Here’s Why The Music Industry Needs To Dump Non-Discretionary Pricing

Spotify’s 2015 UK accounts painted a vibrant picture with both profits and above average Average Revenue Per User (ARPU). However, a little caution is required before assuming all the answers to the streaming market’s woes can be found here. Firstly, only a portion of Spotify’s costs are based in the UK. For example, much of the (more highly paid) exec team is in the US and much of the development team is based in Sweden. Such are the vagaries of financial reporting for multi-territory companies. More importantly though, is Spotify’s higher UK subscriber ARPU (€6.47 per month compared to €5.20 per month globally according to the ever insightful Music Business Worldwide). On the surface this is clear success (and indeed the UK may well have a higher paid-to-free ratio). However, the main reason for the ARPU difference is the music industry’s fixation with non-discretionary pricing. 9.99 is 9.99 in the US, the UK and the Euro zone, even though each of those currencies have very different values. Especially now post-Brexit referendum.

subscription pricing

At current exchange rates, the Euro Zone €9.99 is equivalent $10.86 and the UK £9.99 price point is equivalent to $12.18. Thus Euro Zone subscribers are paying 9% more than US subscribers while UK subscribers are paying 22% more. What makes matters even worse is that US per capita GDP (a measure of relative wealth of the population) is 55% higher in the US than in the EU and 27% higher than in the UK. So in effect that means a combined pricing ‘swing’ of 63% for the US compared to the Euro Zone and 49% compared to the UK.

In short, European subscribers are getting doubly hit by the music industry’s insistence on non-discretionary pricing for music subscriptions. While there are a host of commercial factors that can be cited in favour of the approach (e.g. it helps mitigate against currency fluctuations) there is zero customer value, unless of course you happen to be a US resident consumer.

Regular readers will know I am a long term advocate of a more sophisticated approach to subscription pricing (e.g. mid tier products and super-premium options) but before we get there, a first step should be to ensure that European music fans get a fair deal compared to their US peers. Or of course, we could try the alternative: increasing US subscriptions by 63% which would mean a $16.32 price point. Sounds crazy right? Exactly…

Pandora Plus And The Mid Tier Opportunity

Pandora continued its steady path towards subscriptions today with the announcement of a revamp of its premium radio offering Pandora One and confirmation of a forthcoming 9.99 tier. These of course have been in the works since its acquisition of Rdio’s assets back in November 2015. In the update Pandora One becomes Pandora Plus and gets new features including: ‘predictive offline playback’ for when signal drops, unlimited skips and unlimited replays. Pandora Plus may have a mid tier price point ($4.99) but it is not a mid priced subscription service, instead it is a premium priced radio service. This is not a revival of Rdio’s $3.99 Select offering nor is it a shot across Spotify and Apple’s bows. Nonetheless it is the start of a bolder streaming strategy for Pandora and it does raise the perennial issue of the case for mid priced subscriptions. Premium radio offerings like Pandora One Plus represent around 5 million subscribers in the US and are an important part of the market. But they are only the tip of the opportunity.

The case for mid priced subscriptions is clear: $9.99 is not a mainstream price point. It is fantastic value for music super fans, but more than mainstream fans are willing to pay. 9.99 subscriptions will continue to grow solidly for the next few years as the remaining untapped super fans are converted. But once that base is saturated the market needs something more, that’s where mid priced subscriptions come into play, helping unlock the next layer of consumers. Mid priced subscriptions can represent the best of both worlds, delivering large scale and premium revenue.

Mid Price Is No Easy Sell

However, the mid priced market is not without challenges, indeed, of the original wave of mid priced subscription services that came to market Blinkbox is gone, Cur Media is gone, Guvera is all but gone while Psonar and MusicQubed are still in market. The key challenges this market faces are:

  • It is not easy selling to mainstream consumers: mainstream consumers have less disposable income, are less engaged with music than super fans and are harder to convert
  • It is hard to compete against free: while there are on demand free services in the market (YouTube, Vevo, Spotify free) it is hard for mid priced products to compete in value terms. These free services steal much of the oxygen out of the market. $1 for 3 month trials from Spotify and co only compounds this issue
  • It is hard to differentiate: Label licensing constraints mean that the mid priced products deliver far less value than full priced products due to the restrictions imposed on them. Pandora’s INSERT gives the users 100 on demand tracks a month. That is 0.0003% of the 30 million on Spotify for 40% of the price of Spotify, or 1197% of the price of Spotify’s $1 for 3 months trial

Mid Tier Needs To Be Given More Substance

In short, the mid priced segment needs empowering with proper functionality. Mid tier products need more tracks and more on demand playback. Of course this has to be within clear bounds, else the risk of cannibalizing 9.99 tiers is to strong. But there are many other ways to do this rather than creating a painfully restrictive limit on the number tracks that can be played on demand. Here are some examples of how to differentiate mid tier while maintaining genuine user value by delivering more content and more choice in return:

  • Windowed content only (e.g. a 4 week window on new releases)
  • Limit on number of tracks that can be added to a playlist
  • Genre specific subscriptions
  • Strong focus on pushed playlists
  • Cheaper pricing ($2.99 or $3.99 to reflect the changed marketplace)

For mid tier to work, the music industry needs to have the confidence that the $9.99 product is good enough to keep its core customer base, that these users will not jump ship for a product squarely aimed at the mainstream.

After a couple of years in the wilderness it looks like the marketplace is beginning to warm to mid tier once again. In addition to Pandora’s moves, Sony Music and Universal Music quietly launched the £5.99 Now Music app into the UK market earlier this year while MusicQubed’s MTV Trax has been getting large scale TV advertising support from Viacom. Meanwhile QQ Music and Apple Music are both driving scale in China with a price point equivalent to around $2.

$9.99 was always a blunt instrument, a sledgehammer to crack a nut. Now though, while $9.99 adoption is still growing, is the time to have a far more sophisticated approach to pricing. The safe option would be to wait until $9.99 growth slows. But by then it would be too late.

The End Of Freemium For Spotify?

‘Leaked’ Spotify numbers emerged today indicating that the streaming service has just hit 37 million subscribers, which puts more clear water between it and and second placed Apple Music, despite the latter’s recent growth. It also means that Spotify is now nearly 10 times bigger than Tidal and probably Deezer (which hasn’t reported numbers since its France Telecom bundle partnership ended). It is beginning to look suspiciously like a 2 horse race. But there is a more important story here: Spotify’s accelerated growth in Q2 2016 was driven by widespread use of its $0.99 for 3 months promotional offer. Which itself comes on the back of similar offers having supercharged Spotify’s subscriber growth for the last 18 months or so. In short, 9.99 needs to stop being 9.99 in order to appeal to consumers. Which is another way of saying that 9.99 just isn’t a mainstream price point.

spotify june 1

As the IFPI’s 2015 numbers revealed, the average label revenue per music subscriber fell globally from $3.16 in 2014 to $2.80 in 2015, with price discounting a key factor. According to Music Business Worldwide, 4 million of Spotify’s newly acquired 7 million subscribers were on promotional offers and around 1.5 million of those are expected to churn out when their promotional period ends. That might sound high but it actually represents a 79% conversion ratio, which is a stellar rate by anyone’s standards. Meanwhile Spotify’s total user base is 100 million which means the free-to-paid ratio is 37%. So price promos are converting at more than double the rate of freemium. Does this mean the end of freemium?

spotify june 2

Freemium proved highly valuable to Spotify in its earlier years and continues to be an important entry strategy for new markets. But last year record label execs started to observe that free just wasn’t converting at the same rate it once did in mature markets like the US. This was because most of the likely subscribers had already been converted and so the majority remaining were freeloaders who were never going to pay, and warm prospects who just couldn’t bring themselves to pay 9.99. This is where price promos come into play. They deliver the impact of mid priced subscriptions, which is enough to to hook those wavering free users. Once they get used to paying the majority tend to stick around when the price goes back up.

Mid Priced Subscriptions Will Drive The Market, Even If By Stealth

I have long argued that mid priced subscriptions are crucial to driving the streaming market, and the burgeoning success of Spotify’s mid-priced-subscriptions-by-stealth strategy provides a bulging corpus of supporting evidence. In fact, the average spend of Spotify’s 7 million net new subscribers in Q2 2016 was $3.09 a month.  The tantalizing question is whether that 1.5 million promo users that are expected to churn out would take a $3.99 product if it was available?

As the streaming market becomes increasingly sophisticated, the leading players will have to rely ever more heavily on differentiation strategies. For Tidal and Apple that means urban focused exclusives, for Spotify (for now at least) that means algorithmic, personalized curation and aggressive price discounting. And in Q2 2016 it is Spotify’s strategy that is winning out, resulting in 2.3 million net new subscribers each month compared to 1.4 million for Apple Music and 0.3 million for Tidal.

Freemim is dead, long live price promos?

 

 

The 2 Spotify Charts You Need To See

Tuesday’s media scrum around Spotify’s financials illustrate that whatever ground Apple and Tidal may have made in recent months, Spotify clearly remains the poster child / bellwether for streaming. The stories oscillated between the broken nature of the underlying economics to how streaming is the future of the music business. Both are true. But a closer look at the numbers reveal some even more important findings.

spotify margin per user

Rights costs are Spotify’s Achilles Heel. Rights and associated costs accounted for 83% of Spotify’s 2015 revenue, up from 81% in 2014 and this resulted in a dramatic fall in Spotify’s gross margin per user: down from $4.20 in 2013 to $3.45 in 2015. This is particularly challenging for a model with already wafer thin margins. A number of factors underpin this decline:

  • Discounted promotions: Promos such as the £0.99 for 3 months have supercharged Spotify’s growth for the last 18 months. But as labels only contribute part of the cost this means that Spotify loses more margin with every new promo user
  • Advanced label payments: When Spotify strikes its licensing deals with labels it makes advanced payments and guarantees based on its expected growth. This means that for a growth stage company like Spotify, booked rights costs will always be higher than current booked revenue. This has obvious cash flow implications. Also, should Spotify’s growth slow and it miss those targets, it will still have to pay the monies guaranteed to labels, at which point the rights costs share will rise even further
  • Publisher rates: Over the last couple of years, music publishers have been asserting their role in the digital music value chain, pushing for more equitable rates. The net result is that publishing rights costs can now range up to 15%, depending on the deal, up from a low of 10% in some cases. This upward momentum will continue, and as labels aren’t decreasing their rates, it means less margin for Spotify and other streaming services

As Spotify edges towards an IPO it is doing everything within its power to get its house in order. It is investing in video to show Wall Street it is attempting to lessen its dependence on the labels and it is improving is cost ratios virtually everywhere else in its business, other than rights. Between 2013 and 2015, the Average Cost Per User (ACPU) for Research and Development fell from $2.12 to $1.61 and for Marketing it fell from $3.23 to $2.77. But Rights ACPU grew from $17.59 to $18.35. In fact, even in terms of costs as a % of revenues, every single expense Spotify reported fell except Rights (and Depreciation and Amortization which increased slightly). It is rising rights costs that are keeping Spotify from commercial sustainability.

spotify average pricing

There is another really important part of Spotify’s growth story: subscriber ARPU has fallen from $79.09 in 2013 to $62.30 in 2015. This is a result of multiple efforts to drive growth, including the price promos, telco bundles and student discounts. All of which are viable tactics but the fact they are necessary to drive Spotify’s growth underscore a point I have been making for years: 9.99 is not a mass market price point, and Spotify’s subscribers agree. By transforming the ARPU into an effective monthly retail price, Spotify’s average price point is now just $6.49, down from $8.24. It is about time that the music industry stopped pretending that this isn’t the reality of the market and instead starts pursuing proper pricing innovation rather than by stealth via discounting, which only serves to confuse consumers about long term value.

The music industry is in a transition phase. In such periods, the old and new worlds co-exist and collide. There are statistics that both sides of any argument can hold up in their defence, in fact they can often hold up the very same numbers to support opposite perspectives. Similarly, the comparisons you chose to benchmark with, can paint entirely different pictures. Such is the nature of transitions of human and business behaviour. For example, 83% of Spotify’s gross revenue going to rights is clearly too high and unsustainable, yet $0.00098 per song going to artists is also clearly too low and unsustainable. Something needs to give, for both ends of the value chain.

Maybe if/when Spotify gets to 50 million subscribers it will feel it has enough clout to compel rights holders to rethink licensing economics. Perhaps it will take Spotify getting to a 100 million to make that happen. Perhaps it will never happen. But if it doesn’t, the economics of streaming will remain so broken that only companies with ulterior business objectives will remain viable players, enter stage left streaming’s Triple A: Apple, Amazon and Alphabet (Google). The labels need to ask themselves whether that is the streaming future they want…

Why It’s Time For A Streaming Pricing Reset

There is a growing realization that that streaming revenue is not growing quickly enough to offset the impact of declining download sales. It is an eerily familiar echo of the recurring narrative of the noughties that download sales were not growing quickly enough to offset the impact of declining CD sales. The situation is very different now in that the industry licenses the disruptive force. Back in the noughties the combined impact of changing consumer behavior patterns, growing piracy adoption and the loss of content scarcity were factors the industry had little control over. Yet this present shift is more fundamental and will have much bigger long term impact. This is the shift to the consumption era. Streaming happens to be the tool of the moment for harnessing that shift but with current pricing strategy the industry’s toolset is woefully unable to fully harness the massive potential that exists.

Zero to 9.99 Is Too Big A Leap

The single biggest issue is the binary nature of streaming pricing: 9.99 or free. (Sure there are desktop versions for less but the desktop is yesterday’s consumption platform and is no longer a useful differentiator for price.) The leap from zero to 9.99 is simply too big. Even a 30 day trial still leaves the consumer with the same zero to 9.99 leap at the end.

streaming pricing

Streaming pricing strategy is simply not aligned with consumer music spending (see figure):

  • Super fan aficionados tend to spend between $10 and $30 a month but many are now shifting down to $9.99 a month
  • Mainstream music fans spend less frequently and at best average less than $10 a month, most typically just a few $. $9.99 is just too much for them as is regular spending, so they end up streaming for free
  • Passive fans used to spend occasionally now typically spend nothing and are core users of free streaming, YouTube especially

So streaming is bringing down the spending of the super fans and missing the spending of the mainstream fans.

Most music fans (i.e. not the super fan aficionados who by definition most of the people reading this blog are) engage with music in a very event driven manner. They have their favourite artists and they engage with them when they are in cycle with a new single, album, tour etc. That used to mean buying an album or some tracks, and it still means buying concert tickets. But these days for the digitally engaged mainstream fans it most often does not include buying anything. Instead they stream for free from YouTube, Soundcloud, Pandora.

Just to make things worse, the super fan aficionados are now spending less because of streaming. 23% of them used to buy more than an album a month, now they spend 9.99 a month and that spending is spread across a far greater quantity of music, meaning a smaller pie is being divided into even smaller slices.

Three Ways To Fix Streaming Pricing

It wasn’t meant to be this way. A high tide was meant to rise all boats. Mass market music fans were meant to increase their spending to 9.99. The aspiration is reasonable enough, these same consumers have been persuaded to pay for mobile phone subscriptions over the last decade, and many have adopted Netflix and Amazon Prime too. But it will take some time to get them there and they need a helping hand in the meantime.

There are a number of tactics that will set up streaming to capitalize on the mainstream music fan opportunity:

  1. More price tier differentiation: this means cheaper tiers ($2, $3, $5) to capture spending across a broad a range of consumers as possible
  2. Reduce the main $9.99 price point to $7.99: to capture the upper band of mainstream fans, while adding a $12.99 tier for super fan aficionados who want extras like high quality audio, bios, photos, exclusives etc.
  3. Introduce PAYG / Top Ups: the mobile phone business needed PAYG to take phone subscriptions to the mainstream – they were an unfamiliar concept consumers needed to experience to understand the value of. The same applies to music. But also it gives tentative consumers the benefit of the long term relationship without the commitment

Universal’s Lucian Grainge stated at the WSJD conference this week that revenue from subscription services is simply not enough to stem the decline of downloads and CDs. As things stand he is absolutely right. But fill the chasm between free and paid with a diverse range of pricing options and that will change. Virtually every consumer market, whether it is phones, supermarkets or cars has a segmented pricing strategy, now it is time for streaming to benefit from the same approach. The alternative is leaving most of the potential spend on the table.