Amazon’s Ad Supported Strategy Goes Way Beyond Music

Amazon is reportedly close to launching an ad supported streaming music offering. Spotify’s stock price took an instant tumble. But the real story here is much bigger than the knee-jerk reactions of Spotify investors. What we are seeing here is Amazon upping the ante on a bold and ambitious ad revenue strategy that is helping to reformat the tech major landscape. The long-term implications of this may be that it is Facebook that should be worrying, not Spotify.

amazon ad strategy

In 2018 Amazon generated $10.1 billion in advertising revenue, which represented 4.3% of Amazon’s total revenue base. While this is still a minor revenue stream for Amazon, it is growing at a fast rate, more than doubling in 2018 while all other Amazon revenue collectively grew by just 29%. Amazon’s ad business is growing faster than the core revenue base, to the extent that advertising accounted for 10% of all of Amazon’s growth in 2018.

Amazon is creating new places to sell advertising

The majority of Amazon’s 2018 ad revenue came from selling inventory on its main platform. This entails having retailers advertise directly to consumers on Amazon, so that Amazon gets to charge its merchants for the privilege of finding consumers to sell to, the final transaction of which it then also takes a cut of. In short, Amazon gets a share of the upside (i.e. the transaction) and of the downside (i.e. ad money spent on consumers who do not buy). This compressed, redefined purchase funnel is part of a wider digital marketing trend and underlines one of MIDiA’s Four Marketing Principles.

But as smart a business segment as that might be to Amazon, it inherently skews towards the transactional end of marketing, and is less focused on big brand marketing, which is where the big ad dollar deals lie. TV and radio are two of the traditional homes of brand marketing and that is where Amazon has its sights set, or rather on digital successors for both:

  • Video: Amazon’s key video property Prime Video is ad free. However, it has been using sports as a vehicle for building out its ad sales capabilities and has so far sold ads against the NFL’s Thursday Night Football. It also appears to be poised to roll this out much further. However, Amazon’s key move was the January launch of an entire ad-supported video platform, IMDb Freedive. Amazon has full intentions to become a major player in the video ad business.
  • Music: Thus far, Amazon’s music business has been built around bundles (Prime Music) and subscriptions (Music Unlimited). Should it go the ad-supported route, Amazon will be replicating its video strategy to create a means for building new audiences and new revenue.

It’s all about the ad revenue

Right now, Amazon is a small player in the global digital ad business, with just 6% of all tech major ad revenue. However, it is growing fast and has Facebook in its sights. Facebook’s $50 billion of ad revenue in 2018 will feel like an eminently achievable target for a company that grew from $2.9 billion to $10.1 billion in just two years.

To get there, Amazon is committing to a bold, multi-platform audience building strategy. Whereas Spotify builds audiences to deliver them music (and then monetise), Amazon is now building audiences in order to sell advertising. That may feel like a subtle nuance, but it is a critical strategic difference. In Spotify’s and Netflix’s content-first models, content strategy rules and business models can flex to support the content and the ecosystems needed to support that content. In an ad-first model, the focus is firmly on the revenue model, with content a means to an end rather than the end. (Of course, Amazon is also pursuing the content-first approach with its premium products.)

Amazon is becoming the company to watch

So, while Spotify investors were right to get twitchy at the Amazon rumours, it is Facebook investors who should be paying the closest attention. Amazon’s intent is much bigger than competing with Spotify. It is to overtake Facebook as the second biggest global ad business. None of this means that Spotify won’t find some of its ad supported business becoming collateral damage in Amazon’s meta strategy – a meta strategy that is fast singling Amazon out as the boldest of the tech majors, while its peers either ape its approach (Apple) or consolidate around core competences (Google and Facebook). Amazon is fast becoming THE company to watch on global digital stage.

10 Trends That Will Reshape the Music Industry

The IFPI has reported that global recorded music revenues have hit $19.1 billion, which means that MIDiA’s own estimates published in March were within 1.6% of the actual results. This revenue growth story is strong and sustained but the market itself is undergoing dramatic change. Here are 10 trends that will reshape the recorded music business over the coming years:

top 10 trends

  1. Streaming is eating radio: Younger audiences are abandoning radio for streaming. Just 39% of 16-19-year olds listen to music radio, while 56% use YouTube instead for music. Gen Z is unlikely to ever ‘grow into radio’; if you are trying to break an artist with a young audience, it is no longer your best friend. To make matters worse, podcasts are looking like a Netflix moment for radio and may start stealing older audiences. This is essentially a demographic pincer movement.
  2. Streaming deflation: Streaming music has allowed itself to be outpaced by inflation. A $9.99 subscription from 2009 is actually $13.36 when inflation is factored in. Contrast this with Netflix, for which theinflation-adjusted price is $10.34 but the actual 2019 price is $12.99. Netflix has stayed ahead of inflation; Spotify and co. have fallen behind. It is easier for Netflix to increase prices as it has exclusive content, but rights holders and streaming services need to figure out a way to bring prices closer to inflation. A market-wide increase to $10.99 would be a sound start, and the fact that so many Spotify subscribers are willing to pay $13 a month via iTunes shows there is pricing tolerance in the market.
  3. Catalogue pressure: Deep catalogue has been the investment fund of labels for years. But with most catalogue streams coming from music made in this century, catalogue values are being turned upside down (in the streaming era, the Spice Girls are worth more than the Beatles!). Labels can still extract high revenue from legacy artists with super premium editions like UMG did with the Beatles in 2018, but a new long-term approach is required for valuing catalogue. Matters are complicated further by the fact that labels are now doing so many label services deals, and therefore not building future catalogue value.
  4. Labels as a service (LAAS): Artists can now create their own virtual label from a vast selection of services such as 23 Capital, Amuse, Splice, Instrumental, and CDBaby. A logical next step is for a 3rdparty to aggregate a selection of these services into a single platform (an opening for Spotify?). Labels need to get ahead of this trend by better communicating the soft skills and assets they bring to the equation, e.g. dedicated personnel, mentoring, and artist and repertoire (A+R) support.
  5. Value chain disruption: LAAS is just part of a wider trend of value chain disruption with multiple stakeholders trying to expand their roles, from streaming services signing artists to labels launching streaming services. Things are only going to get messier, with virtually everyone becoming a frenemy of the other.
  6. Tech major bundling: Amazon set the ball rolling with its Prime bundle, and Apple will likely follow suit with its own take on the tech major bundle. Music is going to become just one part of content offerings from tech majors and it will need to fight for supremacy, especially in the ultra-competitive world of the attention economy.
  7. Global culture: Streaming – YouTube especially – propelled Latin music onto the global stage and soon we may see Spotify and T-Series combining to propel Indian music into a similar position. The standard response by Western labels has been to slap their artists onto collaborations with Latin artists. The bigger issue to understand, however, is that something that looks like a global trend may not be a global trend at all but is simply reflecting the size of a regional fanbase. The old music business saw English-speaking artists as the global superstars. The future will see global fandom fragmented with much more regional diversity. The rise of indigenous rap scenes in Germany, France and the Netherlands illustrates that streaming enables local cultural movements to steal local mainstream success away from global artist brands.
  8. Post-album creativity: Half a decade ago most new artists still wanted to make albums. Now, new streaming-era artists increasingly do not want to be constrained by the album format, but instead want to release steady streams of tracks in order to keep their fan bases engaged. The album is still important for established artists but will diminish in importance for the next generation of musicians.
  9. Post-album economics: Labels will have to accelerate their shift to post-album economics, figuring out how to drive margin with more fragmented revenue despite having to invest similar amounts of money into marketing and building artist profiles.
  10. The search for another format: In 1999 the recorded music business was booming, relying on a long established, successful format that did not have a successor. 20 years on, we are in a similar place with streaming. The days of true format shifts are gone due to the fact we don’t have dedicated format-specific music hardware anymore. However, the case for new commercial models and user experiences is clear. Outside of China, depressingly little has changed in terms of digital music experiences over the last decade. Even playlist innovation has stalled. One potential direction is social music. Streaming has monetized consumption; now we need to monetize fandom.

Here’s How Spotify Can Fix Its Songwriter Woes (Hint: It’s All About Pricing)

Songwriter royalties have always been a pain point for streaming, especially in the US where statutory rates determine much of how songwriters get paid. The current debate over Spotify, Amazon, Pandora and Google challenging the Copyright Royalty Board’s proposed 44% increase illustrates just how deeply feelings run. The fact that the challenge is being portrayed as ‘Spotify suing songwriters’ epitomises the clash of worldviews. The issue is so complex because both sides are right: songwriters need to be paid more, and streaming services need to increase margin. Spotify has only ever once turned a profit, while virtually all other streaming services are loss making. The debate will certainly continue long after this latest ruling, but there is a way to mollify both sides: price increases.

spotify netflix pricing inflation

When Spotify launched in 2008, the industry music standard for subscription pricing was $9.99. So, when its premium tier was launched in May 2009, it was priced at $9.99. Incidentally, Spotify racked up an initial 30,000 subscribers that month – it has come a long way since. But now, nearly exactly ten years on, Spotify’s standard price is still $9.99. Its effective price is even lower due to family plans, trials, telco bundles etc., but we’ll leave the lid on that can of worms for now. Over the same period, global inflation has averaged 2.95% a year. Applying annual inflation to Spotify’s 2009 price point, we end up at $13.36 for 2019. Or to look at it a different way, Spotify’s $9.99 price point is actually the equivalent of $7.40 in today’s prices when inflation is considered. This means an effective real-term price reduction of 26%.

Compare this to Netflix. Since its launch, Netflix has made four major increases to its main tier product, lifting it from $7.99 in 2010 to $12.99 in 2019. Crucially, this 63% price increase is above and beyond inflation. An inflation-adjusted $7.99 would be just $10.34. Throughout that period, Netflix continued to grow subscribers and retain its global market leadership, proving that there is pricing elasticity for its product.

Spotify and other streaming services are locked in a prisoner’s dilemma

So why can’t Spotify do the same as Netflix? In short, it is because it has no meaningful content differentiation from its competitors, whereas Netflix has exclusive content and so has more flexibility to hike prices without fearing users will flock to Amazon. If they did, they’d have to give up their favourite Netflix shows. Moreover, Netflix has to increase prices to help fund its ever-growing roster of original content, creating somewhat circular logic, but that is another can of worms on which I will leave the lid firmly screwed.

If Spotify increases its prices, it fears its competitors will not. Likewise, they fear Spotify will hold its pricing firm if any of them were to increase. It is a classic prisoner’s dilemma.  Neither side dare act, even though they would both benefit. Who can break the impasse? Labels, publishers and the streaming services. If they could have enough collective confidence in the capability of subscriptions over free alternatives, then a market-level price increase could be introduced. Rightsholders are already eager to see pricing go up, while streaming services fear it would slow growth. Between them, there are enough carrots and sticks in the various components of their collective relationships to make this happen.

However – and here’s the crucial part – rightsholders would have to construct a framework where streaming services would get a slightly higher margin rate in the additional subscriber fee. Otherwise, we will find ourselves in exactly the same position we are now, with creators, rightsholders, and streaming services all needing more. When Netflix raises its prices it gets margin benefit, but under current terms, if Spotify raises prices it does not.

The arithmetic of today’s situation is clear: both sides cannot get more out of the same pot of cash. So, the pot has to become bigger, and distribution allocated in a way that not only gives both sides more income, but also allows more margin for streaming services.

Streaming music in 2019 is under-priced compared to 2009. Netflix shows us that it need not be this way. A price increase would benefit all parties but has to be a collective effort. Where there is a will, there is a way.

Why India Matters to Spotify, and Why it May Not Deliver

Warner Music and Spotify have been involved in a rather unseemly and very public spat this week over Spotify’s India launch. I’ll leave for someone else, the discussions of the potential implications of a blanket license for songwriter rights in India for an on-demand streaming service. Suffice to say, the words ‘can of worms’ come to mind. Instead, I am going to focus on why India matters so much to Spotify.

The next one billion, perhaps…

Spotify’s Daniel Ek has made much of addressing the next one billion internet users as part of Spotify’s long-term opportunity. Given the fact that China is effectively off the table for now and that sub-Saharan Africa is probably a generation away from being a major streaming market, India is the key component of that next one billion.

Europe and North America accounted for 69% of Spotify’s subscriber growth in 2018. While this was hugely positive for those regions and delivered high-value subscribers – declining ARPU notwithstanding, growth in those regions will slow down towards the end of this year. Next tier markets – Brazil, Mexico, Germany and ideally, though probably not, Japan – will pick up much of the slack. But to sustain the growth rates its shareholders require, Spotify needs other large markets to start building real momentum by 2020/2021. India and the Middle East represent the best options. However, the Middle East already has a strong incumbent – Anghami – and a potentially resurgent Deezer, newly empowered by its exclusive deal with leading local label Rotana. So, India is effectively the last bet on the table.

India is a very competitive but problematic market

India, however, is a problematic market. It has a host of well-backed incumbents – Jio Music, Saavn, and Tencent-backed Gaana – as well as solid performances from Apple and Google. Yet despite all this robust supply, the market heavily underperforms, registering only 1.7 million subscribers in 2018 with a monthly label ARPU of just $0.74. 1.7 million may sound like a solid enough base, but it represents just 0.1% of the total Indian population. There are two key reasons for such weak uptake to date:

  1. Music plays a different role in India:Bollywood and devotional are two of the most widely listened to music genres, neither of which are mainstays of subscription services, nor streaming music consumption in general.
  2. Income levels are low:the average per capita income is $553 a month, with the luxury of a music subscription far out of reach for most Indians, other than urban elites. Spotify’s $1.80 price point in India may sound cheap, but relative to average income, it is 9.3 times more expensive than $9.99 is in the US. So, Spotify would need to be priced at $0.19 to be the same relative affordability as in the US, which coincidentally is the price for its day pass.

The ARPU challenge

The realistic ambition for Spotify should be to drive five to 10 million subscribers over the next five years or so, primarily pulling from urban elites (essentially a re-run of what has been happening in Latin America). While more credible, this falls way short of denting the ‘next one billion’ opportunity. To unlock the scale opportunity, streaming has to look beyond subscriptions, and also beyond ad supported (India’s 270 million free streamers only generated a monthly ARPU of $0.006 in 2018). The scale opportunity is telco bundles. Reliance Communications’s prioritisation of Jio Music makes it the most likely player to capitalise on this in the mid-term.

Spotify needs to find a similar scale partner and somehow convince label partners to accept an ARPU of say $0.08, which would be roughly in line with US telco bundle ARPU on a Purchasing Power Parity (PPP) basis. This would unlock scale without having to tolerate the catastrophically lower ad-supported ARPU rates. But the odds of that happening anytime soon are miniscule. When, and it is a case of when, not if, that time does come, the scale of adoption could be transformative for the global market. In fact, this is exactly where MIDiA thinks the market is heading. In our just published music forecasts, we predict that by 2026 India will have the fourth largest installed base of music subscribers, anywhere in the world.

What matters most, revenue or scale?

The question is whether Spotify can be a major part of the ‘Indian adoption’. Even if it can, the ARPU will be so small that all the current concerns about Spotify’s falling ARPU will look like a storm in a teacup when compared.

Have no doubt, India can, and perhaps will, become a major player in the global streaming market, even helping reshape global music culture. It can also play a major role in Spotify’s future, but the rules of engagement will need to change to unlock that growth, and in doing so Spotify will be sacrificing ARPU. All of this means, Spotify’s investors and partners need to ask themselves, what do they want Spotify to deliver most: strong revenue growth or strong subscriber growth, because India cannot deliver both.

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

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…?

Can Spotify Ever Meet Investors’ Expectations?

Spotify just posted another solid set of results, adding four million subscribers and beating profit and revenue estimates, yet its share price fell. What’s going on? Spotify is on track for where it should be, slightly below, but on track. Before Spotify went public MIDiA laid out three growth scenarios (low, mid, high). Our mid forecast put Spotify at 87.8 million subscribers for Q3 2018, it reported 87 million. So, Spotify is pretty much exactly where it should be. It’s not exceeding expectations, nor missing them, but is plotting a strong, solid course, all the while improving operational metrics such as churn and profitability. Yet still, this is not enough for investors. The reason is simple: misaligned expectations.

Investors want more

Spotify has pretty much had this problem all year, delivering good, steady growth that is good enough for the music industry, but isn’t good enough for investors. Record labels measured Spotify’s success relative to the performance of their revenues, which were coming out of a tailspin. Investors have a higher bar for success. They want faster growth, profitability (never really a label priority – it was Spotify’s problem to fix) and market disruption. Spotify is building its business at a decent rate that meets / exceeds music industry expectations, but not investor expectations. It is also laying the foundations for future self-sufficiency (artists direct, podcast etc.) but investors want more, now.

Tech stocks are the benchmark

The problem with going public as music company is that your investors are not music specialists; most aren’t even media specialists. Consequently, they don’t have the same situational industry expertise that music industry specialists have. They don’t get bogged down with the minutiae of collection society reciprocal agreements, mechanical rights, label marketing strategies, publisher concerns or artist contracts. They can’t. Music is too small a part of an institutional investor’s portfolio to commit the time required to truly understand what is a very complex industry. So instead they look at the big picture and benchmark against Netflix and other tech stocks.

I remember a comment Pandora’s founder Tim Westergren made to me on a panel last year, to the effect that Spotify better be careful what it wished for by going public. Tim learned first-hand that investors didn’t have the appetite to understand the nuances that shaped his business and eventually he paid the ultimate price, foisted out of his own company.

Game changer or industry ally?

In music industry terms Spotify is doing a great job, in tech stock terms, less so. Either it has to start performing even more strongly – no easy task in a maturing market – or it has to start talking up the disruption angle. Tech investors like backing game changers, betting big on something that is going to change the world. In the way that Facebook, Google, Netflix, Amazon (and for a while, Snapchat) did. Thus far Daniel Ek has trodden a difficult middle ground, remaining the firm ally of the music industry but also promising disruptive change. If the stock continues to underperform, he and his exec team might just be forced to start talking up disruption. At that stage it will be gamble time, because Spotify will be swapping allegiances that could make or break the business.

Spotify May Already Be Too Big for the Labels to Stop it Competing With Them

Spotify’s Daniel Ek is betting big on developing a ‘two sided marketplace’ for music. With the company’s market cap on a downward trend despite strong growth metrics, Ek might find himself having to play up the disruption narrative more boldly and more quickly than he’d planned. Investors are betting on a Netflix-like disruptor for the music industry, rather than a junior distribution partner for the labels. And this is where it gets messy. Whereas Netflix can play individual TV networks off each other and can even afford to lose Disneyand Fox, each major record label has enough market share to have the equivalent of a UN Security Council Veto. So when Spotify announced it was going to let artists upload music directly and thenadded distribution to other streaming services via DistroKid,the labels understandably smelt a rat. To the extent they threatened to block access to India. Spotify’s balancing act may be reaching a tipping point (mixed metaphor pun intended), but it may already be too late for the labels to act. Here’s why…

In search of market share

If Spotify is able to become more competitive (and therefore threatening) to labels and keep hold of them, it will all be down to market share. The less market share the big labels have on Spotify, the more negotiating power Spotify has. It is a classic case of divide and rule. If Spotify really wants to play the role of market disruptor (and so far we have strong hints rather than outright statements), it will need to whittle down the power of the majors before they call it and pull their content. Here’s a scenario for how Spotify could achieve that.

1 – Direct indie label deals

The first step is detangling embedded indie label market share from the majors that distribute them and therefore wield their market share as part of their own in licensing negotiations. There are two ways to measure market share:

  1. By distribution (this includes indie labels distributed via major labels being included in the share of the bigger labels)
  2. By ownership (this measures based on the original label, so does not count any indie labels as part of major labels)

By the first measure, the major labels had an 82% market share in 2016 and 79% market share in 2017. By the second measure, according to the WINTel report, major label market share was 62% in 2016 (the 2017 WINTel number is not yet out but will be shortly). So, if Spotify does direct deals with the larger indies currently distributed by majors or major-owned distributors (or persuades them to join Merlin), it unpacks up to more than a fifth of major label market share.

2 – More artists direct

DIY artists uploading directly to Spotify is a long-term play, aimed at harnessing the potential of tomorrow’s stars. In the near term, these artists will generate a smallish amount of streams, even with a helping hand from Spotify’s algorithms and curators. There are about 300 artists right now; let’s say Spotify gets to 2,500 next year, it could potentially deliver around a third of a percent of share of Spotify streams.

3 – Library music

Fake artist gatesaw a lot of people getting very hot under the collar, but nothing that was done was against any rules. Instead library music companies like Epidemic Sounds were – and still are – serving tracks into mood based playlists. The inference is that Spotify is paying less for Epidemic Sounds tracks than to labels. Whether it is or isn’t, this still eats away at label market share on Spotify. With a bit more support from Spotify’s playlist engine, these could account for around 0.7% of streams.  Coupled with artists direct, that’s a single point of share. Not exactly industry changing, but a pointer to the future, and a point of share is a point of share.

4 – Top 20 artists

Where Spotify could really move the needle is doing direct deals with top tier, frontline artists, probably on label services deals, as Spotify doesn’t appear to want to become a copyright owner – not yet at least. Netflix is funding its original content investments with around $1.5 billion of debt every two years, which it raises against its subscriber growth forecasts. No reason why Spotify couldn’t do the same, paying advances that other labels couldn’t compete with. The top 20 artists on Spotify account for around 22% of all Spotify streams. If Spotify could do direct deals with each of them and promote the hell of out of their latest releases, they could contribute up to 15% of all streams. Of that top 20, Taylor Swift is on the lookout for a new label, and Drake is putting out ‘albums’ so frequently that he must be pushing up close to the end of his deal.

spotify streaming repertoire shares midia research

When we add all these components together we end up in a situation where the major labels’ share of total streams would be just 47%. Spotify would have the second highest individual market share, while regional repertoire variations mean that SME and WMG could drop towards 10-11% in a couple of regions.

Of course, this is a hypothetical scenario, and one on steroids: the odds of Spotify signing up all the top 20 artists in the next 12 months is slim, to put it lightly, but it is useful for illustrating the opportunity.

Prisoners’ Dilemma

At this stage we move on to a prisoners’dilemma scenario for the majors:

  • All of the majors help Spotify’s case by over prioritising Spotify as a promotional tool in light of its share of total listening compared to radio, YouTube, other streaming services etc
  • WMG and SME probably couldn’t afford to remove their content from Spotify but would be watching UMG, the only one that probably feel confident enough to do so
  • However, UMG would be thinking if it jumps first and removes its content, each of the other two majors would benefit from it not being there (and would probably be secretly hoping for that outcome)
  • Each other major would be thinking the same, and regulatory restrictions prevent the majors from discussing strategy to formulate a combined response
  • But even if UMG did pull its content, this would hurt Spotify but would not kill it (Amazon Prime Music launched without UMG and spent 15 months growing just fine until UMG came on board)
  • Spotify could easily tweak its curation algorithms to minimise the perceived impact of the missing catalogue, making it ‘feel’ more like 10%
  • So, the likely scenario would be each major paralysed by FOMO and so none of them act

Thus, maybe Spotify is already nearly big enough to do this, and could do so next year. And the more that Spotify’s stock price struggles, the more that Spotify needs to talk up its disruption. History shows that when Spotify makes disruptive announcements, its stock price does better than when it delivers quarterly results. Maybe, just maybe, the labels have already missed their chance to prevent Spotify from becoming their fiercest competitor. The TV networks left it too late with Netflix…history may be about to repeat itself.

Spotify, DistroKid and the Two Sided Marketplace

distrokid spotify

Spotify has taken a minority stake in DistroKid. In itself, it may be a slightly left field but relatively insignificant move, except that it is in fact one small but important step on a much bigger journey. Back in September, Spotify announced that it was enabling artists to upload their music directly to Spotify, simultaneously aggravating record labels, distributors, DIY platforms and Soundcloud all in one fell swoop. This raised an intriguing possibility of a ‘coalition of the willing’ forming against Spotify from slighted partners and competitors. But that’s another blog post. Right now, though, DistroKid’s role in this performance is as an enabler for Spotify in its path to becoming a next generation label / creating a two-sided marketplace (delete as appropriate depending on how all this affects your business).

Bringing efficiencies into the supply chain

Spotify’s DistroKid deal will enable Spotify’s direct artists to “seamlessly distribute their music to other platforms through DistroKid”.So, instead of putting all their streaming eggs in one basket, Spotify’s direct artists now get to stream their music on Apple, Amazon, Deezer and the rest too. What wasn’t made clear in the announcement is whether Spotify will have visibility of the streaming data from those other platforms and / or whether the revenue will be recognised as Spotify revenue and then distributed to its artists. If these statements were to be the case, then Spotify’s competitors would be feeding it data and revenue…

UPDATE: A Spotify spokesperson clarified that “Spotify has no rights to see data from other digital service providers and DistroKid will not share confidential information.”

Why this relatively small announcement matters, is that it is another piece of Spotify’s strategy of shifting its way up the value chain by a) removing some of the distribution component and b) entering into direct relationships with artists. It’s what west coast tech firms call ‘bring efficiencies into the supply chain’. If it all works, Spotify will get more margin, artists will get more margin, but middle players (labels, distributors etc.) will get squeezed.

Treading a subtler path

This is how Spotify can edge quietly towards becoming a record label without going nuclear from the get go. It is a strategy we predicted by in April ahead of Spotify’s DPO:

“As much as the whole world appears to be saying Spotify needs to do a Netflix (and it probably does) it just can’t, not yet at least. In TV, rights are so fragmented that Netflix can have Disney and Fox pull their content and it’d still be a fast growing business. If UMG pulled its content from Spotify, the latter would be dead in the water. So, Spotify will take a subtler path to ‘doing a Netflix’, first by ‘doing a Soundcloud’ i.e. becoming a direct platform for artists and then switching on monetisation etc.”.

The challenge for Spotify is whether it can execute on the strategy quickly enough to excite investors (and thus drive up the share price), but slowly enough to keep record labels on board…so that when they realise where things are heading then it is too late for them to do anything about it.

 

Spotify’s Tencent Risk

NOTE: a previous version of this post referred to a non-compete clause with Spotify detailed in this SEC filing. I have been advised that the scope of this clause is narrower than I had originally interpreted. I have therefore updated this post to remove reference to that clause but the essence of the post remains intact due to the potential role of the major labels which, as outlined below, could have the same effect as a non-compete clause.

On Thursday (September 20th) Spotify grabbed the headlines with its announcement that it is launching a free-to-use direct upload service for artists. While it is undoubtedly a big move, and one that will concern Soundcloud among others, it was not a surprising move. In fact, in April we predicted this would happen soon:“Spotify will take a subtler path to ‘doing a Netflix’, first by ‘doing a Soundcloud’, i.e. becoming a direct platform for artists and then switching on monetisation”. Will labels be concerned, sure, because although Spotify might not be parking its tanks on their lawn yet, it is certainly slowly reversing them in that general direction. However, they may just have a way of clipping Spotify’s wings and waiting in, er, the wings…Tencent.

Still waiting for IPO metrics

Tencent is prepping its music division (TME) for a partial US IPO but announced earlier this week that it will be reducing the amount it is seeking to raise from $4 billion to $2 billion, though still against a reported valuation of around $25 billion. Regular readers will know I have a healthy scepticism of Tencent’s music numbers. It has only ever reported one subscriber number officially – 4.7 million for QQ Music in Q1 2016, therefore it has plausible deniability over all the non-official numbers it puts out via the press. So, the fact there still isn’t an F1 filing revealing TME’s metrics is intriguing to say the least.

Go west

The likelihood is that the numbers will show a relative flattening in music subscriber growth (though other areas of its business should be robust). If so, they fit a wider narrative of Tencent nearing the limits of its potential in China. Video subs, which have grown superfast, will soon slow, messaging is saturated and the Chinese government is curtailing Tencent’s games operations. The title of our April report says it all: “Tencent Has Outgrown China: Now Comes the Next Phase of Growth”. Until last year’s change in Chinese regulations, Tencent could quite happily have spent its time strolling across the globe buying up companies to spread its global wings. But now, operating under limits of how much it can spend on overseas companies, Tencent is restricted to taking minority stakes in companies like Gaana and Spotify. But those efforts do not deliver Tencent the scale of global growth it needs. You can probably see where this is heading: to grow its music business TME will have to roll out internationally, which is quite possibly part of the story it will use to justify its $25 billion valuation.

Ring fencing Spotify’s global reach 

Should TME decide to use the $2 billion it raises via IPO as a war chest, it could then go on a global roll out to all the markets where Spotify is currently not present. Getting their first, with the backing of Tencent and of the $2bn IPO windfall would put Spotify on the back foot. Especially if, and here’s the crucial part, the major record labels took this as an opportunity to knock Spotify down a peg because of its increasingly competitive behaviour. They’ve been relying on Indian licenses already, that could prove to be a template, with Tencent the grateful beneficiary.  This would have the effect of ring-fencing Spotify’s global roll out plans. For fans of the board game Risk, the board would look something like this:

Spotify tencent risk 1

But Risk’s map doesn’t really do it justice. Using a political global map, the respective footprints would look more like this:

Spotify tencent risk 2

The major labels have proven unwilling to license Spotify for India because they weren’t happy with Spotify offering direct deals for a small number of artists. Imagine how they are going to feel with this latest move. With TME waiting patiently on the side lines, they may just see it as an opportunity to carve up the global streaming landscape into two halves, creating a cold war stalemate. Your move Spotify.