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.

The Real Value Of The Independent Sector

Over the course of the last year MIDiA has been working with WIN (the global indie label trade body) on a major study to define the independent sector’s contribution to the global recorded music business. The default accepted wisdom is that the indies account for something like 20% of the global revenue total. However, this study revealed, that figure strongly underestimates the actual share…it is in fact 37.6%. This matters not for bragging rights but because in the digital marketplace, market share shapes the deals that are struck, with more market share translating into better terms. So a more accurate measure of share can help the independent sector compete on fairer terms.

Distribution Versus Ownership

Distribution is the largest single contributor to the variance in market share. The 20% refers to the labels that distribute the music while the 37.6% refers to which labels actually own the music. Indeed, 3rd party distribution is becoming an ever more central element of the independent sector. The growth of streaming services and social media have helped create a burgeoning international opportunity for independent labels across the world. However, because most of these labels do not have the international infrastructure required to tap this global opportunity they often utilise 3rd party partners for distribution and other services. Often these parties are major labels or major label owned distributors. As the music market becomes more global, 3rd party distribution becomes more important for indies. But while this gives the independent sector global scale it also means that much of their revenue ends up being accounted as major label revenue, creating a distorted view of the market.

Most Indies Use International Distributors

In fact, 72% of independent labels use a 3rd party international distributor while 52% use a major label owned one or go direct via a major for distribution. The impact on the global market is huge. Just look at 2 of the biggest independent artist albums recently: Taylor Swift’s ‘1989’ on Big Machine but distributed by Universal Music, and Adele’s ‘25’ on XL/Beggars but distributed by Sony in the US and South America. 2 leading independent success stories that now appear as major label success stories in investor decks. There is no questioning the value that majors and major owned distributors bring but just as importantly these are nonetheless indie label artists.

A Diverse Global Picture 

Even using the ownership approach, there is a massively diverse global picture, with indie market share ranging from just 16% in Finland, up to 64% in Japan and 88% in South Korea. In fact, Japan, South Korea and the US (where the distribution methodology has been in place for a few years now) account for 64% of all global indie revenue.

The disparity between ownership and distribution measures will only increase as music’s shift to streaming accelerates. The more that international markets open up, the more that smaller labels need to utilize international partners to reach music fans in those markets.  And the more that happens, the less relevant distribution market share becomes.

You can download the entire report by following this link.

Meanwhile, this graphic highlights some of the key findings.

wintel_infographic-812x1024

Apple Music And The Listener-to-Buyer Ratio

The next 6 to 12 months could prove to be some of the most disruptive record labels have ever experienced, and nowhere will this pain be felt more than among smaller independent record labels with strong digital sales.   At the heart of this disruption will be Apple Music and the wider continued ramping up of streaming. If Apple Music is a success over the coming year it will do one or both of the following:

  1. It will convert / cannibalize non-subscribing download buyers
  2. It will convert / cannibalize existing subscribers

The probability is that it will do a bit of both with an emphasis on #1. The market level net impact of #1 will depend on the degree to which Apple converts lower spending iTunes buyers versus higher spending ones i.e. whether it increases or lowers the average spend.   But even if it is the latter the effect for smaller labels could still be net negative over the coming year. If you are a big label with hundreds of thousands or millions of tracks then you have enough catalogue to quickly feel major revenue uplift from 5 or 10 million new subscribers. If you only have a few hundred or a few thousand tracks though then the picture is less rosy.

The Listener-to-Buyer Ratio

At the core is the listener-to-buyer ratio i.e. how many new listeners you get for each ‘lost’ buyer. Let’s say that for every download sale lost due to an iTunes customer becoming an Apple Music subscriber transforms into 10 listens by 3 people within 12 months. So 30 streams instead of one download. The listener-to-buyer ratio here is 3:1. A generous assumption perhaps but let’s work with it. Against a base of $25,000 of download revenue that would translate into $6,250 less download revenue and $2,365 more streaming revenue. So a net loss of $3,885, a 16% decline.

If we reduce the average plays to 5 per user the revenue decline becomes 20%. In order for the revenue impact to be neutral the total new streams would have to be 80, which with a listener-to-buyer ratio of 3:1 would require each person to stream the track 27 times. Or alternatively a 8:1 listener-to-buyer ratio with 10 plays per user would also deliver no change in revenue. A great track could feasibly have an average of 27 plays per user per year, a good track could have 10. But an average track is going to be below both. So realistically, more than an 8:1 ratio is going to be required.

Scale Looks Different Depending On Where You Are Sat

What quickly becomes apparent is that the most viable route to ensuring Apple Music streaming revenue offsets the impact of lost iTunes sales revenue is as big an installed base of streaming users as possible. The more Apple Music users there are, the more likely more of them will find and listen to your music. This is why the scale argument so is so important for streaming and also why small labels feel the effect less quickly. If you have a vast catalogue you don’t need to worry too much about the listener-to-buyer ratio because you have so many tracks that you are a much bigger target to hit. The laws of probability mean that most users are going to listen to some of your catalogue.

Let’s say you are a big major with 1 million tracks out of the 5 million tracks that get played to any meaningful degree in streaming services. That gives you a 20% market share. But if you are an independent with 50,000 tracks that gives you 1%, 20 times less than the major. Which means that you are 20 times less likely to have your music listened to. And that is without even considering the biases that work in favour of the majors such as dominating charts and playlists, and other key discovery points. So in effect the major record label in this example could be 30 to 40 times more likely to have its music listened to. Which is why the listener-to-buyer ratio is unlikely to keep the major label’s exec up at night but could be the difference between sinking or swimming for the independent.

In all probability Apple Music will make streaming revenue a truly meaningful income stream for all record labels but in the near to mid term big record labels are likely to see a very different picture than the smaller independents.