What Netflix’s Missing $9 Billion Tells Us About Spotify’s Business Model

On Monday (July 16th), Netflix’s quarterly earnings missed targets, resulting in $9.1 billion being wiped off its market capitalisation due to twitchy investors jumping ship. To be clear, Netflix had a strong quarter, continuing to grow strongly in both the US – a much more saturated market for video subscriptions than for music – and internationally. Netflix also registered a net operating profit. What it failed to do was meet the ambitious expectations it had set. The lessons for Spotify are clear. With Spotify’s Q2 earnings due later this month, it will be bracing itself for another potential drop in stock value if its performanceis good but not good enough to keep ambitious investors happy. Such is the life of a publicly traded tech company.

But perhaps the most telling part of Netflix’s stock performance was that the $9.1 billion of market cap it lost is more than a quarter of Spotify’s entire market cap ($33.3 billion on Tuesday). Netflix of course plays in a much bigger market than Spotify: the US video subscription market will be worth $17.3 billion in 2018—the same amount that the IFPI estimates the entire global recorded music business generated in 2017. But, the perspective is crucial. Lots of institutional investment has flowed into Spotify since it went public – and indeed prior to that, but music is a tiny part of those investors’ portfolio. Netflix’s loss in market cap shows that even the golden child of streaming does not deliver enough promise for many of those investors, but investors have plenty of other TV industry bets to make if they abandon Netflix. For music, institutional investors basically have Spotify or Vivendi. So, while Netflix struggling is a problem for Netflix, a struggling Spotify would be a problem for the entire recorded music business.

Savvy switchers – Netflix’s churn problem

Netflix’s earnings also present some positive signs for the strength of Spotify’s business model compared to Netflix’s, such as its growing quarterly churn rate: around 8% in Q2 2018, up from 6% the prior quarter. This reflects what my colleague Tim Mulligan refers to as ‘savvy switchers’– video subscribers who churn in and out of services when there’s a new show to watch. This is a dynamic unique to video, created by the walled garden approach of exclusives. No such problem faces Spotify, for now at least, because all of its competitors have largely the same catalogue.

Content spend: uncapped versus fixed

Most relevant though, is Netflix’s content spend. One of the much-used arguments against Spotify in favour of Netflix is that Spotify has fixed content costs, hindering its ability to increase profits, because costs will always scale with revenue. However, Spotify’s advantage is in fact that content costs are fixed, there is a cap on how much it will spend on rights. Netflix has no such safeguard, which means that the more competitive its marketplace gets, the more it has to spend on content.

This is why Netflix has had to take on successive amounts of debt – accruing to $9.7 billion since 2013. Servicing this debt cost Netflix $318,804 million for the 12 months to Q2 2018, one year earlier the cost was $181,346 million. For the 12 months to Q2 2018, Netflix’s streaming content liabilities were $10.8 billion, representing 80% of streaming revenues, which compares favourably with Spotify’s 78%. One year earlier, those liabilities for Netflix were $9.6 billion, representing a whopping 99% of streaming revenues. The reason Netflix can do this and generate a net margin is that it amortises the costs of its originals (essentially offsetting some of its tax bill). For the 12 months to Q2 2018 Netflix amortised 64% of its content liabilities, one year earlier that share was 57%, reflecting originals being a larger share of content spend during 12 months to Q2 2018. The more originals Netflix makes, the more it can increase its margin. Which creates the intriguing dynamic of the US Treasury subsidising Netflix’s business model. Welcome to the next generation of state funded broadcaster!

Q2 will tell

Spotify spending billions on original content is some way off yet – assuming it engineers a way to do so without antagonising its label partners, but until then it can rest assured that while Netflix faces growing content costs, it has its exposure capped, allowing it to focus on growing its customer base and enhancing its product. The reaction to the forthcoming Q2 earnings will show us whether investors see it that way too.

Spotify’s New Rules of Engagement

It is easy to feel that the pervasive obsession with Spotify overplays its importance to the recorded music industry. On the one hand it may only represent 27% of global recorded music revenues, but this compares to a peak of around 10% that Apple enjoyed at the peak of the iTunes Music Store. So, whatever label concerns existed back then about market influence – and there were plenty – their apprehensions have now multiplied. The assumption among many investors and label executives is that Spotify’s market share will lessen as the market grows. However, Spotify has thus far held onto its subscriber market share as the market has grown and looks set to do so in the foreseeable future.

If revenue is Spotify’s ‘hard power’ its real influence comes in its ‘soft power’. This takes two key forms:

  • Cultural influence:Despite being less than a third of revenues, record labels, artists and managers typically see Spotify as the proving ground, the place where hits are made. Marketing and promotion efforts are centred around getting traction on Spotify, knowing that success there normally leads to success elsewhere. Thus, Spotify’s cultural influence far outweighs its market share. As is so often the case with soft power, those affected most by it are those who inadvertently ceded it.
  • Innovation / disruption / innovation:Since embarking on its DPO path Spotify has been talking out of both sides of its mouth at the same time. On the one hand it positions itself as a safe pair of hands for the records labels, and on the other it lays out for investors a vision of a future world were artists don’t have to choose to work with labels. Labels have long feared just how far Spotify is willing to go and also, just how quickly. Spotify is now showing signs of going full tilt.

 

A rabbit out of the hat

When Spotify reported its Q1 earnings, the music industry consensus was a job well done. It delivered nearly on-target revenues (though they were down slightly on Q4), solid subscriber growth, improved margins and reduced churn. But it wasn’t enough for Wall Street. Spotify’s stock price fell to $150.07 down from a high of $170 in the days building up to the earnings. So what went wrong? Investors were expecting Spotify to pull a rabbit out of the hat. They’d been promised an industry changing investment and had instead got an industry sustaining investment. Such fickle investor confidence so early on in the history of a public company can be fatal. So, Spotify quickly searched for that rabbit; it announced that it will do direct deals with some artists and managers. Guess what happened? Spotify’s stock price rose to $172.37. The rabbit was bounding across the stage.

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Investors want the new world now

These are the new rules of streaming music. As the bellwether of streaming, Spotify has been dictating the narrative for years, but always with the focus of being a partner for rights holders. Now that it is public, Spotify has found that tough talking trumps sweet talking. Even if Spotify does not intend to go fast on its next gen-label strategy, it now knows it has to talk fast. Speaking from the experience of months of deep conversations with large institutional investors, Wall Street has pumped money into Spotify stock not because of how it will help labels’ businesses, but because they expect it to replace labels, or, at the very least, compete with them at scale. Spotify’s stock was not cheap, so to deliver to investors the returns they crave, it has to show that its influence is as disruptive / innovative (delete depending on your perspective) for the music business as Netflix has been for the TV business. They are investing in the potential upside on a future industry changer, not a present-day industry defender.

Spotify needs to speak boldly but act responsibly

Spotify cannot of course go all guns blazing yet, as it simply cannot afford to operate without the major labels. Netflix could get away with what it did because the TV rights landscape is fragmented. Therefore, Spotify will have to tread carefully until it can pick away at major label market share through various forms of direct deals. But it also has to do this cautiously (as I explained in this post). If it is too quick and bold it will incite retaliatory action from the labels. So, the new rules of engagement for Spotify and rights holders are a bit like international diplomacy: make bold public statements to keep domestic voters happy but adopt a more conciliatory approach with partners behind closed doors. Let’s just hope that Spotify opts for the Justin Trudeau school of international diplomacy over the Donald Trump approach.

Facebook Aims To Bring The Fun Back Into Music

Facebook has announced its long mooted move into music. As widely anticipated the service offering focuses on using music to add context to social experiences. The official blog outlines two key use cases:

  1. Adding music to videos
  2. Doing live stream lip syncs in Facebook Live videos

For now the roll out is limited, which will give Facebook the opportunity to hone the service and learn from the behaviour of a relatively narrow user group. A wider roll out will follow.

facebook music midiaIt’s not about subscriptions, nor should it be

Facebook was never going to try be a Spotify clone. Let me rephrase that, just in case anyone in Facebook’s management team is getting tempted to – wrongly – make the wrong move – Facebook should never try be a Spotify clone. Not only is it the wrong fit, it simply doesn’t need to. Streaming music is a low margin business that is being competed over by a number of very well established heavyweights. Facebook may be embarking on a content strategy like the other tech majors, but unlike Apple and Amazon, its core focus will be ad supported, not premium. (MIDiA subscribers – check out our forthcoming inaugural ‘Tech Majors Quarterly Market Shares’ report to see how Facebook’s content strategy stacks up against Apple, Alphabet and Amazon, and where it will be heading.)

YouTube now has a social music competitor worthy of note

For a whole host of reasons which warrant a blog post of their own, streaming music has coalesced around a very functional value proposition. In short, the fun has been taken out of music. Apps like Dubsmash and Musical.ly showed that it doesn’t have to be that way. These apps were small enough to be able to do first and ask forgiveness later. Even though Facebook has all the ingredients to do what those guys did, but at scale, it is far too big to try to get away with that strategy so had to get licenses in place first. YouTube is the only other scale player that really brings a truly social element to streaming. Now it has got a serious challenger that just upped the ante beyond comments, mash ups and likes / dislikes. The music industry so needs this right now. Especially to win over Gen Z.

Is Facebook bottling it when it comes to messaging apps?

For the moment, Facebook’s strategy is squarely focussed around its core platform. There’s no mention of Instagram (surely the best outlet for this kind of functionality). This hints at a degree of strategic wobbles in Facebook towers. By going all in with its messaging app strategy Facebook took a brave move few big companies do: it decided to disrupt itself before someone else did. It realised that the future of social was in messaging apps not traditional social networks. It is now the world’s leading messaging app company, with only Chinese companies truly challenging it (South Koreas’ Kakao Corp, Japan’s Line and Chinese players excepted). But that shift of user time to under monetized ad platforms threatens Facebook’s ad revenue growth. Hence the focus of music to drive usage back to its core platform where it can generate more ad revenue.

Not a Musical.ly killer, at least not yet

Although some have been quick to liken Facebook’s lip sync functionality to Musical.ly and co, in reality it is not competing head on with those apps because it is initially launched as a Facebook Live feature. Betraying Facebook’s strategic imperative of building its Live business. Expect a true Musical.ly ‘killer’ sometime within the next nine months.

Facebook is not here to compete with Spotify, but it is here to compete with YouTube and Snapchat and to steal some of the clothes of Musical.ly and co. The currently announced features just scratch the surface of what Facebook can do. In many respects music has taken a series of retrograde steps socially speaking since the days of imeem, MySpace and Last.FM. Now Facebook has picked up the dropped baton and is running with it.

Finally for anyone at MIDEM, I will be there from Weds PM to Thursday evening, including doing a keynote Q+A with Napster’s new CEO early Thursday evening. Hope to see you there. My colleagues Zach Fuller and Georgia Meyer are there too, both are speaking, so be sure to say hi.

Spotify’s Censorship Crisis is About Social Responsibility

Spotify has been forced into something of a rethink regarding its hate speech policy. Spotify announced it was removing music from playlists of artists that do not meet its new policy regarding hate speech and hateful behaviour. R.Kelly, who faces allegations of sexual abuseand XXXTentacion, who is charged with battering a pregnant woman, were two artists that found their music removed. Now Spotify is softening its stance following push back externally and internally, including from Troy Carter who made it known that he was willing to walk away from the company if the policy remained unchanged. Spotify had good intentions but did not execute well. However, this forms part of a much bigger issue of the changing of the guard of media’s gatekeepers.

Facebook has been here before

Back in late 2016, Facebook faced widespread criticism for censoring a historic photograph of the Vietnam warin which a traumatised child is shown running, naked, away from a US napalm attack. Facebook soon backed downbut it got to the heart of why the “we’re just a platform” argument from the world’s new media gatekeepers was no longer fit for purpose. Indeed by the end of the year, Zuckerberg had all but admitted that Facebook was now a media company.The gatekeepers might be changing from newspaper editors, radio DJs, music, film and TV critics and TV presenters, but they are still gatekeepers. And gatekeepers have a responsibility.

Social responsibility didn’t disappear with the internet

Part of the founding mythology of the internet was that the old rules don’t apply anymore. Some don’t, but many do. Responsibilities to society still exist. Platforms are never neutral. The code upon which they are built have the ideological and corporate DNA of their founders built into them – even if they are unconscious biases, though, normally, they are anything but unconscious. The new gatekeepers may rely on algorithms more than they do human editors, but they still fundamentally have an editorial role to play, as the whole Russian election meddling debacle highlighted. Whether they do so of their own volition or because of legislative intervention, tech companies with media influence have an editorial responsibility. Spotify’s censorship crisis is just one part of this emerging narrative.

Editorial, not censorship

As with all such debates, language can distort the debate. Indeed, the term ‘censorship’ conjures up images of Goebbels,but swap the term for ‘editorial decisions’ and the issue instantly assumes a different complexion. Spotify was trying to get ahead of the issue, showing it could police itself before there were calls for it to do so. Unfortunately, by making editorial decisions based upon accusations, Spotify made itself vulnerable to being accused of playing the role of judge and jury for artists who live in countries where innocence is presumed in legal process, not guilt. Also, by implementing on a piecemeal rather than exhaustive basis, it gave itself the appearance of selecting which artists’ misdemeanours were considered serious enough to take action upon. Spotify had the additional, highly sensitive, risk of appearing to be a largely white company deselecting largely black artists on playlists. Even if neither semblance was reflective of intent, the appearance of intent was incendiary.

Lyrics can be the decider

Now Spotify is having to rethink its approach. It would be as wrong for Spotify to opt for the ‘neutral platform’ approach as it would be ‘arbitrary censorship’. An editorial role is necessary. In just the same way radio broadcasters are expected to filter out hate speech, tech companies have a proactive role to play. A safer route for Spotify to follow, at least in the near term, would be to work with its Echo Nest division and a lyrics provider like LyricFind to build technology, moderated by humans, that can identify hate speech within lyrics and song titles. It wouldn’t be an easy task, but it would certainly be an invaluable one, and one that would give Spotify a clear moral leadership role. In today’s world of media industry misogyny and mass shootings, there is no place for songs that incite hatred, racism, sexism, homophobia or that glorify gun violence. Spotify can take the lead in ensuring that such songs do not get pushed to listeners, and thus start to break the cycle of hatred.

Is YouTube Serious About Music Subscriptions This Time Round?

In 2014 YouTube launched its inaugural music subscription service YouTube Music Keyin beta. The following year YouTube announced it was closing it ahead of the launch of YouTube Red, a multi-format subscription video on demand (SVOD) offering, of which music was going to be sub-component. Soon after Music Key’s launch I announced on stage at a Mixcloud Curates event that it would close within two years: and

I’m gonna put my cards on the table and say it [YouTube Music Key] won’t exist in 18-24 months after

Now YouTube is backfor another round at the table with the launch of YouTube Music.

In 2014 my Nostradamusmoment was less about being a psychic octopusthan it was simply a case of joining the strategic dots. YouTube is all about advertising. Advertisers pay most to reach the best consumers, who are also the ones most likely to pay for a subscription service, which is ad free. YouTube’s ad business is high margin and large scale. Its music subscription business is low margin and low scale. Hence, the more successful YouTube’s music subscription business is, the more harm it does to its core business and operating margins. The same principles apply today as they did four years ago.

So why bother at all? Because it has to keep the labels on side. Although the labels scored a lobbying own goal with their Facebook music deal, they are still applying pressure on YouTube for its safe harbour framework and the ‘value gap’. So if YouTube does not play ball on premium, it puts its core ad business at risk. And music is still the largest single source of YouTube’s ad revenue. Total YouTube ad revenue was $9.6 billion in 2017 – that is a revenue stream that parent company Alphabet cannot put at risk.

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When YouTube launched Music Key it used those negotiations to get better features for the free YouTube music offering, including full album playlists, which went live the day after the deal was announced and are still there now, even though Music Key is not. YouTube is no slouch when it comes to doing deals. This time however, YouTube Music will last longer. Here’s why:

  • This isn’t actually year zero:Google already has around five million Play Music subscribers and around the same number of YouTube Red subscribers. Red subscribers will become YouTube Premium subscribers, Play Music subscribers will get access to YouTube Music. So, inasmuch as YouTube is launching a cool new app with lots of new features, this is not Google entering the streaming fray, it is simply upping its game.
  • Spotify is making up ground:YouTube Music is not about to become the global leader in music subscriptions, for all the above stated reasons and more, but it can’t stand on the side lines either. Data from MIDiA’s Quarterly Brand Tracker shows that while YouTube is still the leading streaming music app in weekly active user (WAU) terms, Spotify is making up ground. Crucially, Spotify is now more widely used (for music) among 16–19 year olds. And Spotify is betting big on ad-supported, largely because it has finally persuaded the labels and publishers to amend its deals to allow it to, evidenced by the fact that Q1 2018 ad-supported gross margin increased dramatically from -18% to 13% in Q1 2017. YouTube Music is in part a defensive play to ensure it has an enriched offering for thoseconsumers, both now as free users, and for when they want to pay.
  • YouTube is the best featured music service: One of the great ironies of the recorded music industry’s relationship with YouTube is that because it doesn’t have to negotiate deals in the way other services to, it now has the best featured music service. Streaming and social have risen in tandem, but only YouTube has fully embraced this with comments, likes / dislikes, mash ups, user cover versions, parodies, unofficial remixes etc. And all of these features are front and centre in the new service. Spotify and co can’t get that sort of content because the labels can’t license it. Moreover, labels don’t like users being able to thumb down their songs or comment negatively on them. This launch enables YouTube to shout from the roof top about what it has and, by inference, what Spotify does not.
  • Testing:YouTube Music is being rolled out in the same markets as YouTube Red was (US, Australia, New Zealand, Mexico and South Korea). This slightly eclectic mix of markets represent a test base; a wide range of varied markets that will provide diverse user data to enable YouTube to model what global adoption will look like.
  • Upping the ad load: YouTube’s global head of music Lyor Cohen has nailed his colours firmly to the subscription mast. Although Cohen may not be up high in the Alphabet hierarchy he is a strong voice in YouTube’s music business. It also serves Alphabet well to have this particular voice with that sort of message at the forefront. Cohen has gone on record stating that YouTube will up its ad load to force more users to paid, and it is happening, but it is not just a music thing. Ad loads are up across the board on YouTube. Either way, this element was patently missing back in the days of Music Key.

YouTube Music may not be the start of Alphabet’s streaming game, but it is certainly its biggest play yet. And while it will remain focused on protecting its core business, it will likely explore ways to drive ad revenue within its ‘ad free’ premium offerings. Sponsorship and product placement will be one tactic; using MirriAd’s dynamic product placement ad tech could be another. YouTube is unlikely to become the leading music subscription service soon, but there is no denying that it has clearly upped its game.

The data in this chart and some of the analysis will form part of MIDiA’s forthcoming second edition of its landmark ‘State of the YouTube Music Nation’ report. If you are not already a MIDiA client and would like to know how to get access to this report and data, email stephen@midiaresearch.com

Spotify Q1 2018 Results: Full Stream Ahead

Spotify released its first ever quarterly earnings results today. The results reflect strong performance in its first public quarter with growth in subscribers, total users, revenue and also gross profit. Here are the highlights:

  • Subscribers: Spotify hit 75 million subscribers, up 44% from 71 million in Q4 2017, which is wholly in line with MIDiA’s 74.7 million forecast and reflects solid growth for a non-paid trial quarter. That is an increase of 22.9 million on Q1 2017, at which stage total subscribers stood at 52 million. The fact the year-on-year growth is 44% of the total subscriber count from one year previously reflects just how far Spotify has come in such a short period of time. Q2 2018 will be a paid trial quarter so subscriber growth will be markedly stronger. Expect Q2 2018 subscribers to reach around the 82 million mark.
    Takeaway: Spotify’s subscriber growth is maintaining its solid organic growth trajectory, with paid trials continuing to be the growth accelerant that keep total growth on a steeper growth curve.
  • Revenues: Revenues were up 26% from €902 million in Q1 17 to reach €1,139 million, though this was 1% down on Q4 2017. Premium revenue was €1,037 million, comprising 91% of all revenues. Ad Supported revenues were €102m growing at a faster rate (38%) than premium but contributing fewer net new dollars. Labels and publishers have empowered Spotify to fully commercialize its free user base and the dividends are now beginning to manifest, all be it from a low base.
    Takeaway: Premium revenues continue to be the beating heart of Spotify’s business. Though ad supported represents a massive long term opportunity, that business is going to take much longer to kick into motion. Growth though is not linear and is shaped by seasonal trial cycles.
  • Churn: Quarterly churn fell below 5% in Q1 2018 (it was 5.1% in Q4 2017), following a long term downward trend that was only interrupted by a 0.4% point increase in Q3 2017. Applying the churn rate to Spotify’s subscriber base reveals that it while its net subscriber additions for Q1 2018 were 4 million, the gross additions (ie including churned out users) was 7.4 million.
    Takeaway: Any growth stage business that is aggressively pursuing audience growth faces the challenge of bringing a high share of low value users into the acquisition funnel, which in turn keeps churn up. Sooner rather than later Spotify is going to need to start focusing more heavily on retention than acquisition, especially in more mature markets.
  • Costs and margins: Gross margin was 24.9% in Q1, up from 24.5% in Q4 and 11.7% in Q1 2017. This was above guidance and Spotify attributes this largely to changes in estimates for rights holder costs. Spotify is doing everything it can to highlight just how good a job it is doing of reducing rights costs. ‘Recalculating’ costs for Q1 2018 has the convenient benefit of extending that pre-DPO narrative into its first earnings.
    Takeaway: Spotify’s Barry McCarthy stated prior to Spotify’s listing was going to remain squarely focused on ‘growth and market share’. So modest progress on margins needs to be set in the context of a company that is focused on growing now while the market is still in flux, and planning to tighten its belt when the market starts to solidify. Spend now while growth is to be had.

The Netflix Comparison

Since its listing, Spotify has found itself rocketed into the spotlight with no end of financial analysts now setting their sights on the streaming company and making their own estimates for revenues and subscribers. The somewhat predictable dominant narrative is how much Spotify does, or does not, compare to Netflix. Spotify is going to have to get used to those sorts of comparisons. The good news for Spotify is that its first earnings compare well with when Netflix was at similar stage of its growth.

In Q4 2015 Netflix hit 74.8 million total subscribers, up 5.6 million from the previous quarter. Streaming revenues were up 6% to $1.7 billion while cost of revenues were at 70% of revenues and quarterly premium ARPU was $22.37. Over the course of the next 12 months Netflix would add 19 million subscribers to reach 93.8 million by end 2016.

By comparison, in Q1 2018 Spotify hit 75 million total subscribers, up 4 million from the previous quarter. Revenue was up down 1% on previous quarter while cost of revenues were at 75% of revenues and quarterly premium ARPU was €13.80.

It is clear these are snapshots of companies at very similar stages of growth, however Spotify has slightly higher cost of revenue and lower ARPU than Netflix did in Q4 2015, both of which need fixing. The indications are thus that Spotify has a solid chance of following a similar path. Indeed, MIDiA’s estimate for Spotify’s end of year subscriber count is 93 million, putting it on exactly the same growth trajectory as Netflix was in 2016. For now, looking at Netflix’s performance with a 27 months look back is a pretty good proxy for where Spotify is going to be getting to.

Conclusion

Right now, Spotify is trying to strike a Goldilocks positioning: not too disruptive to the traditional music business but not too supportive of it either. Spotify needs to talk out of both sides of its mouth for a while, showing how much value it is delivering to traditional rights holders but also how it is an innovative force for change. The F1 filing leaned more towards the latter position, while the Q1 earnings took a more matter of fact approach. But over time, expect Goldilocks to start trying more of daddy bear’s porridge.

These findings are just a few highlights from MIDiA’s 6 chart Spotify Q1 2018 Earnings report which will be published Thursday 3rdMay. The report includes, alongside core earnings data, proprietary MIDiA metrics such as gross profit per subscriber and gross subscriber adds. If you are not already a MIDiA client and would like to learn how to get access to this report and other Spotify research and metrics, email stephen@midiaresearch.com

Sweden Might Just Have Shown Us What the Future of Music Revenues Will Look Like

Earlier this week the IFPI released its Global Music Report – an essential tool for anyone with a serious interest in the global recorded music business. One interesting trend to emerge was the slowdown in Swedish streaming growth and its knock-on effect on overall recorded music revenues. Sweden has long been the leading indicator for where streaming is likely to head, providing a picture of just how vibrant a sophisticated streaming market can be. But now, with the market reaching saturation, it also gives us some clues as to what the long-term revenue outlook for the global music market could be.

sweden growth

According to the IFPI, Swedish streaming revenues reached $141.3 million in 2017, up from $125.7 million in 2016, with subscriptions accounting for 96% of the total. That was an increase of just $9.3 million, or 7% year-on-year growth, down from 10% in 2016 and 23% in 2015. This is a typical trajectory for a market when it has progressed to the top end of the growth curve. With synchronisationand performance revenues collectively growing by just $1.5 million in 2017 and downloads and physical both continuing their long-term decline, streaming is not only the beating heart of Swedish music revenues, it is the only driver of growth. Consequently, overall Swedish recorded music revenues grew by just 4% in 2017, compared to 6% in 2016 and 10% in 2015. As streaming matures, total market growth slows.

So what can we extrapolate from Sweden onto the global market? Firstly, there are a number of unique market characteristics to be considered:

  • Sweden is the home of Spotify, so adoption over indexes
  • Incumbent telco Telia provided a lot of early stage growth for Spotify
  • iTunes never really got going in Sweden, so the legacy download market was a much smaller part of the market than it is globally
  • Physical music sales are further along in their decline (now just 10% of all revenues)

These factors considered imply that Sweden is an indicator of an optimum state streaming market; others may not get there or will not get there so quickly. This could mean that legacy formats decline more quickly in comparison, making total revenue growth slower. However, given that downloads are a bigger chunk of revenues in most markets, these factors should cancel each other out. Therefore, an annual growth of 4% in total music revenues is a decent benchmark for long-term revenue growth.

The question is, what happens to the remnants of declining legacy format revenue? Do those CD and download buyers disappear out of the market, or does some of their revenue switch over to ensure that growth continues further? The likelihood is that Apple will see much of its longer-term growth come from converting higher value iTunes customers into subscribers, but there is a clear case for expanding the market beyond 9.99. The current 10% price hike experiment Spotify is running in Norway is one route. But, a suite of higher tier products is a better solution, as are super-cheap low-end products (e.g. $0.25 a week for Today’s Top Hits) and, of course, boosting ad-supported revenue to steal audience from radio. That latter point is probably the best long-term option for pushing real continual recorded music industry growth.

Global Recorded Music Revenues Grew By $1.4 Billion in 2017

2017 was a stellar year for the recorded music business. Global recorded music revenues reached $17.4 billion in 2017 in trade values, up from $16 billion in 2016, an annual growth rate of 8.5%. That $1.4 billion of growth puts the global total just below 2008 levels ($17.7 billion) meaning that the decline wrought through much of the last 10 years has been expunged. The recorded music business is locked firmly in growth mode, following nearly $1 billion growth in 2016.

Streaming has, unsurprisingly, been the driver of growth, growing revenues by 39% year-on-year, adding $2.1 billion to reach $7.4 billion, representing 43% of all revenues. The growth was comfortably larger than the $783 million / -10% that legacy formats (ie downloads and physical) collectively declined by.

Universal Music retained its market leadership position in 2017 with revenues of $5,162 million, representing 29.7% of all revenues, followed by Sony Music ($3,635 million / 22.1%) while Warner Music enjoyed the biggest revenue growth rate and market share shift, reaching $3,127 million / 18%. Meanwhile independents delivered $4,798 million representing 27.6%. However, much additional independent sector growth was absorbed by revenue that flowed through digital distribution companies owned by major record labels that were thus reported in major label accounts.

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But perhaps the biggest story of all is the growth of artists without labels. With 27.2% year-on-year growth this was the fastest growing segment in 2017. This comprises the revenue artists generate by distributing directly via platforms such as Believe Digital’s Tunecore, CD Baby and Bandcamp. All these companies performed strongly in 2017, collectively generating $472 million of revenue in 2017, up from $371 million the year before.  While these numbers neither represent the death of labels nor the return of the long tail, they do reflect the fact that there is a global marketplace for artists, which fall just outside of record label’s remits.

 

Up until now, this section of the market has been left out of measures of the global recorded music market. With nearly half a billion dollars of revenue in 2017 and growing far faster than the traditional companies, this sector is simply too large to ignore anymore. Artists direct are quite simply now an integral component of the recorded music market and their influence will only increase. In fact, independent labels and artists direct together represent 30.3% of global recorded music revenues in 2017.

A Growing and Diversified Market

The big take away from 2017 is that the market is becoming increasingly diversified, with artists direct far outgrowing the rest of the market. Although this does not mean that the labels are about to be usurped, it does signify – especially when major distributed independent label revenue and label services deals are considered – an increasingly diversified market. Add the possibility of streaming services signing artists themselves and doing direct deals with independent labels, and the picture becomes even more interesting.

The outlook for global recorded music business is one of both growth and change.

The report that this post is based upon is immediately available to MIDiA Research subscription clients herealong with a full excel with quarterly revenue from 2015 to 2017 segmented by format and by label. If you are not yet a MIDiA client and would like to learn more then email info@midiaresearch.com

Spotify D(PO)-Day

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

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

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

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

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

The Spotify Numbers You Won’t Have Seen

One of the core values that we deliver to our clients at MIDiA Research is finding the ‘third number’— the data point that wasn’t reported by a company but that can be arrived at through a process of modelling and triangulation. Next week, we will publish a report that does just this for the numbers presented in Spotify’s F1 filing. The metrics we arrive at help create a more complete picture of Spotify’s performance for investors and rights holders, as well as the impact of core metrics upon other parts of Spotify’s business. In advance of its publication, here are just a few highlights.

spotify metrics

Spotify’s F1 filing paints a picture of a growing business that is improving metrics across the board, with the foundations for a solid couple of years ahead now well built. But there are also a number of challenges:

  • User growth: Spotify experienced strong growth between Q4 2015 and Q4 2017, increasing its subscriber base from 28 million to 71 million, its ad supported users from 64 million to 92 million and its total monthly active users (MAUs) from 91 million to 159 million. Set in the longer-term context, Spotify’s subscriber growth trajectory indicates it is well up the growth curve, with 2014 representing the earlier growth phase and Q1 2015 the point at which the inflection point occurred. Since Apple Music entered the market in mid 2015, Spotify has seen growth actually increase, and over the period added more net new subscribers by the end of 2017 (49 million) than Apple Music did (34 million).
  • Streams up, but inactive subscribers also: Engagement is growing, with subscribers playing an average of 630 streams a month in 2017 compared to 438 in 2015. Over the same period ad supported users increased average monthly streams from 119 to 222. The net result was 195.4 billion streams in 2017 compared to 59.6 billion in 2015. However, inactive subscribers (i.e. subscribers plus ad supported users minus MAU) grew from one million in Q1 2016 to four million in Q4 2017. Though this is a long way off the ‘zombie users’ problem that Deezer has historically suffered from due to inactive telco bundles, it is a metric Spotify will need to keep on top of.
  • Churn down…: Throughout 2016 and 2017 Spotify progressively reduced its churn rate from 6.9% for Q1 2016 to 5.7% in Q4 2017. This is despite churn being pushed up by the super trials and thus reflects a solid improvement of organic retention across Spotify’s paid user base. In a March investor presentation, CFO Barry McCarthy argued that as Spotify’s subscriber base matures, life time value (LTV) and gross profit will increase, with more subscribers sticking around for longer.
  • …but not out: Despite quarterly falls, churn remains a core issue while Spotify is in growth phase and is acquiring portions of subscribers who try out the service but realise it is not for them. On an annual basis churn 18% in 2017, down from 18.5% in 2016. These lost subscribers totalled 12.8 million in 2017, up from 8.9 million one year earlier. Spotify added 23 million subscribers to its year-end total in 2017 but, including churned out subscriber the total subscribers gained was 35.8 million. Thus, churned subscribers accounted for 36% of all subscribers gained. This process of getting more subscribers in than out is common to all premium subscription businesses and is particularly pronounced when a service is in growth phase, as is the case with Spotify. It is even more pronounced in contract-free subscriptions. Pay-TV and mobile companies have the benefit of long-term contracts to minimise churn. The fact that Spotify reports churn at all is creditable. McCarthy’s old company Netflix got so fed up with investors’ reactions to churn that it stopped reporting it all together.
  • Super trials: Spotify’s subscriber growth has not however been linear. Heavily discounted trials offering three-month subscriptions for $1 have been pivotal in driving strong user growth spikes each quarter in which they run. On average, Spotify’s global subscriber base grew by a net total of 2.8 million each quarter between Q4 2015 and Q4 2017 in the quarters that these ‘super trials’ were not running, but by 7.5 million in the quarters that they did.
  • Non-linear growth affects all regions: In 2016 and 2017, Spotify’s European and North American subscriber bases each grew at an average of one million subscribers in quarters without trials and three million and two million respectively in quarters with them. Thus, Spotify’s organic net monthly subscriber growth in each of these regions was around 330,000. A similar trend appeared in Latin America – where net subscriber growth doubled in each trial quarter from one to two million. The impact is more dramatic in rest of world, where rounded net subscriber growth was flat in all quarters without trials and more than one million in quarters with.

Despite the joint effects of subscriber bill shock and reduced margins, super trials are clearly net positive for Spotify’s business. When it later decides to fade them out in more mature markets – namely when it switches from user acquisition to user retention mode – Spotify will be able to quickly improve both margin and retention.

Barring calamity, Spotify looks set to have a strong 2018 in terms of growth across subscriptions, MAUs and revenue. If it continues its current operating strategy Spotify should reach 93 million subscribers by the end of 2018. By comparison, Apple Music is likely to have hit around 56 million subscribers by Q4 2018, with its rate of net new monthly subscribers having increased to 2 million in 2018.

If you are not yet a MIDiA subscription client and would like to find out how to get a copy of the forthcoming seven-slide report and accompanying dataset, email stephen@midiaresearch.com