The Music Industry’s 6:1 Ratio

One of the many things that the digital revolution has done to the music industry is to create and accentuate a number of imbalances. Imbalances that will either change, become the foundations of the next era of the music business, or both. In fact there are three key areas where, coincidentally, the lesser party is 6 times smaller than the other:

6 to 1

  • Digital music revenue share: A common refrain from songwriters and the bodies that represent them (music publishers, collection societies etc.) is that everything starts with the song. And of course it does. However it is the recorded version of the song that most people interact with most of the time, whether that be on the radio, on a CD, a download, a stream or a music video. This has helped ensure that record labels – usually the owners of the recorded work – hold the whip hand in licensing negotiations with digital music services. Labels have consequently ended up with an average of 68% of total on-demand streaming revenue and publishers / collection societies just 12%. The labels’ share is 6 times bigger. Publishers are now actively trying to rebalance the equation, often referred to as ‘seeking out a fair share’. For semi-interactive radio services like Pandora where labels do not license directly and statutory rates are used instead, the ratio is roughly 2:1.
  • Artist income: While music sales declined over the last 10 yeas, live boomed. And although there are signs the live boom may be slowing, a successful artist can now typically expect to earn as little as 9% of their total income from recorded music, compared to 57% from live. Again, a factor of 6:1. There are many complexities to the revenue split, such as the respective deals an artist is on, fixed costs etc. but these splits tend to recur. Ironically just as everything starts with the song for digital music, everything starts with the recorded work (and the song) for the live artist. The majority of an artist’s fan base will spend most of their time interacting with the recorded work of the artist rather than live. The recorded work has become the advert for live. In fact the average concert ticket of a successful frontline artist costs on average 8 times more than buying their entire back catalogue. Thus for fans the ratio is even more pronounced at 8:1.
  • Free music users: The freemium wars are dominating the contemporary music industry debate. Spotify and other services that have on demand free tiers are under intense scrutiny over how these tiers may be cannibalising music sales. However YouTube’s regular free music user base is about 350 million compared to approximately 60 million free freemium service users across all freemium services. Again a ratio of 6:1. Whatever the impact freemium users may be having, it is 6 times less than YouTube.

The music industry has never been a meritocracy nor will it ever be one. So it would be fatuous to suggest equality is suddenly going to break out. However there will be something of a righting process in some areas, especially in the digital music revenue share equation. Most significantly though, these ratios are becoming the foundational dynamics of the new music industry. These are the reference points that artists, rights holders, and all other music industry stakeholders need in order to understand what their future will look like and how they can help shape it.

The Case For A Freemium Reset

Ministry Of Sound’s Lohan Presencer stirred up a hornets’ nest with his impassioned critique of the freemium model at a recent MWC panel. This is one of those rare panel discussions that is worth watching all the way through but the fireworks really start about 16 minutes in. For a good synopsis of the panel see MusicBusiness Worldwide’s write up, for the full transcript see MusicAlly. I’m going to focus on one key element: free competing with free.

Free Isn’t The Problem, On Demand Free Is

Free music is a crucial part of the music market and always has been thanks to radio. The big difference is that radio is not on demand. Even the Pandora model, which quite simply IS the future of radio, is not on demand. The on demand part is crucial. Although labels have a conflicted view about radio there is near universal agreement that the model works because it is a promotional vehicle, it helps drive core revenues. But turn free into an on-demand model and the business foundations collapse. The discovery journey becomes the consumption destination. To paraphrase an old quote from a label exec ‘if you are playing what I want you to play that is promotion, if you are playing what you want to play that is business’.

P2P Is In A Natural Decline, Regardless Of Freemium

The argument most widely used by streaming services in favour of the freemium model is that it reduces piracy. There is some truth in this but the case is over stated. P2P was the piracy technology of the download era. Its relevance is decreasing rapidly for music in the streaming era. In fact mobile music piracy apps (free music downloaders, stream rippers etc.) are now more than twice as widespread as P2P. So the decline in P2P can only partially be attributed to streaming music services as it is in a trajectory of natural decline as a music piracy platform.

Freemium Isn’t Killing Piracy, It Is Coexisting

But even more importantly free streamers are using those new, next-generation piracy apps to turn their freemium experiences into the effective equivalent of paid ones, by creating local device caches for ad free on demand play back. In fact free streamers are 65% more likely to use a stream ripper app than other consumers. They are also 64% more likely to use P2P and 57% more likely to use free music downloader apps. While it is always challenging to accurately separate cause and effect what we can say with confidence is that whatever impact freemium may have had on piracy, freemium users are still c.60% more likely to be music pirates also. (If you are a MIDiA Research subscriber and would like to see the full dataset these data points are taken from email info AT midiaresearch DOT COM)

Monetizing The Revenue No-Man’s Land Between Free and 9.99

So more needs to ensure the path from free to paid is a well travelled one. It might be that the accelerating shift to mobile consumption of streaming music may help recalibrate the equation. Mobile versions of free streaming tiers in principle may not be fully on demand but they often stretch definitions to the limit and some are simply too good to be free. Being able to create a playlist from a single album and then listening to it all in shuffle mode simply is on-demand in all but name. If we can get mobile versions of free tiers to look more like Pandora and less like Spotify premium, or YouTube for that matter, then we have a useful tool in the kitbag. And if users want more but aren’t ready to pay a full 9.99 yet, let them unlock playlists, or day passes for small in app payments. Lohan made the case for PAYG pricing to monetize the user that sits somewhere between free and 9.99 and it is an argument I have advocated for a long time now.

Freemium Is Not Broken, But It Does Need Re-Tuning

Freemium absolutely can work as a model and it has achieved a huge amount already, but it needs recalibrating to ensure it delivers the next stage of market growth in a way that minimizes the risk to the rest of the business. None of this though can happen until YouTube is compelled to play by the same rules as everyone else. Otherwise all that we end up doing is hindering all music services except YouTube and Apple (which won’t have a free tier). Google and Apple are not exactly in need of an unfair market advantage. So a joined-up market level strategy is required, and right now.

A Manifesto For The Future Of Free Music

In the thankfully long gone days of DRM downloads it could be fairly said that ‘music was born free yet everywhere it is in chains’. Now it is free of DRM and, for most consumers, of price also. Of course the majority of consumers have always spent most of their time listening to music for free via TV or radio. But the internet transformed free into something that was every bit as good as the paid for product. So yes, most people have always listened to music for free most of the time, but they listened to what broadcasters decided they would listen to. In the old model free music was something that would sate the appetite of the passive fan but was not be enough for the dedicated fan. Free music thus very clearly played a ‘discovery’ role for the core music fans. On demand free though has changed the equation entirely. For many consumers the free stream is the destination not the discovery journey. So 50 million YouTube views is no longer a marketing success but instead x million lost sales or paid streams.

For younger consumers the picture is particularly stark. 56% stream for free, 65% listen to music radio and 76% watch YouTube music videos. Compare and contrast to over 25s where the rates are 35%, 47% and 76%.   In short, free is more likely to be something that drives spending among over 25s because it is predominately programmed while among under 25’s it is less likely to do so because it is on demand.

Free needs recalibrating. Here are a set of objectives to help fix free, a Manifesto for the Future of Free Music:

  • Set the objectives: One of the problems with free is there is too little clarity around what purpose it is meant to serve. And this is because it is simultaneously serving multiple purposes: to monetize the masses (ad supported), to drive sales (discovery), to drive subscriptions (freemium). All three are worthy goals but unchecked each one also competes with the other. A consistent industry vision is needed.
  • Programme more: Free has a massive role to play in digital music, but it needs to better targeted. A super engaged music fan should not be able to sate their on demand appetite on free. In short, free music needs to be less on demand and more programmed. That is not to say YouTube or Soundcloud need to become Pandora, but they do need to explore meeting somewhere midway.
  • Use data to segment: It is not enough to simply say users can choose between different services, they services need to better use their data to determine who gets what experience within them. Someone who watches 20 YouTube music videos a day is clearly a target for a Music Key subscription. That person should not just be marketed Music Key, s/he should also have their free experience progressively dialled down to push them towards it.
  • Fix the models: Pandora is a highly viable ad business that happens to have a radio service built on it. There is a world of difference between Pandora’s ad business and Spotify’s. Spotify’s deals with the rights holders essentially preclude it from making free a viable business, which is fair enough. But it does create the unfortunate vicious circle of there never being a case for Spotify investing enough in ad sales infrastructure to drive up CPMs enough to boost ad supported revenue. Labels and publishers need to think hard about what tweaks may need to be made to business models if they want freemium services to be strong enough financially to drive a vibrant subscription market. Not fixing the models will only skew the market to the companies with ulterior business models who can afford to perpetually lose money on free.
  • Don’t give up on free fans: A generation weaned on free music will grow up craving more free music. Just because free dominates younger consumers’ digital lexicon now does not mean that it will inherently always do so. Don’t give up on the lost generation of music consumers with the default position of free.
  • Strike the right balance: This is simultaneously the most important and most difficult part to get right. YouTube, Soundcloud and Spotify’s free tier are legal alternatives to piracy. Turn back the dial too much on the legal sources and illegal ones will flourish again. However the fact that more than a third of free streamers use stream ripper apps to turn streams into downloads means that the distinction between licensed and pirated has long since blurred. Nonetheless the balance needs to be better struck, probably somewhere equidistant between YouTube and Pandora. Ultimately it will require lots of real time honing and perfecting to get the right mix.

Free music will always be part of the equation and it has become a key part of the music industry’s armoury. But there is a difference between a controlled burn and an out of control forest fire. The freemium wars have already accounted for some high profile scalps and more controversy will follow. Free will remain a crucial part of the landscape but it is time for a reassessment of its role and that must encompass all elements of on demand free, not just Spotify.

What the Numbers Tell Us About Streaming in 2014

By the end of 2014 streaming revenues will account for $3.3 billion, up 37% from 2013. However headline market value numbers only ever tell part of the story. Just as important are the numbers on the ground that give us some sense of where the money is flowing and of the sustainability of the business models. During the last two weeks we have been fortunate to have four different sets of data that go a long way to filling in those gaps:

Each is interesting enough in isolation but it is the way that they interact and interdepend that gets really interesting:

  • Sustainability: A lot is rightly made of whether the subscription business model is sustainable. Spotify has showed us that, at least in a local subsidiary, an operational profit can be turned. However that profit rate was just 2.5%, does not account for previously acquired losses and also does not account for the broader company’s cost base where many of Spotify’s other costs lie. 2.5% is a wafer thin margin that leaves little margin for error and would be wiped out in an instant with the sort of the advertising Spotify has been using in the US. Meanwhile Soundcloud have demonstrated that it is also entirely possible to post a heavy loss even without rights costs. Soundcloud is going to need every ounce of its investor money and new revenue streams when it adds a 73.2% rights cost to its bottom line (though Soundcloud is doing all it can to ensure it doesn’t have to play by those rules and instead hopes to operate under YouTube’s far more preferable rates).
  • Transition: Nielsen’s US numbers should finally remove any lingering doubt about whether streaming is eating directly into download revenue. As MIDiA Research revealed last month, 23% of streamers used to buy more than an album a month but no longer do so. Streaming is converting the most valuable downloaders into subscribers and in doing so is reducing their monthly spending from $20 or $30 to $9.99. The combined effect of the perpetual decline of the CD and now of the download make it hard for streaming to turn the total market around. That won’t happen globally until 2018, though in many individual markets streaming driven growth is already here. Spotify pointed to bundles with the Times of London newspaper and mobile carrier Vodafone as key sources of growth in the UK. This sort of deal points to how subscriptions can break out of the early adopter beachhead and drive incremental ‘found’ revenue.
  • The Ubiquity of Free: YouTube, Pandora, Soundcloud and Spofity free are among the largest contributors to streaming’s scale. Some business models are more proven than others – Pandora looks better placed than ever to be a central part of the long term future of radio. YouTube’s role remains controversial though. Its proudly announced $1bn payout milestone is less impressive when one considers Content ID was launched in 2007 and that this is all rights holders, not just music. So let’s say 60% was to music rights holders, over the course of seven years that averages out at $0.07 per year for each of YouTube’s current one billion monthly users. That’s a pretty small return for the globe’s biggest music service.

We are clearly still some distance away from a definitive set of evidence that can tell us exactly what streaming’s impact will be. But in many ways it is wrong to wait for that. There will never be a truly definitive argument. Instead the world will continue to change in ways that will better fit the streaming market. It is a case of streaming and the industry meeting half way. This is exactly what happened with downloads. Early fears that downloads would accelerate the demise of the CD and instigate the decline of the album were both confirmed but the music industry learned how to build a new set of businesses around these new digital realities. The same process will take place with streaming.

We are already seeing some remarkable resilience and appetite for change from artists, from DIY success stories like Zoe Keating, through veteran rockers like Iggy Pop, right up to corporate megastars like Ed Sheeran. These are as diverse a collection of artists as you could wish for but they are united in an understanding that the music industry is changing, again, and that simply bemoaning the decline in sales revenue will not achieve anything. Of course it sucks that sales revenue is falling and of course its infinitesimally easier for me to write these words than to live them. But that sort willingness to evolve to the realities of today’s rapidly changing market will set up an artist with the best chance of surviving the cull. The old adage rings truer than ever: adapt or die.

Sopa Highlights Media Industry Strategic Failings

The controversial US copyright and piracy acts Sopa and Pipa (see this Wired piece for a Bluffer’s Guide on what they are) have been thrust centre stage by Wikipedia’s planned protest black-out on Wednesday.  It has taken an entity the size of Wikipedia to bring the debate out of the confines of the digerati and to the mainstream.   For that Wikipedia deserves great credit.

And the debate does need to take place in the mainstream.  The effects of the bills (if passed, upheld in the face of legal challenge and then successfully implemented) will be felt keenly by mainstream consumers.

However I am not going to add to the already vibrant and detailed discussion about the ethical and constitutional implications of the bills, nor the legion flaws and ambiguities in the proposed legislation. Instead I want to put Sopa and Pipa in the context of wider media industry strategy and response to digital change.

Sopa, Pipa and the Media Meltdown

Back in my days at Forrester I helped develop the concept of the media meltdown to describe the process of media industries responding to the impact of digitization.

The media meltdown occurs in three key stages:

  • Stage 1: Audiences take control of their content consumption via new digital technology (think CD ripping, P2P, on demand video streaming, iPads etc).
  • Stage 2: Traditional media industry business models crumble while media companies grapple with denial.  Instead of comprehending that a paradigm shift in consumer behaviour has occurred they think they can turn back the proverbial clock by fighting online piracy and restricting the disruptive threat of legal services.
  • Stage 3: There are two potential conclusions, either the media industries comprehend that user behaviour has changed for ever and that they need to embrace that change with new business models, or they fail.  (For more on the media meltdown check Forrester’s CPS blog and the ever insightful James McQuivey)

Of course as with any analytical framework, this is a generalized world view but it provides a very useful lens through which to view media industry anti-piracy legal activity, lobbying and resultant legislation.  It is immediately apparent that Sopa and Pipa fall within stage 2 of the media meltdown but it would be disingenuous to suggest that the media companies that have lobbied for them – and for other acts such as the French Hadopi act and the British Digital Economy Bill – are in complete denial.  Rather what we have is a distortion of priorities.  These media companies and their industry bodies in particular rightly identify online piracy as a major disruptive threat to their businesses.  However,  instead of recognizing that behaviour shifts have occurred around which new businesses should be built, they reason that turning off the tap on piracy will starve piracy of oxygen, until it withers away.

Digital Piracy Perennially Outwits the Pursuer

As well intended as this thinking is, it is flawed.  Digital piracy (in its many, many guises) is all about innovation and change.  Every time media companies manage to finally catch up with digital piracy – either through enforcement, legislation or technical measures – the pirates have already moved on. Fighting piracy is akin to a game of whack-a-mole, but in this version of the game the moles learn.  Every time one is smacked down another one comes up that is smarter, harder to see and more difficult to reach.

Mainstream Consumers Become  the Effective Targets of Anti-Piracy

The simple and unavoidable fact is that piracy will always move more quickly and more effectively than its pursuers.  Technology improvements can be measured in days, even hours.  Legislation takes years.  This dynamic is one of the key reasons why acts like Sopa and Pipa have such far reaching implications for mainstream consumers: the hard core tech savvy pirates will always find ways of evading the counter measures, the mainstream will not.  Remember how DRM inconvenienced legitimate customers and did nothing to impact pirates?  The parallels here are clear.  Of course there are obvious and important differences between digital content buyers and passive pirates, but there are also similarities.  One of the most important of which is that they are often the same people.  Many paid content buyers also access free illegal content: they blend their content acquisition practices, often using free illegal sources for either discovery or the content they are just not willing to pay for, and then paying for the rest.

Legislation is Fully Necessary But Strategic Priorities Need Rebalancing

To be clear, this is not an apology for piracy, nor is it an argument against legislation – indeed it is crucial that laws evolve quickly enough to keep up with digital change so they can establish the frameworks in which legitimate content business models can prosper and illegal ones cannot.  Instead I am making the case for a rebalancing of strategic priorities and for taking the long view.  Consumer behaviour has changed for ever.  More people are consuming more content across more platforms than ever before, but fewer of them are paying for it.  Making free illegal content harder to get will only weaken consumption and demand unless game-changing legal alternatives simultaneously fill the vacuum.

For example, turning off access to the Pirate Bay and then pointing users  to iTunes will fall far, far short.  Media companies need to get brave, like never before, and quickly so.  They need to start looking at what makes the illegal services so threatening to them and then give legitimate companies licenses to do just the same, legally.  Some media industries get this more than others. For example the TV studios quickly realized the best way of fighting free was with free itself, launching Hulu, ABC.com and iPlayer as genuinely compelling (in fact even more convenient) alternatives to BitTorrent.

Legislators: Compel Media Companies to License to Identikit Legal Alternatives

If the US Congress wants to ensure that Sopa and Pipa are balanced in a way that will help drive digital innovation rather than stifling it in favour of analogue-era protectionism, they should look to baking-in binding innovation commitments from media companies.  To ensure that for every type of illegal service that is wiped out of the US-facing Internet, the opportunity is created for new companies to offer the same type of service legally, with guaranteed licenses from media companies (i.e. without being watered down to irrelevancy with usage restrictions).  Then Sopa and Pipa could become the foundation stones of a period of unprecedented media industry innovation that would finally recast the mould of media business models in the post-meltdown world.  The alternative is media industry failure.  Though they might not realize it, the media industry lobbyists are currently on track for hastening their industries’ demise, not safeguarding their futures.

Why Rhapsody Needs More Than Just Napster To Flourish

Rhapsody yesterday announced the acquisition of long term rival Napster from US retailer Best Buy.  Rhapsody will retire the Napster brand and migrate the customer base over to its own service, with Best Buy gaining a minority stake in Rhapsody. It is a somewhat poignant end to one of digital music’s old guard, going out with a whimper rather than a bang.

The acquisition will give Rhapsody an important boost in scale at a pivotal time, namely as Spotify aggressively grows its US subscription business and simultaneously disrupts the entire market with its introduction of free on-demand music to the US market (a ship which of course MOG and Rdio are also busy jumping on).

When 2+2=2.5

In the near-term the Napster acquisition will put more clear water between Rhapsody’s subscriber count and Spotify’s.  It should also grant Rhapsody membership of the the ‘1 Million Club’, with its 800,000 subscribers swelled by a few hundred thousand from Napster.  The last time Napster reported their numbers in December 2008 they had 700,000 subscribers.   After three years in the Best Buy wilderness and shifts towards bundled download products I estimate there to be no more than 400,000 fully fledged subscribers left, probably more like 300,000.

But Rhapsody will be keenly aware that even keeping hold of just 300,000 subscribers will be no mean feat. They will remember keenly the 2008 acquisition of Yahoo! Music’s 400,000 subscribers and their rapid disappearance into the ether.  Napster will also recall the similar magical disappearing trick of the 350,000 AOL Music Now subscribers they acquired in December 2007 for $43 per subscriber.  In the business of acquiring music subscribers 2+2 too often = 2.5.

Rhapsody’s President Jon Irwin said of the acquisition that “scale is extremely important in this business.”  He is of course entirely correct.  Rights fees leave little in the way of margins.  For sake of full disclosure I’ve been a very long term fan of Rhapsody, right since their earliest days. It was partly our experiences of Rhapsody that led myself and my former colleague David Card to be so bullish about music subscriptions when we were helping build the Jupiter Research digital music forecasts.  But the time has come for Rhapsody not just to change but to drive change.

The digital music market is a different world from that Rhapsody was built for.  Unless Rhapsody wants to be limited to spending the next year or two simply trying to stay one subscriber ahead of Spotify it needs to overhaul its product roadmap.

Rhapsody needs unlimited MP3, now!

I’ve long advocated that if the record labels really want to ensure the extant premium subscription services don’t become extinct that they must empower them with dramatically more powerful licenses: namely unlimited MP3.  Of course it will be a good year or two more of global music revenue decline before the labels hurt enough to really countenance unlimited MP3, but Rhapsody needs it now.

So what can Rhapsody do in the meantime?  Well they’ve already got great discovery and editorial etc. so it is not really the experience they need to fix, rather the entire value proposition.  They need to ask themselves ‘what do we want to mean to consumers in the Spotify age?  What can makes us dramatically and unmistakeably different?’  Unless they can really address this fundamental question Rhapsody will face the very real prospect ending up looking like Spotify’s stuffy old uncle, which would be a criminal insult for the Grand Old Lady of digital music.

The Socially Integrated Web and Facebook’s Content Strategy

Click on the video below to view my latest Music Industry Blog podcast.  This episode addresses the Socially Integrated Web, the term I use to describe Facebook’s content strategy.

Topics covered in this episode include:

  • Joining users’ digital dots
  • The four types of digital content ecosystems
  • How Facebook will extend its ecosystem reach
  • The universal content dashboard
  • What will happen to content companies that integrate with Facebook

In Conversation With Boinc’s Adam Kidron

Here is the video of my conversation yesterday with the CEO and founder of the forthcoming music service Boinc.  We discuss a number of things, including:

  • the state of digital music
  • Facebook’s potential impact on the space
  • reestablishing value in music
  • addressing the emerging market challenge

Adam also shares his vision for the music industry annd his concept of ‘creating an API around the entirity of music’.

Take a look and let me know your thoughts and comments.

Waiting For Facebook

As the market collectively holds its breath in anticipation of Facebook’s much (over?) hyped music service launch this coming Thursday, it is instructive to take stock of where we are at the moment to better understand the eager expectation.

Digital music is stuck in a rut

At the start of the year I made a speech at Midem, positing that digital music was at an impasse.  Now, with the best part of a year gone, it still is. Granted we’ve had some important and encouraging developments (Spotify’s US launch and 1 million+ paying subs and Pandora’s IPO among them) but the fundamentals remain unchanged (see figure):

 

  • Paid downloads are an Apple micro-economy not a marketplace. Despite valiant efforts from the likes of 7 Digital and Amazon, the 99 cent download just isn’t translating well outside of the iTunes ecosystem.  Why?  Because the tail is wagging the dog.  iTunes downloads are an extension of i-devices not vice versa.   The iTunes 99 cent download is effectively monetized CRM.  Deep, elegant device integration is crucial for any digital music experience, especially so paid downloads. 7 Digital’s Music Hub build for Samsung’s Galaxy Tab is the sort of implementation needed, but both 7 Digital and the market as a whole need a much wider addressable base than Galaxies alone (retail embargoes notwithstanding).
  • Premium rentals are an evolutionary dead-end. Despite Spotify doing a most admirable job of breaking the 1 million premium subscribers mark – which all other services had spent years failing to do the fact remains that 9.99 rented music is a high-end aficionado market.  Spotify have done a great job of building on the fantastic pioneering work of Rhapsody but in doing so they have developed the ‘faster horse’ that Henry Ford said his customers would have requested instead of the Model T if he’d asked them what they wanted.  Rdio and Mog both have great user experiences but have struggled to make headway because the basic value proposition of 9.99 a month for rented music just doesn’t appeal to most consumers.  Heck, 9.99 a month for owned music doesn’t even appeal anymore to most consumers anymore.  Mass market consumers may be willing to pay much more than 9.99 a month on TV, broadband, mobile etc. but they won’t for music. It may not be pretty but this is the harsh reality that must be accepted. As far as music is concerned the contagion of free is legion and the best way to fight free is with free itself (or at least something that feels like free – see my previous post on subsidized subscriptions for more).
  • Digital music is cluttered and complex. There is so much choice of catalogue and services that paradoxically there is no choice at all for consumers, unless you’re a savvy aficionado willing to wade your way through the clutter. Mass market consumers need the digital dots joining.  Back in my days at Forrester I wrote about the need for 360 Degree Music Experiences, where the disparate parts of the digital music journey get pulled together by an interconnected ecosystem.  The case for this is even stronger now.

Music: Facebook’s user lock-in

And this is where Facebook comes in.   As I wrote earlier this year, it doesn’t make any sense for Facebook to try to ‘do a MySpace’ or for that matter to ‘do a Spotify’ or ‘do an iTunes’.  Facebook is becoming a launch pad for our online lives just as Google is.   But whereas Google largely gets us to places we don’t yet know, Facebook is what (and who) we do know.  And in that lies a massive asset for digital music and an even larger platform for Facebook’s future growth.

I expect Facebook to join music’s digital dots and become a social dashboard for digital music activity.  By plugging our music activity into our social graph Facebook can both enrich those services and tap into the tastes of our friends.  The net result will be a richer digital music experience across multiple services and – most crucially for Mark Zuckerberg – one more reason why we’ll want to stick with Facebook when the Facebook-Killer finally raises its long overdue head.

Spotify’s US Launch: First Take

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

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

When Unlimited Isn’t Actually Unlimited

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

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

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

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

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

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

Can Spotify Afford to Be Successful in the US?

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

What Do US Music Services Have to Lose?

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

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

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

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