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…

After The Album: How Playlists Are Re-Defining Listening

Later this week we’ll be publish a new report in the MIDiA Research Music report and data service: ‘After The Album: How Playlists Are Re-Defining Listening’.  In it we explore the changing role of streaming playlists and in particular how they are impact albums both as a consumption format and as a revenue model. The full 18 page report includes half a dozen graphics and a couple of sheets of excel, including a detailed revenue model.  I want to share with you here one of the key themes we explore in the report…

Playlists Are The Lingua Franca Of Streaming

Streaming hit a host of milestones in 2015, reaching 67.5 million subscribers and driving $2.9 billion of trade revenue, up 31% on 2014. While the competitive marketplace upped the ante, music services wielded curation to drive differentiation. Playlists have always been the core currency of streaming, but now more than ever they are becoming the beating heart, the fuel which drives both discovery and consumption. In doing so they are helping drive hit singles into the ascendancy and albums to the side lines.

The Album Is No Longer The Market

Perhaps the biggest problem with streaming’s dissolution of the album is that the wider industry is still catching up with the concept. Artists still consider the album as their core creative construct, their novel. Similarly, labels still build P&Ls, marketing campaigns and their core business models around albums and album release schedules. There will long remain a market for albums, especially among core fan bases, as TIDAL’s exclusive album campaigns for Kanye West and Beyoncé reveal. But it is just that: a market, not the market anymore.

Income Per Streaming User

The most effective way to measure the value of streaming is to measure the value per user. For record labels at a macro level this equated to $2.80 annual revenue per subscriber and $0.37 per free streamer globally in 2015. But even that measure is too blunt to allow label campaign teams, artists and their managers to understand the value to them because that value is wrapped up with all the music in the world. For these stakeholders a more meaningful measure is the average amount they earn per album per streaming user.

Income Per Album Per Streaming User

Music subscribers in the US and UK streamed an average of 3,447 streams each in 2015, averaging 66 streams a week. But the average number of complete unique albums streamed was just 47 for the whole year. The average across free and paid streaming users was 11. Less than one new album per year. In the old model that average would have been just fine, pulling in more than $100 in retail revenue per user but in the streaming model that equate to a combined total of $0.73 in rights holder revenue.

promo slide

Even that measure though, is only partially useful for an artist, manager, songwriter or label campaign manager. What matters for them is how much they earn per streaming user, not the music industry in general. The average royalty income per album per streaming user is $0.21, with $0.03 flowing to the artist and $0.02 flowing to the songwriter. For subscribers the average income is $0.44 with $0.05 flowing to the artist and $0.04 flowing to the songwriter. While for free users it is $0.13 and $0.01 for artists and $0.01 for songwriters.

What It All Means

Albums are not the currency of streaming.  Everyone needs to rethink what long form, artist led content consumption looks like on streaming. Music fans still want artist led experiences. Drake’s 46 million Spotify listeners is more than double all the Filtr, Digster, Topsify and Todays’ Top Hits followers put together. As I have suggested before, multimedia artist subscription bundles for $1.50 on top of standard streaming fees feel like the right fit and would also help start pushing up streaming ARPU.

The power of music discovery used to lie in the hands of the radio DJ, now it lies in the hands of the playlist curator. And because streaming has melded discovery and consumption into a single whole, that means their power is becoming absolute. Albums are not quite an afterthought in the curated playlist world, but they are certainly an awkward relative that doesn’t quite fit in at the party.

None of this to say that the album is dead, but it can no longer be considered the main way most people listen to music. Of course some would argue that with radio it has ever been thus…

To find out more about the report and how to access MIDiA reports and data either visit our website or email us on info AT midiaresearch DOT COM

Spotify’s Billion Dollar Challenge

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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.

 

Quick Take: Soundcloud Goes Premium

 

SoundCloud_logo.svgFollowing weeks of licensing announcements, Soundcloud has finally launched its premium subscription service, a $9.99 tier ($12.99 on iOS), currently only in the US. The move is both encouraging and disappointing. Soundcloud has a truly unique market footprint and has the potential to be a platform for an entirely new approach to monetizing streaming music. But it is also a poor fit for a cookie cutter $9.99 freemium model.

Soundcloud has a whole set of unique challenges and characteristics that make it so different than the rest of the pack:

  • Artist-first experiences: Unlike its now-direct streaming competitors Spotify and co, Soundcloud is an artist-to-fan platform. Most streaming services are effectively a music-store-meets-HBO hybrid. A place you go to get music. Music as a service, or even a utility. Soundcloud is that as well of course, but it is first and foremost it is a place where artists connect directly with their fans. A $9.99 All You Can Eat (AYCE) is not the right model for a place where fans go to engage with artists rather than looking to turn on the water tap.
  • This is a pivot for Soundcloud: Unlike Spotify and Deezer, whose free tiers have long been geared towards driving subscriptions, for Soundcloud this is not a funnel tweak, it is a pivot. It is a complete change in strategy.
  • Competing against free: The problem with giving something away for free for years is that its really difficult to convince people to start paying for it. It is the same challenge YouTube faces with YouTube Red Which is why instead of simply whacking a pay wall around previously free content, YouTube is investing so much in creating new original content only available on Red. In short, Soundcloud needs to explore how it can deliver new, unique value to paid users rather than simply charging them for what they already get (plus a few convenience features).
  • Non-traditional content: Soundcloud’s strength lies in the music that you just don’t find elsewhere, much of which also happens to be dance music. All of the mash ups, bootlegs, un-authorized remixes, 2 hour long mixes are what make Soundcloud such a valuable component of the music landscape. The only problem is that most of them are not covered in standard major label licenses. In fact, many of them aren’t covered at all. Even Dubset, which is trying to build a business around this type of non-traditional content, hasn’t yet been able to get a full suite of licenses in place. For now, it appears that the majors are willing to turn a blind eye to that content. Which raises an interesting question: who gets paid for the revenue generated by unlicensed tracks?
  • Major labels are shaping an indie platform: Major label content is a massive part of Soundcloud but not the majority. In fact, in dance mixes majors typically account for only 30% of the tracks. Yet it is the major labels that are shaping the future of Soundcloud, forcing it down a road that works well for majors on the AYCE services but could skew Soundcloud against its indie community.

No doubt, Soundcloud had to get licenses in place. It had traded on label good will for long enough. But the current model will not maximise Soundcloud’s vast potential. Instead of Spotify-like 15-20% conversion rates instead expect King and Supercell-like 1.5-5% rates. Let’s hope this is simply a hygiene release, preparing the way for a set of products that fit Soundcloud like a glove rather than odd boots. What could a next iteration look like? Well for a start it could be artist focused and secondly it could be cheaper. Imagine a $4 a month, 5 artist subscription that gives you everything by your favourite artists, including premium-only exclusives. Every month you can swap any number of those artists for different ones for the next month. That is the sort of thinking that needs to be applied to Soundcloud’s subscription business if it is going to live up to its capabilities. The alternative is being condemned to being a freemium also-ran.

Warner’s Streaming Equity Pay Out Is Commendable But Not Enough

During his latest investor conference call Warner Music’s CEO Stephen Cooper announced that the label will pay artists a portion of any income it earns from equity stakes in services such as Spotify and Soundcloud. With Spotify potentially announcing its IPO next quarter the announcement is more than a token gesture. It is a bold move by Warner and follows on from Sony and Universal both announcing last year that they will pay artists a portion of streaming breakage revenue (the difference between what services pay labels in guarantees and how much royalty revenue they actually generate – WMG has been doing this since 2009). The big labels are waking up to the fact that transparency is key if they are going to keep artists on side. Streaming is where consumer behaviour is going, but currently YouTube is growing quicker than everyone else. The labels need premium and freemium services to make up ground fast. Which is why they cannot afford the Black Keys-Taylor Swift-Adele-Coldplay trickle to turn into a torrent. They need artists to be as vested as they are.

Streaming Hostilities May Have Thawed But Underlying Issues Remain

With the exception of the songwriter class action suits that closed out the year, 2015 was actually a pretty good year for streaming service – artist relations. Artists became a little more accustomed to streaming and many started to see a meaningful in their streaming income. But there is still much distance to go. The crucial issue for the majority of mid ranking and lower artists is how to deal with sizeable up front payments being replaced by a long term flow of micro payments. If you are a sizable label or a big artist you won’t feel the pain too much, but for the rest it normally means a very serious tightening of the belt.

The True Value Of Streaming Doesn’t Lie In Equity Stakes After All

There has, wrongly, long been a suspicion among many that streaming services are some sort of elaborate money making scam for labels, with the real value hidden in the money they will earn from their equity stakes. But as the ever excellent Tim Ingham explains, Warner is likely to only make around $200 million from a successful Spotify floatation. Of course $200 million is no small amount of money, and would represent more than half of Warner’s quarterly digital income. But it represents just 16% of the money Warner has earned from streaming since 2010 and just 2% of all global streaming revenue in 2015 (at retail values). Thus the label equity stakes in Spotify & co. are meaningful but they are far from where the real label value exists. Indeed as Cooper stated: “the main form of compensation we receive from streaming services is revenue based on actual streams”.

So If Artist Equity Income Isn’t Going To Fix Streaming, What Will?

All of which then raises the awkward question: if artists getting a Spotify IPO pay out isn’t going to ‘fix’ the model for artists, then what is? There is not really much scope for streaming services to pay out more to rights holders (80% of revenue doesn’t leave much scope for operating profit). While there is certainly scope for increasing ARPU among the super fan subscribers, there is little opportunity to raise prices for the majority of users ($9.99 is already more than most are willing to spend). So the only part of the equation left is how much labels pay artists.

Streaming Is Neither A License Nor A Sale And Its Time Artist Deals Recognise It

Right now the entire recorded music business is trying to figure out whether streaming is replacing radio or sales. The likelihood is that it is doing both and by doing so creating something new in between. That means that labels need to rethink how they pay artists, because currently they typically pay them on either one or the other of those models, and most often on the basis of a stream being a sale. A stream being the equivalent of a sale is completely counterintuitive because streaming is all about consumption not transaction. So why are labels most commonly treating streams as sales? Because the % they have to pay artists is so much lower, often in the 10% to 15% range rather than around 50% for a license. Of course there is as strong an argument to be made for streams not to be considered as a pure license as there is a sale, but there is an even stronger one for a hybrid rate that sits in the middle. Doing so would double the amount of money most artists make from streaming, instantaneously transforming its revenue impact for many. There is some precedent too. In 2012 Universal was successfully sued by FTB Productions over its treatment of Eminem downloads as sales rather than licenses, for which Eminem would have been paid a 50% rate instead of the much smaller sales rate.

Warner Music deserve credit for their commitment to paying artists a portion of equity related income (though no mention of how much of course) but it is just one step on a bigger journey. A wholesale reassessment of artist streaming compensation is required. Increasing artist streaming rates will dent label margins but ultimately the labels need to decide whether they want to build a business that is as sustainable for artists as it is for them.

Postscript: One interesting quote stood out from Cooper: “Although none of these equity stakes have been monetized since we implemented our breakage policy…there are some services from which we receive additional forms of compensation”. Translation(?): Sony used to get paid by the big streaming services on some sort of stock dividend basis and probably still does from some others.

The Labels Still Don’t Get YouTube And It’s Costing Them

This is the fifth post in my YouTube economy series. You can read the other posts here, here,here and here

2015 was the year that streaming came of age across global markets (it had already got there in the Nordics and South Korea of course). In the UK and the US stream volumes grew by 85% and 93% respectively in 2015. These markets matter because they are the 1st and 4th largest recorded music markets and between them account for 40% of global revenue. But as strong as a validation of the music streaming model as those numbers might be, the real success story here isn’t Spotify, Deezer or Apple Music…it’s YouTube. In both the US and UK YouTube outgrew audio streaming services. With YouTube delivering so much less back per stream to rights holders than freemium audio services and the whole issue of safe harbour and un-monetized tracks (however good Content ID has gotten) it is little wonder that the record labels are having an identity crisis over YouTube. Indeed, as I wrote last year, the YouTube discovery journey has become the consumption destination. The advert has become the product. But there’s even more to it than this. Not only is YouTube outperforming the audio pure plays, music is being outperformed on YouTube by its growing body of native creators, the new generation of YouTubers.

youtube economy

YouTube started out as a place simply to watch (and upload) videos but has evolved into a sophisticated entertainment platform that supports a multitude of diverse use cases, both in terms of content and audience. Nowhere is this more pronounced than in channel subscriptions. In many respects ‘channel’ isn’t the most appropriate term as they are in effect talent feeds rather than channels in a traditional video / TV sense. Nonetheless, or perhaps because of this, they have become the lifeblood of native YouTube creators as diverse as Michelle Phan, PewDiePie, Zoella, SMOSH, stampylongnose and IISuperwomanII.

These are creators who often do everything from writing, filming, production through to front-of-camera. DIY superstars if you like. And they are fast becoming the lifeblood of YouTube. Of the 330 million subscriptions in the top 50 YouTube channels, YouTubers account for 34%. Compare and contrast with the measly 15% music artist and label channels have. And despite all the excitement around the increased subscribers Adele and Justin Bieber have racked up these last few months – they gained 8 million subscribers between them, making them the two fastest gainers across all of YouTube – music artists as a whole lost ground, accounting for just 31% of the top 50 gains during the last 90 days compared to 53% for YouTubers.

Music Is Losing Ground To Native YouTubers

Music does fare better in terms of views with 36% of the 41 billion top 50 views in the last 90 days. However it still plays second fiddle to YouTubers who account for 45%. But it is the direction of travel that reveals the most telling trend. Over the last 90 days 42% of the 50 top 50 growing channel views compared to 39% for music. In itself that may sound like a modest difference, but this is just the latest 90 day chapter in a much longer story. Music used to be the clear focal point of YouTube but that is changing. In terms of all time views music actually outpaces YouTubers with 42% compared to 41%. But at current rates that lead will be wiped out in the next 90 days. And here’s the paradox: music’s hold on YouTube is slipping even though YouTube is outperforming music services.

Part of driving force is out of the hands of the labels: video is eating the world, with more than 5 trillion short form views in 2015 alone. Music is always the first mover in digital content consumption, the trailblazer for other media. Once distribution, bandwidth and consumer sophistication all improve, video moves in.

Time To Stop Using YouTube Like School Kids Use Instragram

But record labels and artists can seize some control of their destiny, by taking a more sophisticated view of YouTube and exploring how to build strategies that work for YouTube in 2016 not for YouTube in 2010.  Right now record labels are using YouTube like school kids use Instagram, obsessing with vanity metrics such as views rather than thinking more deeply about how to build lasting relationships with YouTube audiences. A new generation of music artists is emerging that have created and nurtured audiences on YouTube, often with little or no help from labels. Artist like Dave Days, Tyler Ward, Boyce Avenue and Hannah Trigwell have built their fanbases on YouTube, often starting with covers but also crucially often non-music content such as parodies and vlogs. Raised in YouTube these artists are entirely native to the platform. They understand what audiences want because that’s where they come from.

If the big traditional artists and labels want to start making up some ground on the YouTuber revolution they could do worse than take a few hints from this new breed of YouTube artist.

The Beatles, Streaming And The End Of The Record Label Business Model

So the Beatles are finally coming to streaming…well much of the Beatles’ catalogue is at least.  Is it a big deal?  Kind of. The Beatles were late to iTunes and they’re now late to streaming.  Fashionably late though. No so soon as to be left standing awkwardly waiting for something to happen and not too late to miss the real action.

The Beatles are unique enough, and important enough to dictate their own terms and set their own timetable. For streaming services the Beatles catalogue is strategically important in the way it was for iTunes in that it helps communicate the value proposition of all the music in the world…well most of it. For the Beatles it represents the opportunity to reach younger audiences that sales are currently missing (which in large part explains why the catalogue is being made available on free tiers too).

It’s All About Targeting

20 years ago everyone pretty much bought the same product, the CD. Now though the music consumer landscape is fragmented and siloed. The fact that Adele’s ‘Hello’ simultaneously delivered stellar performance across audio streaming, video streaming, download sales and radio illustrates that there are many highly distinct groups of consumers that do one but not the other. This what Universal will be banking on with bringing the Beatles to streaming: they’ll be hoping that most of the future prospective buyers of Beatles albums are not streaming. For as long as this elongated transition phase continues, this sort of approach can work.

What Happens When The Bottom Falls Out Of the Catalogue Business?

The business model of record labels has long depended on revenue from back catalogue propping up the loss-leading new artists, on whom labels have to spend heavily to break. That model works as long as back catalogue sales are vibrant. But cracks are now showing in that model. Labels, especially the big ones, are increasingly spending even more heavily on a smaller number of big bets. For major labels many of these are either manufactured or laser targeted pop acts that grow big fast but like genetically modified crops, soak the nutrients out of their fan-base soil and are less likely to have long term careers. This means breaking artists are costing more to break and have less long term revenue potential.

That double whammy in itself would be bad enough, but there is an even more important structural factor at play. Catalogue sales depend on people buying classic albums, reissues and retrospectives. The secret is in the term ‘sales’. The model does not translate the same way to sales. Getting someone to spend $10 on an album for old times’ sake that they might listen to a handful of times but value having in their collection is very different from earning $0.20 or so from the same number of listens. But that is the way the world is heading. Older music buyers (i.e. from late 30’s onwards) are the lifeblood of catalogue sales.

That model works for older consumers that grew up buying music and thus have the habit. But what happens what happens when the first millennials enter their late 30s? Which is exactly what is going to start happening from 2016 onwards. As each new cohort of aging millennials passes 35 a smaller percentage of them will have ever regularly bought music. Thus from 2016 onwards every year will mean an ever smaller number of catalogue buyers coming into the top of the funnel.

The long term implications are clear. While this will not be anything like an instant collapse, the impact will be progressively more painful as each year passes. The old label model of developing a vast bank of copyrights will become less and less relevant.

So Beatles, welcome to streaming, this will be your last new format hurrah.

YouTube And The Attention Economy

This is the third in the series of posts exploring how the music industry can better leverage the potential of the YouTube economy.  You can see the first post here and the second here.

Short form video is accelerating at a rapid pace, racking up 4.2 trillion views in the first half 2015.  While challengers Facebook, Snapchat and others now account for just over half of that total, few platforms of scale yet provide content creators and owners comparable ability to build engaged audiences and income.  For music the situation is even more pronounced – no other platform is even on the same lap of the race (and I include Vevo as an extension of YouTube). YouTube is the most popular online music destination by far (46% of consumers use it regularly) and its role for Digital Natives cannot be exaggerated – 65% of US under 25’s use YouTube for music regularly.  But the share that regularly watch YouTube as a whole is even higher: 76%.  The added complexity is that most artists and labels do not feel that YouTube is pulling its weight in revenue terms.  Free music streamers – of which YouTube is the largest single component – comprise 92.5% of all music streaming users and just 32% of all streaming revenue.  Yet a whole generation of non-music creators like PewDiePie, Smosh and the Janoskians have via YouTube built audiences and income that most artists could only dream of.  So what’s the secret?

Talk Don’t Shout

One of the key factors is the way in which YouTubers use the platform, releasing 2, 3 or more videos every week.  Contrast this with an artist releasing a music video maybe once every couple of months.  YouTubers treat the platform as place to build relationships with their audiences and to engage them in regular interaction.  The prevailing approach among artists, their managers and labels is to simply view YouTube as a place to promote.  YouTubers use YouTube as an interactive digital platform for engaging in conversations.  The music industry uses it as a broadcast channel, a soap box from which it can shout about its wares.

While clearly it doesn’t make sense for most artists to be creating 3 videos a week there has to be a compelling middle ground between that and one promo video every quarter.  Nearly half of music’s super fans say that music for them is more than just the song, that they want to know the artist’s story.  Music videos, the highly stylized form that they are, are hardly a vehicle for telling the artist’s story.  In fact there are few mediums less suited for the task.  But there is so much around the video that can be harnessed.  Imagine how much extra content could be created by adding half a day to the video shoot to film extras such as goofy outtakes, the band talking about the song, a making of, behind the scene reportage etc.

Think Of It Like DVD Extras That People Actually Want To Watch

And the costs should be modest.  YouTube is DIY.  Part of the authenticity most YouTubers deliver is by not being over produced.  So only a fraction of the crew used for the music video shoot would be needed.  The resulting video extras could then be planned into a release schedule on the artists’ YouTube channel, building up weekly to the main music video and then maintaining interest thereafter.  This is just one illustration of how it is entirely feasible to create lots of added value content with relatively little additional burden on the artist.  Yes, this might feel like creating the extras for the bonus disc on a DVD, and in some ways it is.  But there is a crucial difference.  DVD bonus discs are a means of charging more for a release and usually go unwatched.  Among young YouTube viewers this sort of content is often of comparable – though different – value to the song itself.

Prospering In The Attention Economy

In the sales era fans invested in their favourite artists by buying an album.  That cash investment usually meant a fan would spend time listening to the album again and again.  And that familiarity became the foundations of a long term relationship that would result in buying concert tickets and future albums.  But now as sales dwindle (down by 29% in the last 5 years) music fans are investing in their favourite artists in time and attention rather than money.  We now operate in an attention economy.  YouTubers totally get this, artists and labels less so.

This is all so important to artists because YouTube is not suddenly going to start delivering dramatically better music stream rates, largely because labels and publishers haven’t had the courage to demand the requisite fair share it should pay.  Rights owners’ fears are understandable: one senior label executive recounted a YouTube negotiator saying ‘Don’t push us.  Right now you don’t like us much and we’re your friend.  Imagine what we’d be like if we weren’t your friend.’  Sooner or later bullying tactics need standing up to.  But that will not be a quick process, regardless of the steps currently being taken behind the scenes.

So in the meantime artists and labels need to figure out how to get more out of YouTube in a way that complements the other ways they make money digitally.  Put simply that means making more non-music video content to generate more viewing hours and thus more ad revenue from YouTube. Heck, they might even generate some YouTube subscription revenue some time.  But do it they must, else they’ll forever be leaving chunks of YouTube money on the table.

The irony of it all though is that the biggest reason of all for doing it isn’t even about the money.  Treating YouTube as a fan engagement platform rather than a marketing tool is currently the most sure fire way artists have of creating engaged fan bases at scale in the digital marketplace.

Ad Supported Is 56% Of US Streaming Revenue

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.

freemium what freemium

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.

us subscriber growth and pandora

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.

The Real Problem With Streaming

Much of the debate around the sustainability of streaming has understandably focused on artist and songwriter income and transparency.  It is a debate that I have contributed to frequently.  But the more fundamental structural issues are whether the business models are commercially sustainable and if they are, what the implications are.  Music consumption is inarguably moving towards access based models so the question is not whether streaming should happen or not, but how to make it work as well as it possibly can for all parties.  As unfair as it might seem, the baseline issues regarding creator income could go unchanged without streaming business models falling apart.  But, as I will explain, if broader commercial sustainability issues are not fixed then many streaming businesses will collapse leaving just a couple of companies standing.  And that scenario would almost certainly be worse for creators than the current one.

The Steve Jobs Revenue Share Legacy

As I revealed in my book ‘Awakening’, when Steve Jobs struck the original iTunes Music Store deal he walked away a happy man despite having given the major labels the big revenue percentages they wanted.  Why?  Because it meant that it was really hard for anyone without ulterior business aims like Apple had, to make money from selling tracks as a standalone business.  The revenue shares negotiated back then set the reference point for all digital deals since.  The fact that streaming services pay out more than 70% of revenues to rights holders can be traced back to that deal.

The Great Role Reversal And The De Facto Label Monopoly

In the digital era the record labels undisputedly hold the whip hand, and some.  In the analogue era the roles were reversed.  Retailers were the dominant partners and they knew it.  Record labels actually paid retailers for placement to promote new releases.  Compare and contrast that with labels contractually compelling services to provide placement.  Both models are wrong and both engender corrosive behaviour.  Because the major labels account for the majority of music sales it is nigh on impossible for a non-niche music service to operate without all three on board.  This gives each label the effective power of veto.  So even though no major label is a monopoly in its own right each has an effective monopoly power in licensing.  These factors give labels them the strength and confidence to demand terms that would not take place in an openly competitive market.  This, for example, is very different to how digital deals are done in the much more fragmented TV rights landscape.

Loading The Risk Onto Music Services

Why all this matters for the sustainability of streaming services is because of how it manifests in commercial terms.  Recent contract leaks have revealed to everyone the details of what insiders long knew, that labels and publishers front-load deals.  Services both have to pay large amounts up front and agree to guaranteed payments to rights owners regardless of how well the service performs.  (Some labels proudly state they don’t charge advances but instead charge a ‘set up fee’ for every track in their catalogue. Call it what you like, making a music service pay money up front is an advance payment.)  Even without considering the entirely intentional complexity of details such as minimas, floors and ceilings, the underlying principle is simple: a record label secures a fixed level of revenue regardless, while a music service assumes a fixed level of cost regardless.

Labels call this covering their risk and argue that it ensures that the services that get licensed are committed to being a success.  Which is a sound and reasonable position in principle, except that in practice it often results in the exact opposite by transferring all of the risk to the music service.  Saddling the service with so much up front debt increases the chance it will fail by ensuring large portions (sometimes the majority) of available working capital is spent on rights, not on building great product or marketing to consumers.

Skewing The Market To Big Tech Companies

None of this matters too much if you are a successful service or a big tech company (both of which have lots of working capital).  Both Google and Apple are rumoured to have paid advances in the region of $1 billion.  While the payments are much smaller for most music services, Apple, with its $183 billion in revenues and $194 billion in cash reserves can afford $1 billion a lot more easily than a pre-revenue start up with $1 million in investment can afford $250,000.  Similarly a pre-revenue, pre-product start up is more likely to launch late and miss its targets but will still be on the hook for the minimum revenue guarantees (MRG).

It is abundantly clear that this model skews the market towards big players and to tech companies that simply want to use music as a tool for helping sell their core products.   Record labels complain that they don’t get enough value out of big companies like Google and Samsung, but unless they make the market more accessible to companies that are only in the business of selling music they can have no room for complaint.  The situation is a direct consequence of major label and major publisher licensing strategy.

Short Termism And From Evil To Exceptional

Matters are compounded by an increasingly short term outlook from label licensing divisions, with the focus on internal quarterly revenue targets, or if you are lucky, annual targets.  The fact that much of label and publisher digital revenue comprises guarantees and advance payments means that their view of the digital market is different from how the market is performing.  If our small start up that pays $250,000 in rights payments doesn’t even get its product to market, the rights holders still see that digital revenue even though the marketplace does not.  (One failed music service that didn’t even launch went into bankruptcy owing two major labels $30 million).

This revenue comfort blanket insulates labels and publishers from much of the marketplace pain.  So if/when things go wrong, they feel it later, delaying their response.  There is also a cynicism in much deal making, with rigid templates applied to deals and a willingness to compromise principles if the price is right. The latter point was illustrated by the leaked negotiations between UMG and industry bête noir Kim Dotcom in which former digital head Rob Wells referred to being able to ‘downgrade’ Dotcom from ‘evil to bad’ and then from ‘bad to good and from good to exceptional partner’.  The message is clear, if there is enough money on the table, anyone can be a business partner whatever the implications might be for the rest of the market.

Wafer Thin Margins, Deep Pockets And The Innovation Drain

Current licensing strategy biases the market towards those with deep pockets and fatally compromises profitability.  Once all costs are factored in, a music subscription can theoretically have an operating margin of between 3% and 5%. Though only if it doesn’t invest sufficiently on marketing, customer retention and product innovation. But of course the streaming market is in early growth stage so every service has to spend heavily which means that profitability becomes a hostage to fortune. No wonder Daniel Ek is clear that Spotify is a growth business rather than on a profit crusade.

The market dynamics also create an innovation talent drain.  If you were a would-be start up founder the huge up front costs, non-existent margins, and complex time consuming licensing do not exactly make building a music app a welcome experience.  Building a games app however is an entirely different proposition: you own 100% of the rights, you don’t pay a penny to 3rd party rights holders and consumers actually pay for your product.  Music is already a problematic enough sector as it is without burdening it with a punitive licensing framework.

These are the structural challenges that could yet bring down the entire edifice of the streaming music economy.  The irony is that if Spotify has a successful IPO (sans profit of course) it will trigger a wave of copycat services and investment that will perpetuate the status quo a little further.  But it will only be a temporary delay.  Sometime or another the hard questions must be answered.