Spotify D(PO)-Day

Arguably the most anticipated day in the history of digital music is upon us. By the end of it we will have the first hint at whether Spotify is going to fall at the Snap Inc. or Facebook end of the spectrum of promising tech IPO, or DPO in the case of Spotify. Of course, we’ll need a few quarters’ worth of earnings in place before firmer conclusions can be drawn as to the strength of Spotify as a publicly traded company, but the first 24 hours will lay down some markers. However, it is the mid and long-term market factors that will give us the best sense of where Spotify can get to. Here are a few pieces of pertinent market context that can help us understand where Spotify is heading:

• Streaming is just getting going: Downloads are yesterday’s legacy market, streaming is the future. But streaming has a long way yet to go. To date, downloads have generated around $35 billion in revenue for labels since the market started. That compares to around $15 billion for subscriptions. Apple accounted for around $23 billion of that download revenue, Spotify accounted for around $5 billion of that subscription revenue.
• Spotify retains leadership: While the streaming market is competitive, Spotify has retained around 36% subscriber market share. However fast the market has grown, Spotify has either matched or beaten it. Apple is growing fast too but is adding fewer net new subscribers per quarter than Spotify is. Fast forward 12 months from now, Spotify will still be the number one player. Fast forward 24 months, it will probably still be.
• Tech majors want the same thing: Of all the big streaming services, only Spotify is truly independent. Apple Music – Apple, Amazon Prime Music – Amazon, YouTube – Google, QQ Music – Tencent, Deezer – Access Industries, MelON – Kakao Corp, and now, Facebook) all have parent companies that have ulterior business objectives with music streaming. None of them have to seriously worry about streaming generating an operating profit. This means that there is little pressure in the marketplace to drive down label rights costs. All of this means that Spotify is the only main streaming service that is trying to make the model commercially sustainable.
• Spotify can’t be Netflix yet: 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 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. In the near-term Spotify will happily have record labels sign artists that bubble up on the platform. But over time, expect Spotify to start competing for some signings.
• Unpicking the distribution lock: The major record labels represent around 80% of recorded music revenues globally on a distribution basis, but just 61% on a copyright ownership basis. They get the extra market share through the distribution they provide indies, either directly or via divisions like Sony’s The Orchard or WMG’s ADA. The 80% share gives the majors the equivalent of a UN Security Council veto. Nothing gets through without their approval, which acts as a brake on Spotify’s ambitions. But, if Spotify was to persuade large numbers of those indies distributing through majors to deal direct, then some of that major power will be unpicked, which, combined with increased revenue, subscribers and market share, would strengthen Spotify’s hand.

Right now, Spotify has soft power (playlist curation, user-level data, subscriber relationships etc.). Spotify’s long-term future will depend on it building out its hard power and bringing it to bear in a way that brings positives both for it and for its industry partners. That will be a tightrope act of the highest order.

If you want the inside track on Spotify’s metrics, get access to MIDiA’s latest report:

Spotify by the Numbers: Trials, Churn and Margin which is available to purchase on MIDiA’s report store and to MIDiA clients via our subscription service.

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

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

When narratives alone will not be enough

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

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

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

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

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

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

Growth at what cost?

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

Music market IQ

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

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

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

Is QQ Music Worth $10 Billion?

Western appetite for the Chinese market has long been based upon accessing the 1.4 billion consumers. This has in turn impacted valuations of Chinese companies, particularly when eager western investors are involved. However, there is a growing realisation that market potential does not always translate to [performance]. Now we have Chinese tech major Tencent seeking pre-IPO investment in its music streaming service QQ Music, against a valuation of $10 billion. That is only $3 billion less than Spotify’s valuation. So, is QQ Music worth $10 billion?

Valuations in isolation can be misleading and therefore need context and scale. For example, Deezer had a valuation of $1.25 billion for its aborted IPO, while Spotify’s valuation is nearly 10 times higher. Moreover, Spotify’s subscriber count (60 million) is nearly 10 times higher than Deezer’s was (6.5 million), leading up to the aborted IPO. So, the best way to make meaningful comparisons between streaming music valuations is to look at the valuation divided by the number of subscribers, to give us a valuation per subscriber metric (see above). Here are a few ways to assess the value of QQ Music compared to other streaming services:

• Valuation per subscriber: On the valuation per subscriber basis Spotify and Deezer’s valuations per subscriber are quite similar ($217 for Spotify, compared to $198 for Deezer). Tidal is significantly higher at $300 (well done that man Jay-Z for talking up the value of his service to Sprint), while QQ Music with its reported 10 million subscribers comes in at $1,000. This obviously begs the question, are QQ Music subscribers worth 5 times more than Spotify subscribers?

• Subscriber revenue: The headline consumer retail price for Spotify is $9.99, while the headline price for QQ Music is $1.60. Spotify’s actual average revenue per user (ARPU) in 2016 was around $6.10, so if we scale QQ Music by a similar rate we get an ARPU of $0.98. If we multiply those ARPUs by the current subscriber number for each company, we end up with a monthly subscription revenue of $366 million for Spotify and $9.8 million for QQ Music. Therefore, rather than QQ Music subscribers being worth 10 times more than Spotify subscribers, they actually generate just 3% of Spotify’s subscriber revenue each month.
• Addressable market: Valuations are of course based on potential, not just actual. China has 717 million smartphone owners (30% of the global total) and a GDP of $11.2 trillion (14% of the total). Given QQ Music’s Chinese positioning, that is its addressable market. By contrast, Spotify is a global service, though pointedly not in China, so its addressable market (excluding China) is technically 1.7 billion smartphone owners, and $67 trillion of GDP. QQ Music’s addressable market is in fact smaller, unless of course it decides to roll out to more territories. Likewise, Spotify could also roll out to China.
• Like-for-like comparisons: We also need to be careful about the numbers behind QQ Music. 10 million QQ Music subscribers may not be the same as 10 million Spotify subscribers. Firstly, QQ Music [subscription] includes karaoke features, such as Bullet Screening, which many would not consider to be music subscribers as such. Additionally, 10 million might not actually be 10 million. Back in Q1 2016, Tencent reported to the markets that it had a little under four million QQ Music subscribers. Then in July 2016, in a Mashable piece, it claimed to have 10 million subscribers. Then nothing until January 2017, when it did another media push, announcing…10 million subscribers. If we take these reports at face value, it means QQ Music had an incredible Q2 2017 then did absolutely nothing, and I mean nothing, thereafter. Whatever the subscriber number actually is for QQ Music, the 10 million figure, at the very least, merits some scrutiny.

So, to answer the opening question, is QQ Music worth $10 billion? That depends. Compared to other streaming music services, the metrics suggest that it isn’t. But, to Tencent’s local investor market, maybe so. 80% of Chinese stock market transactions are from small retail investors, i.e. not institutional investors. So, while a $10 billion valuation might look high to institutional investors, to enthusiastic local retail investors who know QQ Music and have read all the stories about the booming streaming music market, this will appear to be a golden opportunity to get in on the great streaming boom.

Is QQ Music worth $10 billion? It depends on who you are!

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

 

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

What It Means For Spotify And UMG

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

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

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

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

What It Means For The Wider Market

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

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

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

Getting The Right Kind Of Growth

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

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

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

Four Companies That Could Buy Spotify

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

The World Has Changed

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

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

$8 Billion Valuation Narrows Options

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

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

Western Companies Are Not Likely Buyers

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

Go East: Four Potential Suitors For Spotify

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

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

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

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

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

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

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

How Spotify Can Become A Next Generation “Label”

One of the themes my MIDiA colleague Tim Mulligan (the name’s no coincidence, he’s my brother too!) has been developing over in our online video research is that of next generation TV operators. With the traditional pay-TV model buckling under the pressure of countless streaming subscriptions services like Netflix (there are more than 50 services in the US alone) pay-TV companies have responded with countless apps of their own such as HBO Go and CBS All Access. The result for the consumer is utter confusion with a bewildering choice of apps needed to get all the good shows and sports. This creates an opportunity for the G.A.A.F. (Google, Apple, Amazon, Facebook) to stitch all these apps together and in doing so become next generation TV operators. Though the G.A.A.F. are a major force in music too, the situation is also very different. Nonetheless there is an opportunity for companies such as these to create a joined up music experience that delivers an end-to-end platform for artists and music fans alike. Right now, Spotify is best placed to fulfil this role and in doing so it could become a next generation “label”. I added the quote marks around the word “label” because the term is becoming progressively less useful, but it at least helps people contextualise the concept.

Creating The Right Wall Street Narrative

When news emerged that Spotify was in negotiations to buy Soundcloud I highlighted a number of potential benefits and risks. One thing I didn’t explore was how useful Soundcloud could be in helping Spotify build out its role as a music platform (more on that below). As I have noted before, as Spotify progresses towards an IPO it needs to construct a series of convincing narratives for Wall Street. The investor community generally looks upon the music business with, at best, extreme caution, and at worst, disdain. To put it simply, they don’t like the look of low-to-negative margin businesses that have little control over their own destinies and that are trying to sell a product that most people don’t want to buy. This is why Spotify needs to demonstrate to potential investors that it is working towards a future in which it has more control, and a path to profitability. The major label dominated, 17% gross operating margin (and –9% loss) 9.99 AYCE model does not tick any of those boxes. Spotify is not going to change any of those fundamentals significantly before it IPOs, but it can demonstrate it is working to change things.

The Role Of Labels Is As Important As Ever

At the moment Spotify is a retail channel with bells and whistles. But it is acquiring so much user data and music programming expertise that it be so much more than that. The role of record labels is always going to be needed, even if the current model is struggling to keep up. The things that record labels do best is:

1. Discover, invest in and nurture talent
2. Market artists

Someone is always going to play that role, and while the distribution platforms such as Spotify could, in theory at least, play that role in a wider sense, existing labels (big and small) are going to remain at the centre of the equation for the meaningful future. Although some will most likely fall by the wayside or sell up over the next few years. (Sony’s acquisition of Ministry Of Sound is an early move rather than an exception.) But what Spotify can do that incumbent labels cannot, is understand the artist and music fan story right from discovery through to consumption. More than that, it can help shape both of those in a way labels on their own cannot. Until not so recently Spotify found itself under continual criticism from artists and songwriters. Although this has not disappeared entirely it is becoming less prevalent as a) creators see progressively bigger cheques, and b) more new artists start their career in the streaming era and learn how to make careers work within it, often seeing streaming services more as audience acquisition tools rather than revenue generators.

The Balance Of Power Is Shifting Away From Recorded Music

In 2000 record music represented 60% of the entire music industry, now it is less than 30%. Live is the part that has gained most, and the streaming era artist viewpoint is best encapsulated by Ed Sheeran who cites Spotify as a key driver for his successful live career, saying “[Spotify] helps me do what I want to do.” Spotify’s opportunity is to go the next step, and empower artists with the tools and connections to build all of the parts of their career from Spotify. This is what a next generation “label” will be, a platform that combines data, discovery, promotion (and revenue) with tools to help artists with live, merchandise and other parts of their career.

How Spotify Can Buy Its Way To Platform Success

To jump start its shift towards being a next-generation “label” Spotify could use its current debt raise – and post-IPO, its stock – to buy companies that it can plug into its platform. In some respects, this is the full stack music concept that Access Industries, Liberty Global and Pandora have been pursuing. Here are a few companies that could help Spotify on this path:

• Soundcloud: arguably the biggest artist-to-fan platform on the planet, Soundcloud could form a talent discovery function for Spotify. Spotify could use its Echo Nest intelligence to identify which acts are most likely to break through and use its curated playlists to break them on Spotify. Also artist platforms like BandPage and BandLab could play a similar role.
• Indie labels: Many indie labels will struggle with cash flow due to streaming replacing sales, which means many will be looking to sell. My money is on Spotify buying a number of decent sized indies. This will demonstrate its ability to extend its value chain footprint, and therefore margins (which is important for Wall Street). It could also ‘do a Netflix’ and use its algorithms to ensure that its owned-repertoire over performs, which helps margins even further. But more importantly, indie labels would give Spotify a vehicle for building the careers of artists discovered on Soundcloud. Also the A&R assets would be a crucial complement to its algorithms.
• Tidal: Spotify could buy Tidal, taking advantage of Apple’s position of waiting until Tidal is effectively a distressed asset before it swoops. Though Tidal is most likely to want too much money, its roster of exclusives and its artist-centric ethos would be a valuable part of an artist-first platform strategy for Spotify.
• Songkick: In reality Songkick is going to form part of Access’ Deezer focused full stack play. But a data-led, live music focused company (especially if ticketing and booking can play a role) would be central to Spotify driving higher margin revenues and being able to offer a 360 degree proposition to artists.
• Musical.ly: Arguably the most exciting music innovation of the decade, Musical.ly would give Spotify the ability to appeal to the next generation of music fans. The average age of a Musical.ly user is 20, for Spotify it is 27. Spotify has to be really careful not to age with its audience and music messaging apps are a great way to tap the next generation in the same way Facebook did (average age 35) did by buying up and growing messaging apps. (e.g. Instagram’s average age is 26).
• Pandora: A long shot perhaps, but Pandora would be a shortcut to full stack, having already acquired Ticket Fly, Next Big Sound and Rdio. If Pandora’s stock continues to tank (the last few days of recovery notwithstanding) then who knows.

In conclusion, Spotify’s future is going to be much more than being the future of music retail. With or without any of the above acquisitions, expect Spotify to lay the foundations for a bold platform strategy that has the potential to change the face of the recorded music business as we know it.

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Spotify May Be Buying Soundcloud, But Who Wins?

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

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

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

 

Can The Music Industry Afford Pandora to be the Shape of the Future?

The music industry has been following Pandora’s IPO with baited breath and has largely been encouraged by the degree to which the financial markets value one of the few true gems of the digital music space. But it doesn’t all smell of roses. Indeed Pandora’s Tim Westergren has made no secret of his concern over how large a share of his revenues are accounted for by royalty payments: they are by far the largest single cost and following a (very) brief spike into profitability Pandora remains unprofitable, despite massive consumer adoption.

The debate about royalty payments and music service profitability is well documented – profitability remains a wishful daydream for Spotify and even Apple only just break even on iTunes. But a quote from Pandora’s CTO Tom Conrad opens up an intriguing new angle:

“The figure that surprises most folks is that about 80 percent of music consumed each week comes from music radio. Only 20 percent comes from owned music. We’re really focused on defining the future of radio. That’s the mainstream opportunity.”

If streaming is the future of music consumption it raises some big questions because there are inherent tensions and contradictions in the current situation:

1. Digital music is a low margin, often loss-making business for services
2. Streaming services (including iCloud etc.) are helping driving a paradigm shift from ownership to access
3. Yet those often ad-supported streaming services (especially semi-on-demand services like Pandora) don’t generate enough income for the music industry.

The irony is that the more successful they become in terms of listening hours and user adoption the more rights owners feel concerned about them cannibalizing higher value ownership based transactions such as downloads and CDs. And in turn the more tempted they may be to hike royalty fees.

Radio has always played a dual role for the music industry: it has been the best discovery service out there but also the single largest competitor to music sales. The paradox is that many music fans wouldn’t buy as much music if they didn’t have radio and yet also many radio listeners would buy more music if they didn’t have radio.

The future of music consumption is going to become increasingly access-based. There’s simply no escaping the fact. And yet the current digital music value chain is not prepared for it. Something needs to change, and soon. More common ground needs to be found between rights holder and services but also new types of services are required that throw the out-dated distinctions between ownership and listening out of the window.

The future of music will be access based, but access has to mean much more than streaming alone.