not quite as stellar as the headline numbers would suggest, with the single most important factor being the impact of advanced payments distorting the bigger picture and crippling cash flow for streaming music services. Expect more impressive growth throughout the remainder of 2016 but also expect streaming music economics to continue to be fractured.