Access Industries’ full stack music company has, ahem, company: Liberty Media. With a combined market market cap of $37 billion John Malone’s Liberty group of companies is by anyone’s standards is a serious player. In the world of media and telecoms it is one of the biggest. Liberty grabbed the headlines this week with its $2.7 billion acquisition of a 15% stake in Formula One, with an option to acquire the entire company, possibly by year’s end. It is a typically bold move for a company that makes a habit of acquiring companies and consolidating markets. Over the past 11 years Liberty Media and Liberty Global have spent around $50 billion on acquiring companies such as UK TV operator Virgin Media, Dutch cable company Ziggo and (indirectly via a holding company) major league baseball team Atlanta Braves. So far so good, but where’s the music angle I hear you ask. Well, just a few weeks ago Liberty made a bid for a certain Pandora Media to add to its already extensive collection of music assets.
For our recently published MIDiA report ‘State of the Streaming Nation’ we conducted an exhaustive programme of research to assess the global streaming music market, from each of the consumer, market and service perspectives. In pulling together subscriber numbers for each of the music services (there’s a full table in the report) we found that there were 67.5 million subscribers globally in 2015. That was 24 million more subscribers compared to 2014 (also nearly double the number of new subscribers in 2014). It is clear that global subscriptions are gathering pace. However, all is not as it may at first appear:
- Zombies still walk the streaming streets: Back in 2013 I ruffled a few feathers highlighting the issue of zombie subscribers, music subscribers that are recorded in the headline numbers but that are actually inactive, normally because they are on telco bundles. Fast forward to 2016 and the issue is more firmly in the public domain due to Deezer’s IPO filings. Zombies coupled with overstating by music services accounted for around 12 million subscribers in 2015 so the active ‘actual’ subscriber number was nearer 55 million.
- Emerging markets are gaining share: Emerging markets will play a key role for streaming over the next few years. They are already driving growth for Apple and Spotify and they will collectively bring the most dynamic growth with western markets nearing saturation for the 9.99 price point. Much of the growth though will come from indigenous companies, such QQ Music (China), KKBOX (Taiwan), MelOn (South Korea) and Saavn (India).
- Free still dominates: For all the scale of of subscriptions, free still leads the way with free streaming services accounted for nearly 600 million unique users (1.3 billion cumulative users if you add together the user counts of all the services). Free thus outweighed paid by a factor of 10-to-1.
Streaming’s Identity Crisis
Streaming must overcome its identity crisis. Depending on where you sit in the music industry, streaming is either the future of retail or the future of radio. It can be both, but there is increasing pressure for it to be retail only. That would see only a fraction of the opportunity realised. Throughout its history, a small share of people have accounted for the majority of spending. Casual buyers and radio accounted for the rest.
17% of music buyers account for 61% of spending. These are the people who are either already subscribers or that will become subscribers over the next couple of years. Which leaves us with the remaining 83% of consumers. The majority of these listen to radio while a growing minority use free streaming (mainly YouTube). The question the music industry must now answer is how seriously does it want to treat the opportunity represented by these consumers? Does it want to only serve its super fans or does it also want to be global culture? Radio enabled music to be global culture in the 20th century, free streaming will enable it to be in the 21st.
The Free Streaming Debate Is As Complex As It Is Nuanced
This is why the free streaming debate is important but also so complex. Yes, too much free music will curtail the opportunity for paid subscriptions, but too little could consign music culture to the margins. With streaming there is an opportunity to monetize a bigger audience at higher rates than radio ever enabled. At the moment free streaming bears the burden of being all about driving sales (either subscriptions or music purchases) but that misses the far bigger opportunity for free in the streaming era: mass monetization.
What we have now is a dysfunctional system. Freemium services have licensing minimas (the minimum that must be paid per stream) that effectively prevent them from building profitable ad supported businesses, while YouTube has licenses unlike any other but is the industry’s bête noire. Only Pandora has a model that is both (largely) acceptable to the industry and (theoretically) profitable. I say, ‘theoretically’ because Pandora could get towards a 20% margin if it wasn’t investing so heavily in ad sales infrastructure and other companies.
Out of those three disparate models an effective middle ground can and should be found so that the streaming debate becomes one of free AND paid rather than free VERSUS paid. Then we will have the foundations for creating a market that enables subscriptions to thrive within their niche and for global audiences to be monetized like never before.
Spotify just changed the rules of the game, raising an unprecedented $1 billion in convertible debt. I’ll leave the financial analysts to pore over the financial permutations (and there are plenty) but there are a few key strategic implications:
- This is an IPO war chest: Spotify is effectively priced out of trade sales for two reasons 1) it has received so much funding that its valuation is astronomic (somewhere close to $10 billion) and 2) the competitive market has changed so much that most companies that were potential buyers 3 years ago no longer are. Samsung neither has the growth story nor the music focus any longer, Microsoft is almost out of the game, Sony is out of the game, Apple couldn’t admit defeat so soon, Amazon is focused on the mass market and Google is focused on YouTube. So an IPO is the only realistic option and for that….
- Spotify needs a growth story: To achieve an IPO valuation as high as Spotify needs, it is not enough to just be the leading player, it needs to be seen to be growing at a healthy clip, especially with Apple constantly making up ground and still odds on to be the long term market leader. Wall Street needs growth stories. Just look at what has happened to Pandora, a company with stronger fundamentals and a more secure licensing base. Yet Pandora has lost billions of market cap because Wall Street hasn’t warmed to the long term mature company story.
- Growth will come from three key areas: The $9.99 model only has finite opportunity. The top 10% of music buyers only spend $10 a month on music. So to grow beyond that beachhead Spotify has to grow where the market isn’t yet mature (emerging markets), make the offering feel like free (telco deals) and make the offering feel super cheap ($1 for 3 months promos). All, in different ways, cost, which is where much of this money will be spent, along with hefty marketing efforts.
- Some of it will be spent on strategic acquisitions: Small music services around the globe will be hastily editing their investor decks, pitching for an acquisition or hoping Spotify will come calling uninvited. But there aren’t too many realistic targets. Soundcloud would probably cost most of the raise, and Spotify would have the same problem Soundcloud now has of trying to force a 9.99 model on a user base it doesn’t fit. TIDAL wouldn’t be cheap either and besides a bunch of exclusive rights for some super star artists, would only add 10% to Spotify’s user base, less after all those users who came in for ‘Life of Pablo’ churn out. A more realistic bet would be for Spotify to target a portfolio of niche services that would add little to its user base but would communicate to the street that it is set up for super serving niches to grow its user base.
- All bets are on Spotify: For the last 2 years the recorded music industry, the majors in particular, has been holding its collective breath. If Spotify has a successful IPO it will likely spur an inflow of much needed investment to the space. If it doesn’t then it is back to the drawing board. In many respective that should happen anyway. The 9.99 subscription model is incredibly difficult (perhaps impossible) to run profitably at scale.
The next 6 months will be ones of hyper activity for streaming, and don’t expect Apple to take this lying down. Await the battle of the gargantuan marketing budgets. Even if no one else does well out of this, the ad agencies will make hay.
The internet, smartphones, app stores, open source software, all have accelerated innovation at a rate that makes Moore’s law look positively pedestrian. What defines digital technology markets is disruptive innovation, the constant challenging of accepted wisdoms and of established practices. Nothing stays still long enough to give stakeholders the luxury of feeling complacent and to fall back on slower moving sustaining innovations. These are the the realities of consumer technology, unless you happen to be in the digital music business, in which case the prevailing attitude is ‘we have reached our destination’, we have identified the model that is our future and we’re sticking with it. That approach worked fine in the old days of innovation, when Consumer Electronics (CE) companies used to spend years hashing out market standards and then competing in a gentlemanly fashion on implementation. That approach brought us VHS, CDs, DVDs Compact Cassettes etc. Everyone got a bite of the cherry and technologies stuck around for decades. Now they stick around for years, at best. So why is the music industry trying to insist on the $9.99 subscription being the new CD, a 20th century approach to standards in the dramatically different 21st century? And more crucially, why is it able to?
Consumers Are Predictable Creatures
Consumers adopt technology in highly predictable ways. First come the early adopters, the tech aficionados who are always the first to try out new apps, services and devices, next come the early followers who supercharge growth, then the mainstream who bring scale of adoption and finally the laggards who adopt at a more measured pace and slow growth. The result is an ‘S-Curve’ of adoption, with slow growth followed by fast growth, followed by slow growth again at the top of the curve. Music services are no exception, usually starting slowly before accelerating and then slowing again when they have saturated their addressable audience. Exactly where growth peaks varies by service and is determined by the type of service, but the same shape of adoption curve plays out nonetheless, most of the time.
Spotify’s 30 Million Might Just Be The Start Of Maturation
Spotify yesterday announced it had it 30 million paying subscribers. A true digital music landmark. But in the context of its long term growth curve it looks like it might be the start of the end of rapid growth. (It is worth noting that the accelerated growth of the last 16 months has been supercharged by the $1-for-3-months promos so the maturation point may have otherwise been reached earlier or it may have happened at the same time but with a lower number). This isn’t however, some failing of Spotify, rather an illustration that the $9.99 stand alone subscription model is nearing maturity. And this is where the scarcity of innovation comes into play. The major record labels, some more than others, have become increasingly unwilling to threaten the $9.99 status quo. Services that don’t fit the mould either find it impossible to get licenses for new models or they are forced to adhere to the $9.99 cookie cutter subscription model (Soundcloud anyone?).
Video Sets The Standard For Streaming Innovation
Compare and contrast with the streaming video subscription market. Alongside the mainstream Netlfix, Amazon and Hulu Plus services (the Spotify and Deezer equivalents) there is a growing body of targeted niche services with diverse pricing. These include: Hayu (a reality TV, $5.99), MUBI (cult movies, $4.99), Disney Life (Disney shows and movies, £9.99), Twitch (live streamed gaming, $4.99), YouTube Red (YouTuber originals, $10), Vessel (short form originals, $3) Comic-Con HQ (Comic Con content, pricing tbd).
Of course music is drastically different from TV and it is far easier to have a video service with just one slice of all available content than it is for music. Nonetheless, in the video sector there is no prevailing attitude of not wanting to disrupt the dominant $7.99 broad catalogue model. TV and video industry stakeholders are not only willing to tolerate disruptive innovation (online at least!), they understand it is crucial to drive the market forwards. So why don’t labels take a similar view? A key reason is rights concentration. Because three labels account for the majority of music rights, each has de facto veto power. Most companies that are dominant in their markets pursue smaller, sustaining innovations that improve the product but that do not threaten their businesses. So it is fully understandable that major labels have not empowered disruptive innovations that could risk turning their digital businesses upside down. It would be like turkeys voting for Christmas. And yet the growth trajectory of most leading music services shows that by sticking with sustaining innovations they are unwittingly curtailing the scale of their future growth.
Again, compare and contrast with TV where rights are far more fragmented and are becoming even more so. No single TV network or studio has the ability to stop a service in its tracks. The result is a far greater rate of innovation.
Music Subscription Services Are Compelled To Behave Like CE Companies
Thus music subscription services are forced to behave like the old CE companies, competing on the implementation of fundamentally the same product. TIDAL do exclusives and high definition, Spotify do playlist innovation and video, Apple does curation and exclusives. But when it comes down to it they are selling the same $9.99, 30 million tracks, on demand, mobile caching product to largely the same group of consumers.
Postscript: The Unusual Case Of Apple
The keen eyed among you will have noted that Apple Music’s growth curve does not fit the S-Curve model, or at least not what we can see of it yet. It certainly appears that Apple is set for a very different adoption path. There are mitigating factors. The streaming market is far more mature now than when Spotify and Deezer launched. Additionally, Apple has a unique platform and ecosystem advantage that enables it to short cut adoption rates. It can sell straight to its user base of Apple-super-fans. Selling additional products and services to its installed base of 850 million iTunes customers will be key to the next stage of Apple’s story and music will play its role in that. (Amazon is potentially another exceptional case given its ability to sell directly into its customer ecosystem and also with its focus on a more mainstream audience.)
But even Apple will eventually reach the saturation for the $9.99 product within its user base. In fact, one reading of Apple’s adoption curve is that it skipped the first stage of slow growth, has had a brief period of mid period strong growth and is now settling down for a long gradual arc of adoption that looks like an amalgamation of the final 2 stages of the S-Curve model. Whatever the path, let’s just hope that long before Apple Music hits maturity, the record labels will have woken up to the need to support an unprecedented phase of experimentation and innovation to identify all the other opportunities for premium music that exist outside of the super fan beachhead. Remember its 2016 not 1986.
Earlier this week Soundcloud’s financials revealed that the company was haemorrhaging cash (even before it had to start worrying about content license fees). Now news comes that Pandora is working with Morgan Stanley to meet with potential buyers. Back in Q4 2014 free streaming got a stay of execution when the majors decided to put their weight behind freemium after a period of many executives seriously considering canning the model. In 2015 free streaming was the growth story, with YouTube out performing everyone. Now though free streaming looks to be in seriously troubled waters. So what gives?
Pandora’s Problem Is Wall Street
Probably the biggest problem of all that Pandora has is the story it tells Wall Street. Every year Pandora accounts for a little bit more of total US radio listening, builds ad revenue and steadily strengthens its business. But that’s not the sort of story Wall Street expects from a streaming media company. Investors expect dynamic growth. But Pandora is, along with Rhapsody, the granddaddy of streaming and had 10 million users before Spotify was even launched in Sweden, let alone the US. Pandora long since passed its dynamic growth stage in the US and is now a mature business that is going about sensibly building a sustainable business.
The standard thing to do at this stage for streaming companies is to roll out internationally and find new markets where you can start a new dynamic growth story. This is exactly what Netflix is doing now that US subscriber growth has slowed. The approach has also served Spotify well. But the unique compulsory licensing structure in the US the underpins Pandora’s business model does not exist elsewhere. There is no global landscape of SoundExchanges for Pandora to plug into. With the exception of Australia and New Zealand Pandora has not been able to negotiate rates that it launch internationally with.
Actually, Slowing Growth Is A Problem Too
All of which explains why Pandora has gone down the acquisition route, buying Next Big Sound, Ticket Fly and Rdio in a bid to become a full stack music company. The problem is that Wall Street either does not buy it, or simply does not get it. In fact, Wall Street does not really make much of a distinction between semi-interactive radio or on-demand streaming. The pervasive view among the investor community is that Pandora is being out competed by Spotify, regardless of the fact that there is only partial competitive overlap in terms of value proposition, target audience and business model. The net result is that Pandora’s market capitalization has fallen from $7bn to $1.8bn and to make matters worse it had to raise $500 million in debt, with revenue growth slowing.
Pandora Needs A New Wall Street Narrative
In just the same way Apple needs a new Wall Street narrative, so does Pandora. Even if just to maintain some market value while it finds a buyer. The full stack music strategy should be central to that narrative, even though the real story is that Pandora is the future of radio. Unfortunately that story will take a decade or more to play out and most investors do not have that kind of patience. (Spotify, these are the sorts of problems you’ll be having to worry about this time next year). And, to be precise, it is the Pandora model that is the future of radio, not necessarily Pandora itself. Though the odds are still on Pandora playing that role, in the US at least.
If Pandora really does not have the stomach for seeing out the long game it should not find it too difficult to find a buyer, if the price is right. Exactly because Pandora is the future of radio, some of those big radio incumbents are likely buyer. Hello iHeart Media.
The much anticipated outcome of yesterday’s Copyright Tribunal decision was a 20% increase of Pandora’s ad supported stream rate from $0.0014 per non-interactive stream to $0.0017. The result was roughly equidistant between the two parties’ preferred rate: Pandora wanted $0.0011, SoundExchange (the body that collects the royalties on behalf of the labels) wanted $0.0025. As with any good compromise neither party will be truly happy, though on balance Pandora probably came out slightly better. Both the rate and the whole rate setting process shine a bright light on the economics of streaming, especially when contrasted against on-demand services.
Pandora’s semi-interactive radio service operates under statutory rates in the US that are set by the Copyright Royalty Board for a few years at a time, with inflation baked in. This means a continual rise in rates (see figure). It also gives Pandora a degree of certainty over its mid term future but prevents record labels from negotiating for better rates (publishers however are able to strike direct deals with Pandora). Spotify, and other on-demand streaming services, negotiates deals directly with multiple record labels, publishers and rights bodies. Deals typically come up for renewal every couple of years, involve large upfront payments and Minimum Revenue Guarantees (MRGs). They also run the risk of core product features being threatened in renegotiations – as we saw with the labels’ dalliance with killing off freemium this time last year.
The most significant difference between the models is how the per stream rate works. For on-demand services a royalty pot as a % of revenue is determined. This is then divided between rights holders based on plays in a given period and allocated on a per stream rate basis. Thus royalty payments remain a comparatively constant share of revenue, assuming of course that the service hits the MRG targets – if it doesn’t the share increases, often above 100% of revenue. This model also implies a clear ceiling to the potential profit an on-demand service can earn. By contrast Pandora pays out on a (largely) pure per stream basis. The direct consequence of this is that Pandora is able to increase it revenue per play faster than its rights cost per play which in turn creates the potential to grow margin (see next figure).
Between 2009 and 2014 Pandora’s content acquisition costs per listener hour increased by 27% from $17.52 to $22.29. This reflects both the CRB set rate as well as deals with rights bodies and publishers. But over the same period Pandora’s revenue per listener hour increased by 114% from $21.48 to $45.97. Now clearly, an increase in revenue per hour does not inherently mean increased profitability, or even profitability at all. Indeed, Pandora’s continued losses have been a perennial bugbear for investors. But Pandora has chosen to invest its increased revenue to grow its business, building out regional ad sales teams and making acquisitions such as Next Big Sound, Ticket Fly and Rdio. In short, Pandora could have been profitable for some time now if it had so chosen. Instead it is chasing a bigger prize, namely to become the single biggest revenue driver in US radio. To get big it needs to spend big.
Pandora’s Core Strength Is Being Able Increase Profitability Per User
The underlying principle is clear: while on-demand services have little meaningful way of increasing revenue per user with the current model, Pandora has more than doubled revenue per user in 6 years while rights costs have declined in relative terms. Content acquisition costs fell from a high of 82% of revenue in 2009 to 48% in 2014. That rate will increase in 2015 due to direct deals struck with publishers and the $90 million pay out for the pre-1972 works ruling. But it still remains well south of Spotify’s 70%+.
On Demand Services Have Similar Fixed Costs But Tighter Margins Because Of Royalties
While there is a clear case for semi-interactive radio rates being markedly lower than on-demand rates many of the fixed costs of both types of streaming business are the same. Both have to commit similar amounts to product development and tech, bandwidth, data analysis, reporting marketing, customer care, management. This puts on-demand services at an operational disadvantage compared to webradio services.
If paid-for streaming services are going to become commercially sustainable there is going to need to be pricing and product innovation to both reach more mainstream users (cheaper tiers) and to drive more revenue from high value users (more expensive tiers and bolt ons). Right now there is relatively little commercial incentive for on-demand services to innovate upwards as profitability will remain largely the same. There is an opportunity for labels to offer Spotify and co a Pandora-style pure per-play license structure for all products launched above and beyond the standard 9.99 tier. This would give the services the ability to follow Pandora’s path of growing revenue per user faster than rights costs per user, thus improving commercial sustainability and allowing them to invest more in product innovation.
Rights Frameworks Need To Engender Commercial Sustainability
Pandora is one of the few stand out, independent success stories of the entire history of digital music. It has become one of the world’s biggest music services despite being largely constrained to the US, it has built a commercially viable model and it has delivered a big return for investors via its IPO. Only Last.FM, Beatport and Beats Music can genuinely lay claim to having delivered big returns for their investors. There are many mitigating factors, but the unique licensing structure Pandora operates under is the single most important one. Do songwriters and labels feel that they’re getting short changed? Absolutely. But it is in the interest of every music industry stakeholder that the economics of digital music are structured in a way that enables standalone companies like Pandora, Spotify and Deezer to thrive. Otherwise there can be no complaints when the only options left on the table are companies like Apple, Amazon, Facebook and Google whose interest in music all stems from trying to sell something else. That’s when artists and songwriters are really at risk.
Pandora today announced that it was acquiring the assets of now failed subscription service Rdio. While the whispers about Rdio’s future had been building for some time, the deal is more interesting for what it says about Pandora’s plans than what it says about the state of the subscription business.
Rdio Battled Bravely And Set Innovation Standards But Fell Short
For what Rdio lacked in subscriber numbers it made up for in innovation. It continually set product and feature precedents that Spotify and others subsequently aped, and its $75 million dollar ad inventory deal with US radio giant Cumulus sets a business model blueprint that other streaming services will follow. But for all its efforts and extensive marketing efforts Rdio was simply not able to get to the same sort of level as Spotify’s 2nd tier competitors, let alone to seriously challenge Spotify itself. The music subscription business is not a winner-takes-all market. But it is one in which some degree of meaningful scale is required to trigger the telco partnerships and brand advertiser deals that are necessary to achieve sustainability. Eventually a company transitions from ‘bright new hope with potential’ to an ‘also ran that isn’t ever going to make it’. Once that imperceptible line of market perception has been crossed it is only a matter of time before the end comes.
Pandora Will Use Rdio’s Assets To Go Global
Crucially Pandora is not acquiring Rdio as a going concern but only its assets, which won’t include licenses (as they have to be renegotiated when a music service changes corporate hands). What those assets represent, or at least the bits that matter to Pandora, are teams, product and tech, licensing know how and an international footprint. That last bit is particularly pertinent. Rdio’s 100 markets contrasts sharply with Pandora’s 3 (US, Australia and New Zealand). Indeed Pandora CEO Brian McAndrews stated “We seek to be the definitive music source for music discovery and enjoyment globally”. While 100 markets is probably a step too far for Pandora, expect a healthy selection of top tier and emerging markets to feature in Pandora’s roadmap. And if you’re eager to identify which ones, just take a look at the bigger radio markets globally (Japan possibly excepted).
Pandora’s Success Is Built On Lean Back Not Lean Forward
Pandora’s success is firmly rooted in delivering a high quality, lean back experiences to largely mainstream audiences. That’s how it reaches 78 million monthly listeners, more than a quarter of US adults. That positioning has served Pandora well and made it one of the few success stories of digital music. In fact, other than Beatport and Last.FM, it is one of the very few music start ups that had an exist that considered to be a true financial success. Crucial to that success has been the fact Pandora has operated under statutory licenses for semi-interactive radio, which leaves it with dramatically higher (potential) operating margins than on demand services. Which begs the question, just why is Pandora getting into the subscription business?
This Is The Latest Part Of A Major Strategic Pivot
The answer is that it forms part of a much bigger, much bolder plan. Pandora has spent the last couple of years quietly amassing the assets that will transform it into a music platform super power. In 2015 it acquired music data company Next Big Sound (c.$50 million), then came ticketing company Ticketfly in October ($450 million) and now Rdio ($75 million). The combined $0.6 billion is a truly sizeable investment in a streaming-centred business model by anyone’s standards. It also accompanies a concerted and costly investment in Pandora’s regional ad sales teams across the US to compete on a level footing with traditional radio’s sales teams. Couple all that with November announcements to become the exclusive streaming outlet for popular podcast series ‘Serial’ and the landmark direct deal with Sony/ATV Publishing and a picture of something truly ambitious starts to emerge.
Pandora was fortunate to be able to IPO at a time when public offerings were still a highly viable option for digital start ups. Spotify and Deezer (which just cancelled its IPO) will look on with no little jealousy at the power that a market capitalisation of nearly $3 billion gives you. Now it is using this financial firepower to take the next step on its streaming journey. Whatever that will prove to be, expect it to be a platform in its truest sense, rather than simply a streaming service with a few loosely attached ‘alternative revenue’ models, which is a mistake some of the subscription incumbents have made thus far.
Discovery Doesn’t Lead Anywhere Anymore, At Least Not To Sales
Pandora may aspire to be the definitive source of ‘music discovery’ but streaming discovery is becoming streaming consumption. i.e. it is increasingly not leading to sales. Live music sales is one alternative way to make money from ‘discovery’ but if ‘free music to sell tickets’ is Pandora’s end game then some difficult conversations with songwriters (who of course often don’t play live) will need to be had.
Pandora has just thrown its hat into the ring as a top tier player in the global streaming business. By some measures you could say it is poised to become the biggest. McAndrews left no room for doubt by stating “We plan to substantially broaden our subscription business.” But in doing so Pandora will have to look itself in the mirror and ask itself “what am I now?”.
Late 2014 a minor crisis emerged in the music industry, with major record labels at one stage looking like they were going to kill off freemium. The outcome of the Freemium Wars was actually less dramatic, resulting instead in an effective continuation of the status quo. The labels had however made it very clear to Spotify who held the whip hand. Though their tones have softened, major label execs retain an at best sceptical view of free streaming. The net result is that freemium has almost become the inconvenient streaming truth that no one really talks about. However free is too big to ignore. In fact free is much bigger than some would like to admit.
According to the IFPI ad supported streaming accounted for just 19% of all US streaming revenues in 2014, down from a high of 30% in 2011. Which points to the success of subscriptions. Except that those numbers ignore a major part of the equation: Pandora (and other semi-interactive radio services). The IFPI has Pandora hidden away with cloud locker services, SiriusXM and a mixture of other revenues in ‘Other Digital’. Extracting the semi-interactive radio revenues that count as label trade revenues wasn’t the most straight forward of tasks but it was worth the effort. Once Pandora is added into the mix it emerges that 56% of US streaming revenues are from free, ad supported services. While that share is down from a high of 66% in 2012 it remained flat in 2013 and 2014. Which means that however fast subscriptions grew Pandora, Slacker, Rhapsody UnRadio and co grew even faster in order to offset the decline in on demand ad supported income.
Semi-interactive radio revenues grew by 40% in 2014 compared to 35% for subscriptions. Subscriptions had grown much faster in 2013 (76% compared to 25%) but Pandora and co found their mojo again in 2014. None of this is to suggest that subscriptions aren’t making great progress but it does show us that free is more than an inconvenient truth, it is both the most widely adopted behaviour and the largest revenue source in the US (which accounts for 48% of global digital revenues).
The music industry is beginning to get its head around the fact that the role of streaming as a retail channel (i.e. subscriptions) is always going to be smaller (in reach terms at least) than its role as a radio channel (i.e. free streaming). This more accurate view of the US streaming market shows us that free is even more important than many thought.
Free streaming also has much bigger growth potential. The percentage of consumers that have the inclination to pay 9.99 a month for music is inherently limited, thus constraining subscriptions to a niche addressable audience. Music radio listening by contrast has near ubiquitous reach. Most significantly Pandora currently only represents about 10% of all US radio listening time. The addressable market is much bigger and the vast majority of it remains untapped.
Streaming monetization is polarized between premium subscriptions on one end and free streaming on the other. The middle ground that was the scale heartland of the CD and the download is disappearing and taking with it the mainstream consumer. It is into this environment Rdio just announced a new $3.99 tier.
Mid priced subscription tiers are thin on the ground. We have a couple in the UK (MTV Trax and O2 Tracks from MusicQubed, Blinkbox Music, now owned by Guevara) and a number of ad free radio offerings from Pandora, Rhapsody and Slacker. It is a heavily underserved segment as the slide above shows. The mainstream streaming subscription market is squeezed between premium and nothing. The average music spend of a consumer is around $3 a month, so $9.99 subscriptions are far out of reach of most consumers. $3.99 however is far, far closer to a realistic price point for the mass market.
Regular readers will know that I have been a long term advocate of lower priced subscriptions and micro-billing / Pay As You Go pricing models to entice the more mainstream user. The labels have been super cautious because they are scared of cheaper services cannibalizing the premium tier. The concern is a valid one but ultimately if a bunch of 9.99 users aren’t getting full value from an unlimited service they are going to bail out eventually anyway. At least with mid priced subscriptions they have somewhere to land instead of disappearing straight to free streaming.
Currently streaming monetization is split between the top and the bottom of the monetization pyramid and this needs to change. Rdio’s new Select tier gives users ad free radio plus 25 songs of their choice each day. That might not sound like a lot of tracks but for the majority of mass market music listeners that will be more than enough. In fact in some respects it could almost be too much. What matters for the mass market listener is less the number of tracks and more how the tracks they like are surfaced to them. Curation is a much-overused term these days, but expert curation and programming is crucial to engaging the mainstream. Radio is still so popular because most mainstream consumers are lean back customers that want to be led on a music journey not to have to hack their way through the musical undergrowth themselves.
Monetizing The Revenue No-Man’s Land
The leap from zero to 9.99 is far too big and Rdio Select is an important step towards monetizing the revenue no-man’s land between free and premium. Of course zero to anything is still a major hurdle but the success of iTunes (250 million global buyers) shows us once you make the first step small enough, consumers will follow. The simple fact is that the streaming market will not be sustainable without the mainstream engaged as paying customers on the same sort of scale that was achieved with downloads. An even simpler fact is that 9.99 will not achieve that end.
Apple’s entry into the subscription market later this year will fire a broadside across the freemium model. But there are not many companies that can do what Apple can. Every product and service needs to acquire customers and usually that entails advertising and marketing. If what you are selling is a relatively nuanced proposition, and music subscriptions are exactly that, then you are going to need to spend a lot of time and money building the awareness and understanding of the product. That typically either means a big ad budget or having a captive audience to talk to directly without the marketing middleman. For freemium services that is the free tier. For Apple that is the installed base of device owners. It is all well and good for Apple to crusade against free in its entirety because that also happens to make it increasingly difficult for anyone else to make the subscription model work. As I argued in my previous post there is a need for a rethink of free, to ensure that it acts as an acquisition funnel for subscriptions not as a replacement for them. But there is another part of the puzzle that needs solving too: the subscription model itself. If freemium is on borrowed time, a solution is needed that the entire market can work with, not just Apple. Pay As You Go (PAYG) is part of the answer.
Music Subscriptions Cap ARPU
Currently the music industry is trying to migrate all of its paying customers to subscriptions. The theory is that this should increase the Average Spend Per User (ARPU) to 9.99 but as MIDiA’s research revealed, thus far it appears to be doing a better job of reducing the ARPU of the most valuable. Thus we have a worst of both worlds scenario in which the ARPU of the most valuable customers is capped (something no other media industry does) and the lower value customers aren’t offered enough options to get on the spending ladder.
When I wrote back in October that it was time for a pricing reset I pointed to three things that need to happen:
- More price tier differentiation
- Reduce the main $9.99 price point to $7.99
- Introduce PAYG / Top Ups
The good news is that we’re beginning to see some movement on all three counts, including Apple poised to tick off the second item later this year when it launches its subscription offering.
The Return Of The Day Pass
Last week Pandora announced that it was introducing a $0.99 day pass to its ad free subscription offering. The idea isn’t new, Spotify had a day pass in its earlier days, but the timing is now right for a reassessment of the tactic. Most people are not in the habit of paying for music on a monthly basis and most do not spend anything close to 9.99 a month. Little surprise then that only 10% of consumers are interested in a 9.99 subscription. But PAYG pricing interest, while still relatively modest, is the clearly the pricing that has strongest appeal (see figure). PAYG pricing allows consumers to ‘suck it and see’ to try out. It is what the mobile phone business needed to kick start cellular subscriptions and it is what the music industry needs too. And done right PAYG can even uncap ARPU by allowing customers to spend more than they would on a monthly plan, something that happens frequently among pre-pay mobile phone customers.
Currently there is only a handful of companies pioneering this approach, including the MusicQubed powered MTV Trax’s ‘Play As You Go’ model and Psonar’s ‘Pay Per Play’ offering. It should only be a matter of time before the big streaming services start experimenting with a la carte pricing but they will have to tread carefully to ensure they do not cannibalize the spending of their 9.99 customers. At an industry level though the case is clear and it is one that other media industries are already heeding. In the TV industry services like Netflix are empowering cable and satellite TV subscribers to cancel or reduce their subscriptions. Consequently TV companies are busy experimenting with unbundling their subscription offerings to meet the needs of their newly empowered customers. The most interesting example for the music industry is Sky’s Now TV in the UK which offers its core programming with no monthly contract and enables users to simply add on extra content such as and ‘entertainment pass’ or a ‘sports pass’ as one off payments.
The future of music consumption is clearly going to be on demand but 9.99 subscriptions are just one part of the mix. PAYG pricing will be crucial to ensuring that streaming can break out of its early adopter beachhead.