Why Spotify needs Russia

Spotify’s delayed Russia launch finally happened this week. While it did not drive a stock price growth like the Josh Rogan deal did (the stock closed just 1 cent higher than the previous day’s close) it will actually prove much more important in the medium term.

Podcasts are Spotify’s long-term bet, the moon shot that keeps investors excited and that points to a future where Spotify is better able to plot its own destiny without being constrained by record labels. But that future destination does not mean anything if Spotify is unable to maintain strong growth in its core business in the interim. Which is where Russia comes in.

Spotify has an Apple-like problem but chose a very non-Apple solution

Global streaming revenue growth was 22% in 2019 and growth will slow significantly in the COVID-19 impacted 2020. Growth rates however were already slowing due to the maturation of developed western markets, while subscriber numbers were growing faster than revenues, pushing down ARPU. Spotify has the same challenge as Apple.

Apple is the market leader in smartphones but does not own the majority of the market and the overall smartphone market is slowing, which means that iPhone sales have slowed. Apple could have decided to go ‘down market’ and created cheaper devices for less affluent consumers and emerging markets. It decided not to, and instead to start pushing its top-end devices even higher up the market with higher price points. Spotify has taken the opposite approach. Rather than increase prices in high-value markets, it is prioritising lower ARPU emerging markets. Spotify has done so because a) it does not have a diversified product like Apple so is less able to risk slowing sales, and b) its product is not sufficiently differentiated from other streaming services to prevent churn if prices went up.

Betting big on emerging markets

Instead of focusing on maximising revenue growth among existing subscribers, Spotify is rolling the dice on subscriber growth. It keeps telling investors to measure it on growth and market share, and that is exactly the game Spotify has chosen to play. Which is where Russia comes in.

Emerging markets are where the subscriber growth lies: Asia Pacific, Latin America and Rest of World combined will drive 71% of global music subscriber growth between 2019 and 2027. Spotify is already committed to this strategy and is already seeing results. In its Q1 2020 earnings, Latin America and Rest of World were the workhorses of Spotify’s growth during the quarter, accounting for 73% of all new subscribers; one year previously the share was just 30%.

But emerging markets take time to convert, users need to get familiar with the service via ad supported and extended trials before slowly converting to paid, though always at lower rates than in developed markets due to lower spending power. So, Spotify needs to keep expanding the user acquisition funnel which means launching in populous new markets such as Russia.

Russia’s contribution to the global picture is what matters for Spotify

The question many are asking is, has Spotify left it too late for Russia? There is no doubt that 2019 was a big year for streaming in Russia, with revenues growing at 79% to reach $249 million in retail terms, which makes it a sizeable, but not (yet) a large market. By way of comparison, Brazil’s streaming revenues are comfortably more than double that. As of Q1 2020 there were 7.4 million subscribers with Vkontakte and Yandex commanding a combined market share of 80%, so Spotify is entering an established market with well-established indigenous players.

This is not Spotify’s modus operandi and the last time it took this approach was India, which is yet to deliver results. So Russia is unlikely to be a runaway success for Spotify, but it is entirely reasonable for it to expect to pick up three million subscribers there over the next three years, which in turn will help sustain Spotify’s global subscriber growth. This is not about winning in Russia but instead winning globally. Or put another way, Spotify needs Russia more than Russia needs Spotify.

Why the Music Industry Needs Bytedance to Disrupt It

Back in September 2018 I suggested that Spotify faced a Tencent risk,with the potential of Tencent launching a competitive offering in markets that Spotify is not yet in. This would effectively divide the world between Spotify in Europe, Americas and some of Asia, and Tencent potentially everywhere else. Since then, Tencent has been distracted by acquiring a 10% stake in Universal Music. The fact it is now reportedly looking for partners to share the investment could point to Tencent getting spooked by slowing streaming growth in the second half of the year, something MIDiA predicted in November last year. Meanwhile, as all this was happening, Bytedance’s TikTok has become a global phenomenon – adding 500 million users in 2019 to reach 1.2 billion in total. On the back of this success, Bytedance has picked up Tencent’s dropped baton and has been working on a subscription service that now looks set for a December launch. The streaming market desperately needs a breath of fresh air; the only question is whether music rights holders feel bold enough to let Bytedance launch something truly market changing.

Change, but remain the same

TikTok has undeniable scale, even though the 1.5 billion figure likely refers to installs rather than active users. While it is certainly bigger than previous music messaging apps, the tech graveyard is full of once-promising, now-dead or near-obsolete ones (Musical.ly, Flipagram, Dubsmash, Ping Tunes, Music Messenger etc). In order to ensure it does not go the way of its predecessors (i.e. burn bright but fast) TikTok must learn how to expand and evolve its content offering but remain true to its users’ core use cases. The smart digital content businesses do this. Facebook and YouTube have both dramatically changed their content mixes since launch, yet fundamentally meet the same underlying use cases they started out with. It is essential for TikTok to ensure it grows with its young audience in the way Instagram has – otherwise it risks following the unwelcome path of its predecessors.

Do first, ask forgiveness later

The three global-scale consumer music apps which are genuinely differentiated from the rest of the streaming pack are YouTube, Soundcloud and TikTok. All three have one thing in common: they did first and asked forgiveness later. Rather than coming to music rightsholders to acquire rights and then building platforms around whatever rights they were able to secure, they built apps, built scale and then entered into serious licensing conversations. Crucially, they did so from a position of strength. The rest managed to secure fundamentally the same sets of rights, resulting in a marketplace of streaming services that lack differentiation. They all have the same catalogue, pricing and device support. They are even competing largely in the same markets. They are forced to differentiate with extras, such as playlists, personalisation and branding. This contrasts sharply with the highly-differentiated streaming video market and is the equivalent of the automotive market telling everyone they have to buy a Lexus but can choose what colour paint they want. Those three disruptors did exactly that: they disrupted, and in doing so fast-forwarded the rate of innovation.

The music market needs Bytedance to do something transformational

This is the context in which Bytedance is building a music subscription service. What the music market really needs is for this to be something that builds on the ethos and use cases of TikTok rather than becoming a cookie-cutter “all you can eat” service. Soundcloud and YouTube both found themselves dumbing down their core propositions in order to launch music subscriptions. Now, with streaming growth slowing, the market needs a disruption more than ever. It needs a Plan B to reinvigorate growth.

It is all too easy to say that rights holders have held back the market, and in some respects they have. But they also have an obligation to protect their rights and core revenue source: streaming. Indeed, there is an argument that YouTube is currently holding back streaming potential by delivering such a compelling free proposition – something that would not have happened if it had licensed first and launched later.

Emerging markets testbed

Music experiences from China, Japan and South Korea look very different from the ones that have come from the West, whether you are looking at Tencent’s music apps or K-pop artists. While there is a temptation to say that these reflect the unique cultural make ups of their respective markets, in all probability much of it will export. Indeed, we already see this happening with the success of BTS and of course TikTok in Western markets. What unifies these experiences is monetising fandom rather than consumption (which is what Western services do). The problem is that it is difficult for music rightsholders to agree with digital service providers (DSPs) on how much of the assets monetised in fandom platforms should bear royalty income, and just how much. This is one of the main stumbling blocks in monetising fandom.

Emerging markets may be the perfect testbed. We have already seen this approach in Brazil, where Deezer launched a prepay carrier-billing-integrated 60% discounted music bundle with local carrier TIM and has enjoyed strong subscriber growth as a result. The fact that Bytedance may launch first in emerging markets such as India, Indonesia and Brazil suggests that this approach may be being followed. If so, there is a chance that we might see something genuinely innovative coming to market.

While this may not yet constitute the Tencent risk model, there nonetheless remains a chance that Bytedance could end up being an emerging market counterweight to the Western market incumbents. The streaming market needs something new to up the innovation ante; let’s hope Bytedance can take on that mantle…

Why Music Streaming Could Really Do with a Disney+

The music and video streaming markets have long been best understood by their differences rather than similarities, but the flurry of video subscription announcements in recent months have upped the ante even further. New services from the likes of Disney, Warner Bros, Apple and AMC Cinemas point to an explosion in consumer choice. These are bold moves considering how mature the video subscription business is, as well as Netflix’s leadership role in the space. Nevertheless, Netflix is going to have to seriously up its game to avoid being squeezed. The contrast with the music streaming market is depressingly stark.

Diverging paths

The diverging paths of the music and video subscription markets tell us much about the impact of rights fragmentation on innovation. In music, three major rights holder groups control the majority of rights and thus can control the rate at which innovation happens. As a consequence, we have a streaming market in which each leading service has the same catalogue, the same pricing and the same device support. If this was the automotive market, it would be equivalent of saying everyone has to buy a Lexus, but you get to choose the colour paint. Compare this to video, where global rights are fragmented across dozens of networks. This means that TV rights holders have not been able to dictate (i.e. slow) the rate of innovation, resulting in dozens of different niche services, a plethora of price points and an unprecedented apogee in TV content.

Now, Apple and major rights holders Disney and Warner Bros have deemed the streaming video market to be ready for prime time and are diving in with their own big streaming plays. Video audiences are going to have a volume of high budget, exclusive content delivered at a scale and trajectory not seen before. There has never been a better time to be a TV fan nor indeed a TV show maker.

The music streaming market could really do with a similar rocket up its proverbial behind right now. The ‘innovation’ that is taking place is narrow in scope and limited in ambition. Adding podcast content to playlists, integrating with smart speakers and introducing HD audio all are important – but they are tweaking the model, not reimagining it. Streaming music needs an external change agent to shake it from its lethargy.

Do first, ask forgiveness later

The nearest we have to that change agent right now is TikTok. TikTok has achieved what it has by not playing by the rules. It has followed that long-standing tech company approach of doing first and asking forgiveness later. Sure, it is now locked in some difficult conversations with rightsholders – but it is negotiating from a position of strength, with many millions of active users. TikTok brought a set of features to market that rightsholders simply would not have licensed in the same way if it had gone the traditional route of bringing a business plan, pleading for some rights, signing away minimum guarantees (MGs) and then taking the neutered proposition to market.

I recall advising a music messaging app client who was just getting going to do the right thing. I hooked him up with some of the best music lawyers, made connections at labels, and basically helped him play by the rules. Two years later he still hadn’t managed to get a deal in place with any rightsholders – though he had racked up serious legal fees in the process. Meanwhile, Flipagram had pushed on ahead without licensing deals, secured millions of users and tens of millions of dollars of investment and only then started negotiating deals – and the labels welcomed it with open arms. To this day, this is my single biggest professional regret: advising this person who was betting his life savings to play by the rules. He lost. The ‘cheats’ won.

We need insurgents with disruptive innovation

The moral of this story is that in the consumer music services space, innovation happens best and fastest when rights holders do not dictate terms. This is not necessarily a criticism. Rights holders need to protect their assets and their commercial value in the marketplace. They inherently skew towards sustaining innovations, i.e. incremental changes that sustain existing products. New tech companies looking to build market share, however, favour disruptive innovations that create new markets. Asking an incumbent to aggressively back disruptive innovation is a bit like asking someone to set fire to their own house. But most often it is the disruptive change that really drives markets forward.

Streaming subscription growth will slow before too long, and as a channel for building artist-fan relationships they are pretty much a dead end. There is no Plan B. Back in 1999 there was only one format; it was growing well, but there was no successor. Looks a lot like now.

Spotify, the Decline of Playlists and the Rise of Podcasts

The following is a small excerpt from MIDiA’s forthcoming third edition of its ‘landmark State of the Streaming Nation’ report. For more information about this report email stephen@midiaresearch.com

Most things that Spotify does are scrutinised and cross-examined within an inch of their lives, with vested interests trying to second guess what may be the intended or unintended consequences for them. Most actions are viewed through the disruption lens i.e. how will this hurt or compete with Spotify’s rightsholder partners? The streaming market is of course so much more than just Spotify, but the company acts as a lightning rod for the wider market and most often sets the strategic agenda.

Spotify’s Two Phases of Growth

Two of Spotify’s most significant moves have been playlist curation and podcasts. Spotify is moving into the second major phase of its existence. Phase 1 was about establishing itself as a streaming music powerhouse, Phase 2 is about what it becomes next, extending beyond the streaming music beachhead. This is the typical trajectory of tech companies, establishing themselves in their core competencies and then expanding. This can either be a dramatic expansion – e.g. Amazon moving from eCommerce into video and music – or a more focused value-chain extension – e.g. Netflix moving from simply streaming other’s shows to making its own. For Spotify, playlists were a Phase 1strategy and podcasts are very much part of Phase 2.

midia playlists and podcasts

Podcasts may just have come in the nick of time for Spotify because curated playlists remain much more about potential than they do reality. Just 15% of streaming consumers listen to curated playlists. In fact, of all the key streaming feature activities, curated playlists come lowest. Curated playlists are clearly not to streaming music what binge watching is to streaming video. Instead streaming activity is fragmented across multiple features and just 10% of streaming consumers regularly do all four of the activities listed in the chart above.

‘But wait’ I hear you ask, ‘that doesn’t make sense, look at all these streams we’re getting from playlists’. The key factor here is the difference between the number of playlist users and the number of playlist streams. Playlists over index in terms of contribution to streams. With dozens of tracks per list, lean-back playlist listening can easily generate more streams per user than lean-forward listening. Thus, we have one of the great emerging paradoxes of streaming: passive audiences can generate more streams, and thus rightsholder pay outs, than engaged, aficionados. However, a word of caution, should casual playlist listening become large enough, then the net result will be a dilution of the royalty pool and thus diminishing per stream rates.

Perhaps not the holy grail of promotion

A few years ago, playlists looked like the future of artist marketing, now they are looking a bit like a busted flush. They may be great at generating streams but are not so great at building an artist’s story. The near-obsession with Spotify playlists in label marketing strategy reflects the fact that most record label executives use Spotify and thus often have a Spotify-centric (and therefore playlist-centric) worldview. But labels are now beginning to question the artist ROI of playlists. The growing adoption among casual listeners only compounds matters and means that a playlist ‘hit’ does not necessarily do much to help long-term artist brand building. To put it simply: a playlist is not a shortcut to cultural relevance.

Podcasts could be bigger than streaming

Enter stage left podcasts. With its acquisitions of Gimlet, Anchor and Parcast, Spotify is betting big on podcasts. Already, more streaming users (18%) listen to podcasts than curated playlists while overall consumer podcast penetration is 11%. In Sweden – the early adopter market that gives us a view of where other markets are heading – podcast penetration is 19%, rising to 28% among streamers. Podcasts are a Netflix moment for radio and may even have the potential to be bigger than streaming music (US radio ad revenues alone are $16 billion). Right now, the growth in overall podcast audiences is fairly slow, but engagement is accelerating as are content creation, monetisation and distribution. It is not entirely inconceivable to think that five years from now, podcasts could be a bigger business for Spotify than music. Certainly, creators could be making much more money, even now.

While it remains more likely that music will be the core of Spotify’s business half a decade from now, all the early indications are that Phase 2 will mean a degree of diversification of user experience, business model and revenue stream, with podcasts at the vanguard. Playlists are not dead, but nor are they the golden child anymore.

New MIDiA Latin American Streaming Report, in English, Spanish and Portuguese

MIDiA Latin America Streaming reportMIDiA has just published its latest report on the Latin American streaming music market, and we have versions available in English, Spanish and Portuguese.

MIDiA has been tracking the Latin American music market for over five years, including annual consumer data and market metrics.

Our latest report ‘Latin America Streaming Music Market: YouTube and Spotify Take Hold’is written by our long term Latin American music analyst Leo Morel and features data on Mexico, Brazil and the region as a whole.

 

 

The report includes analysis and data on:

  • Consumer adoption of YouTube, Spotify, Apple Music, Deezer and other streaming services
  • Playlist penetration
  • Wider consumer music behaviour eg downloads, CDs
  • Streaming revenues (subscriptions, ad supported music ad supported video)
  • Streaming users (subscriptions, ad supported music ad supported video)

Companies and brands mentioned in the report: Apple, Deezer, Google, iPhone, iTunes, Movistar, Spotify, TIM, Virgin Mobile, Vevo, Vivo, YouTube

The reports are immediately available to our clients, while you can purchase the individual reports here:

The reports each come with PDF, Slides, Excel and infographic.

For any questions please email info@midiaresearch.com

What the 2018 Success of the Beatles for UMG Tells Us About Where Streaming is Heading

Universal Music Group recorded an impressive €6 billion in revenue in 2018, bolstering a JP Morgan valuation of $50 billion. No doubt, UMG is enjoying a purple patch, riding and driving the wave of recorded music industry growth. But as with an any industry transition, progress is not linear and the past can have a lingering embrace. In UMG’s earnings report lies a small but crucial detail that point to the fact that the music industry’s path ahead may not be quite as straight as it first appears: the continued success of the Beatles.

The Beatles were UMG’s fourth best seller in 2018 

On page 13 of Vivendi’s year-end financial report, the Beatles’ ‘White Album’ is listed as UMG’s fourth best seller in 2018. It finished ahead of frontline artists including XXXTentacion, Migos and Ariane Grande. Above it were Drake’s ubiquitous ‘Scorpion’, Post Malone’s ‘Beerbongs & Bentleys’ and the soundtrack to ‘A Star is Born’. On the one hand this reflects the continued importance of the Beatles as a revenue driver for UMG. The Beatles, along with Abbey Road, were among the ‘crown jewels’ that UMG gained when it acquired EMI in 2012, so it is encouraging for UMG that the Beatles continue to deliver top tier revenue. However, Beatles revenue is not only a very different thing from Drake revenue, it also highlights the earnings divide between physical sales and streaming.

Streaming’s twin promise

The long-term promise of streaming is the combination of:

  1. Delivering larger audiences
  2. Replacing near-term, large volume revenue for a longer-term, annuity-like income model

Item number two happened very quickly; item number one is still in progress, but moving sufficiently enough to ensure many artists are now able to earn meaningful streaming income. However, we are not yet at our streaming destination, which is illustrated by the prominence of the Beatles in UMG’s 2018 sales. A ranking that owes little to streaming.

The Beatles are not a streaming powerhouse

According to the BPI, music from the 1960s accounted for just 3.6% of catalogue streams in the UK, which represents about 2% of all streams. Let’s assume the Beatles account for 40% of those streams – which is probably a generous assumption, this would mean the Beatles represented 0.8% of the $9.6 billion of streaming revenue in 2018, which translates as $79 million, which in turn equates to 2.7% of UMG’s 2018 streaming revenue. A meaningful amount for sure for a single artist, but not that significant in the greater streaming scheme of things. Therefore, the Beatles did not get to be UMG’s fourth biggest seller through streams. Instead, it did so through physical sales.

midia beatles umg

The main release in 2018 was the 50th Anniversary edition of the White Album. This premium physical release includes a $25 edition, right through to a $145 deluxe box set. With such high-unit prices, only small numbers need be sold to generate meaningful revenue.

To illustrate the point, let’s assume UMG collects around $15 of the $25 retail price and $100 of the $145 edition. To generate $7.5 million of label revenue, UMG would need to sell just half a million copies of the $25 edition and only 75,000 of the Boxsets. To generate the same $7.5 million from streaming UMG would need to have 62.5 million people each streaming 15 tracks from the album. $7.5 million is incidentally also roughly the amount a label would earn from selling a million copies of a standard priced album.

Streaming cannot yet match CD-era album revenue metrics

This gets to the heart of the matter of why streaming is creating, alongside a welcome growing body of middle-tier artists, a small handful of megastars. To replicate physical sales success, an artist must have exceptional streaming success. To replicate standout physical success requires as yet ungraspable streaming success.

For example, the number one album in the US in 2000 – NYSNC’s ‘No Strings Attached’ – sold over nine million copies, which would require 600 million people each streaming it all once — roughly 8.5 billion streams — to generate the same income. That is more streams than the entirety of Drake’s 2018 Spotify streams across the entire planet – Drake was Spotify’s most streamed artist. In short, streaming is currently large enough to make record labels grow, but not yet vast enough to create artist-level revenue on the same scale that that the CD peak once did.

Longer-term revenue may, or may not, add up.

The counter argument is that over a number of years the revenue will add up to the equal. But even with that assumption, an album would need to generate around a billion streams a year over eight years to replicate the success of NSYNC’s ‘No Strings Attached’. No easy task when you factor in the dynamics of streaming consumption i.e. playlists replacing albums, new music being pushed over catalogue etc.

None of this is to suggest that streaming is failing, nor that UMG’s revenues are in question. Both are doing well. Instead, it is evidence that we still have much distance to go with streaming before we can start seeing artist-level successes on a par with the peak of the industry. Though of course streaming-level success needs measuring differently than CD-era success, so these comparisons provide context rather than performance targets.

Will there ever be another Beatles’ greatest hits?

One intriguing post-script to all of this is that with download revenue falling by 15% in 2018, and physical by 7%, the days of large-scale album sales are long gone. When this is considered alongside the Beatles’ under-representation on streaming, the elephant in the room is whether UMG would ever risk releasing a Beatles greatest hits album for fear of underwhelming sales numbers damaging the Fab Four’s legacy. The last greatest hits was ‘1’ back in 2000 during the EMI years. Might it just be that UMG bought the Beatles too late ever to release their last ever greatest hits?

Why Music and Video are Crucial to Apple’s Future

Apple’s downgraded earnings guidance represents its first profit warning in 10 years. This is clearly a big deal, and probably not as much to do with a weakening Chinese economy if Alibaba’s 2018 Singles’ Day annual growth of 23% is anything to go by. But it does not indicate Apple is about to do a Nokia and quickly become an also-ran in the smartphone business. Nokia’s downfall was triggered by a corporate rigidity, with the company unwilling to embrace — among many other things — touchscreens. Apple’s touchscreen approach, coupled with a superior user experience and its ability to deliver a vibrant, fully integrated App Store, saw it quickly become the leader in a nascent market. Apple’s disruptive early follower strategy is well documented across all its product lines and the iPhone was a masterclass in this approach. But the smartphone market is now mature and in mature markets, market fluctuations need only be small to have dramatic impact. That is where Apple is now, and music and video will be a big part of how Apple squares the circle.

Apple started its shift towards being a services-led business back in Q1 2016, issuing a set of supplemental investor information with detail on its services business and revenue. Fast forward to Q3 2018 and Apple reported quarterly services revenues of $10 billion—16% of its total quarterly revenue of $62.9 billion. So, services are already a big part of Apple’s business but the high-margin App Store is the lion’s share of that. App Store revenues will continue to grow, even in a saturated smartphone market, as users shift more of their spending to mobile. But it will not grow fast enough to offset slowing iPhone sales. Added to that, key content services are moving away from iTunes billing to avoid the 15% iTunes transaction fee. Netflix, the App Store’s top grossing app in 2018, recently announced it is phasing out iTunes billing, which is estimated to deliver Apple around a quarter of a billion dollars a year. That may only be c.1% of Apple’s services revenue but it is a sizeable dent. So Apple has to look elsewhere for services revenue. This is where music and video come in.

Streaming will drive revenue but not margin

Streaming is booming across both music and video. Apple has benefited doubly by ‘taxing’ third-party services like Spotify and Netflix, while enjoying success with Apple Music. With third-party apps driving external billing, Apple needs its own streaming revenue to grow. A video service should finally launch this year to drive the charge. However, the problem with both music and video streaming is that neither is a high-margin business. Apple’s residual investor value lies in being a premium, high-margin business. So it has a quandary: grow streaming revenues to boost services revenue but at a lower margin. This means Apple cannot simply build its streaming business as a standalone entity, but instead must integrate it into its core devices business.

Nokia might just have drawn Apple’s next blueprint

During its race to the bottom, Nokia launched the first 100% bundled music handset proposition Comes With Music (CWM). It was way ahead of its time, and now might be the time for Apple to execute another early (well, sort of early) follower move. CWM was built in the download era but the concept of device lifetime, unlimited music included in the price of the phone works even better in a streaming context. I first suggested Apple should do this in 2014. Back then Apple didn’t need to do it. Now it does. But rather than music alone, it would make sense for Apple to execute a multi-content play with music, video, newsand perhaps even monthly App Store credits. Think of it as Apple’s answer to Amazon Prime. To be clear, the reason for this is not so much to drive streaming revenue but to drive iPhone and iPad margins and in doing so, not saddle its balance sheet with low streaming margins. Here’s how it would work.

Streaming as a margin driver for hardware

Apple weathered much of the smartphone slowdown in 2018 by selling higher priced devices such as the iPhone X. This revenue over volume approach proved its worth. The latest earnings guidance shows that even more is needed. Apple could retail super premium editions of iPhones and iPads with lifetime content bundles included. By factoring in these bundled content costs into iPhone and iPad profits and losses, Apple can transform low margin streaming revenue into margin contributors for hardware. Done right, Apple can increase both hardware and services revenue without having a major margin hit. Add in Apple potentially flicking the switch on the currently mothballed strategy of becoming mobile operator, and the strategy goes one step further.

Free streaming without the ads

If reports that Apple is buying a stake in iHeart Media are true, then it will have another plank in the strategy. Radio is an advertising business, but Tim Cook hates ads so the likelihood is that any streaming radio content would be ad free. Given that consumers are unlikely to want to pay for a linear radio offering, Apple would need to wrap the content costs into hardware margins. This could either be part of the core content bundle, or could even be a lower priced content bundle, with Apple Music being available as a bolt-on, or as part of a higher priced bundle or, more likely, both. Ad-supported streaming becoming ad free would of course scare the hell out of Spotify.

Music to the rescue, again

2019 will probably be too soon for this strategy to finds its way into market, but do expect the first elements of it coming into place. Music saved Apple’s business once already thanks to the iTunes Music Store boosting flagging iPod sales. This paved the way for the greatest ever period in Apple’s history. Now we are approaching a similar junction and music, along with video and maybe games, are poised to do the same once again.

How YouTube’s Domination of Streaming Clips the Market’s Wings

Firstly, happy new year to you all. Now on to the first post of 2019.

The Article 13 debate that shaped so much of the latter part of 2018 will continue to play an important role throughout 2019 while European and then national legislators deliberate on the provision and the wider Digital Copyright Directive of which it forms a part. Regular readers will know that MIDiA first highlighted the risk of unintended consequences of Article 13. Today we present the case for the impact YouTube has on the broader streaming market, driven by the advantages of its unique licensing position. (This is a complex and nuanced topic with compelling evidence on both sides of the debate).

To illustrate YouTube’s impact on the streaming market this post highlights a few of the findings from a new MIDiA report: Music Consumer Behaviour Q3 2018: YouTube Leads the Way But At What Cost?

midia youtube penetration

YouTube is the dominant music streaming platform, with 55% of consumers regularly watching music videos on YouTube, compared to a combined 37% for all free audio streaming services. YouTube usage skews young, peaking at nearly three quarters of consumers under 25. Although YouTube leads audio streaming in all markets — even Spotify’s native Sweden — there are some strong regional variations. For example, emerging streaming markets Brazil and Mexico see much higher YouTube penetration, peaking at close to double the level of even traditional music radio in Mexico. Indeed, radio is feeling the YouTube pinch as much as audio streaming. 68% of those under 45 watch YouTube music videos compared to 41% that listen to music radio. The difference increases with younger audiences and the more emerging the market. For example, in Mexico YouTube music penetration is 84% for 20–24 year olds, compared to 37% for music radio. Streaming may be the future of radio, but right now that streaming future is YouTube.

YouTube’s advantage

While cause and effect are difficult to untangle, the implied causality here is that YouTube’s unique value proposition steals much of the oxygen from the wider streaming market. Due to its unique licensing position – which Article 13 would likely change, YouTube has more catalogue and fully-on-demand free streaming, not to mention standout product features such as complete music video catalogue and social features such as song comments, likes / dislikes. Services that do not use safe harbour protection (i.e. the vast majority of audio streaming services) do not have these assets and so are at a distinct market disadvantage to YouTube. If you are a consumer in the market for a free streaming service, you have the choice between everything that you want, with complete control or constraints and restrictions, with fewer features. It’s not hard to see why consumers from Mexico through to Sweden make the choice they do. With a free proposition this good (especially when you factor in stream ripper apps and ad blockers), who needs a subscription?

A new value gap emerging?

Against this though, must be set two crucial factors:

  1. Audio streaming services would fare better if they had more of the features YouTube and Vevo have
  2. YouTube and Vevo are still the best ad monetisation players in the global market (i.e. discounting Pandora as it is US only). What’s more, (annual) audio ad supported ARPU declined in 2018 to $1.23, while video ad supported ARPU rose to $1.08. Ad-supported users grew faster than revenue while the opposite was true of video. There is a real risk here of an audio ad-supported value gap emerging. Spotify needs to get better at selling ads, fast.

Fully committed to subscriptions?

The final part of the YouTube impact equation is premium conversion. Since appointing Lyor Cohen, YouTube has taken a much more proactive approach to subscriptions, heavily touting its, actually-really-quite-good, YouTube Music premium product. Whether Alphabet’s board is equally exuberant about subscriptions, and whether YouTube Music’s launch lining up with the Article 13 legislative process was coincidental, are both open questions…

But politics and intent aside, YouTube is always going to be far poorer at converting to paid subscriptions because a) its user base is vast, and b) that user base is there for free stuff. So, while 58% of Spotify’s weekly active users (WAUs) are paid, the rate for YouTube Music weekly active usership is in single digit percentage points. That dynamic is not going to change in any meaningful way. In fact, YouTube has a commercial disincentive for pushing subscriptions too hard. It makes its money from advertising, and advertisers pay to reach the best possible consumers. Subscription paywalls lock away your best users, out of the reach of ads, which in turn reduces the value of your inventory to advertisers, which leads to declining revenues. YouTube is not about to swap a large-scale high-margin business for a small-scale low-margin one. Moreover, this issue of advertisers trying to reach paywalled consumers is going become a multi-industry issue in 2019. See my colleague Georgia Meyer’s excellent ‘Marketing to Streaming Subscribers’report for a deep dive on the topic.

Article 13 as a platform for innovation?

The overarching dynamic here is of a leading service that constrains the opportunity for services that are not able to play by the same rules. A levelling of the playing field is needed, but this should not just be legislation (and of course should be careful not to kill music’s ad supported Golden Goose). It should also see labels and publishers finding some common ground between the Spotify and YouTube models, and making those terms available to all parties. Because if YouTube does one thing really well, it shows us how good the streaming music user proposition can be when it is not too tightly constrained by rights holders. Let’s use Article 13 to raise the lowest common denominator, not to bring YouTube down to it.

Streaming music services need a user experience quantum leap in 2019; wouldn’t it be great if Article 13 could be the springboard for transformation and innovation?

Spotify’s Tencent Risk

NOTE: a previous version of this post referred to a non-compete clause with Spotify detailed in this SEC filing. I have been advised that the scope of this clause is narrower than I had originally interpreted. I have therefore updated this post to remove reference to that clause but the essence of the post remains intact due to the potential role of the major labels which, as outlined below, could have the same effect as a non-compete clause.

On Thursday (September 20th) Spotify grabbed the headlines with its announcement that it is launching a free-to-use direct upload service for artists. While it is undoubtedly a big move, and one that will concern Soundcloud among others, it was not a surprising move. In fact, in April we predicted this would happen soon:“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”. Will labels be concerned, sure, because although Spotify might not be parking its tanks on their lawn yet, it is certainly slowly reversing them in that general direction. However, they may just have a way of clipping Spotify’s wings and waiting in, er, the wings…Tencent.

Still waiting for IPO metrics

Tencent is prepping its music division (TME) for a partial US IPO but announced earlier this week that it will be reducing the amount it is seeking to raise from $4 billion to $2 billion, though still against a reported valuation of around $25 billion. Regular readers will know I have a healthy scepticism of Tencent’s music numbers. It has only ever reported one subscriber number officially – 4.7 million for QQ Music in Q1 2016, therefore it has plausible deniability over all the non-official numbers it puts out via the press. So, the fact there still isn’t an F1 filing revealing TME’s metrics is intriguing to say the least.

Go west

The likelihood is that the numbers will show a relative flattening in music subscriber growth (though other areas of its business should be robust). If so, they fit a wider narrative of Tencent nearing the limits of its potential in China. Video subs, which have grown superfast, will soon slow, messaging is saturated and the Chinese government is curtailing Tencent’s games operations. The title of our April report says it all: “Tencent Has Outgrown China: Now Comes the Next Phase of Growth”. Until last year’s change in Chinese regulations, Tencent could quite happily have spent its time strolling across the globe buying up companies to spread its global wings. But now, operating under limits of how much it can spend on overseas companies, Tencent is restricted to taking minority stakes in companies like Gaana and Spotify. But those efforts do not deliver Tencent the scale of global growth it needs. You can probably see where this is heading: to grow its music business TME will have to roll out internationally, which is quite possibly part of the story it will use to justify its $25 billion valuation.

Ring fencing Spotify’s global reach 

Should TME decide to use the $2 billion it raises via IPO as a war chest, it could then go on a global roll out to all the markets where Spotify is currently not present. Getting their first, with the backing of Tencent and of the $2bn IPO windfall would put Spotify on the back foot. Especially if, and here’s the crucial part, the major record labels took this as an opportunity to knock Spotify down a peg because of its increasingly competitive behaviour. They’ve been relying on Indian licenses already, that could prove to be a template, with Tencent the grateful beneficiary.  This would have the effect of ring-fencing Spotify’s global roll out plans. For fans of the board game Risk, the board would look something like this:

Spotify tencent risk 1

But Risk’s map doesn’t really do it justice. Using a political global map, the respective footprints would look more like this:

Spotify tencent risk 2

The major labels have proven unwilling to license Spotify for India because they weren’t happy with Spotify offering direct deals for a small number of artists. Imagine how they are going to feel with this latest move. With TME waiting patiently on the side lines, they may just see it as an opportunity to carve up the global streaming landscape into two halves, creating a cold war stalemate. Your move Spotify.

Article 13 – Laws of Unintended Consequences

I do not normally add disclaimers or qualifiers at the start of blog posts, but given how divisive the whole Article 13 debate has become, there is a big risk that some readers will make incorrect assumptions about my position on Article 13. The emerging defining characteristic of popular debate in the late 2010s has been the polarization of opinion e.g. Brexit, Trump, immigration. Article 13 follows a similar model, leaving little tolerance for the middle ground. You are either anti-copyright / pro-big tech or you’re pro-big government / anti-innovation.

Such extremes are the inevitable result of multi-million-dollar lobby campaigns by both sides. Reasoned nuance doesn’t really play so well in the world of political lobbying. My objective, and MIDiA’s, from the outset has been to strike an evidence-based, agenda-free position, that considers the merits of all aspects of both sides’ arguments. So, before I embark on a blog post that will likely be viewed by some of being pro-Google and anti-rights holder (it is not, nor is it the opposite), these are some ‘value gap’ principles that MIDiA holds to be true:

  • YouTube has misused fair use and safe harbour provisions against the legislation’s original intent
  • YouTube’s ‘unique’ licensing model creates an imbalance in the competitive marketplace
  • YouTube’s free offering is so good that it sucks oxygen out of the premium sphere
  • Google has rarely demonstrated an unequivocal commitment to, nor support of current copyright regimes
  • YouTube being able to license post-facto rather than paying for access to repertoire, gives it a competitive advantage over traditional licensed services
  • There is too big a gap between YouTube ad-supported payments and Spotify ad-supported payments, meaning too little gets to rights holders and creators
  • Take down and stay down is a feasible and achievable solution (albeit within margins of error)
  • The current situation needs fixing in order to rebalance the streaming market

Nonetheless, for each one of these positions from the rights holder side of the debate, we also see an equally long and compelling list of points from YouTube’s side. Rather than list them however, I want to explain how ignoring some of the counterpoints could unintentionally create a far bigger problem for the music industry than the one it is trying to fix.

Value gap or control gap?

What really riles labels is that they cannot exercise the same degree of control over YouTube that they can over Spotify and co. This is very understandable, as they rightly want to be able to determine who uses their music, how it is used and how partners pay for usage. However, taking a very simplistic view of the world, the label-licensed approach has created: a few tech major success stories that don’t need to wash their own faces (Apple Music, Amazon Prime Music); a collection of smaller loss-making services (e.g. Deezer, Tidal); and one big break out success story that can’t turn a profit (Spotify). In short, the label-led model has not (yet at least) resulted in the creation of a commercially sustainable marketplace. Rights holders want to pull YouTube into this controlled economy model. YouTube is understandably resistant. After all, YouTube is a crucial margin driver for Alphabet. It cannot afford it to be loss leading. Alphabet’s core ad businesses generate the margin that subsidises Alphabet’s loss-making bets such as space flight, autonomous cars and curing death (I kid you not). Ad revenue has to be profitable.

Fixed costs / variable revenue

As we explained in our recent State of the YouTube Economy 2.0 report, YouTube went double or quits during the last two years, doubling down on music, making music over index across its user base, in order to try to make it an indispensable hit-making partner for labels. That bet now looks to have failed. So, the question is, will YouTube acquiesce to the new command economy approach to streaming or do something else—perhaps even walk away from music?

The fundamental commercial imperative for YouTube is as follows:

  • Spotify pays a fixed minimum fee to rights holders for each ad supported stream, even if it does not sell any advertising against it. The rate is the same for every song, every day of the year.
  • YouTube pays as a share of ad revenue. This means it is always paying rights holders a consistent share of its income, including all the up side on revenue spikes. But ad inventory is not worth the same 365 days a year. There are seasonal variations meaning a song can generate less rights holder income in December say, than January. Also, not all songs are worth the same to advertisers: they are willing to pay much more to advertise against a Drake track than they are for an obscure 1970s album track.

This revenue share approach without minimum per stream rates is why YouTube has a profitable, scalable ad business, but Spotify does not (as recently as Q1 2018 Spotify had a gross margin of -18% for ad supported, compared to a +14% gross margin for premium). Remember, that’s gross margin, imagine how net margin looks…

The walk away scenario

Minimum per-stream rates could break YouTube’s business model, especially in emerging markets where it usage is strong, but digital ad markets are not yet developed. It would also set a precedent that other YouTube rights holders and creators would want the same applied to them.

So, it is not beyond the realms of possibility that YouTube could simply opt to walk away from music, applying take down and stay down its way (i.e. every piece of label content stays down). It could feasibly continue to provide ad sales support and audience to Vevo, but if YouTube gets to this point, then relationships are likely to be fractured beyond repair, meaning Vevo would likely have to decamp to Facebook and build a new audience there, one which is crucially not accessible to under 13s.

A YouTube shaped hole

So, what? you might ask. The so what, is the YouTube shaped hole that would exist in the music landscape. Readers of a certain vintage will remember the long dark years of piracy booming and corroding the recorded music business. It was YouTube that killed piracy, not enforcement. Okay, I’m exaggerating a bit, but the ubiquitous availability of all the world’s music on demand, on any device, nullified the use case for P2P in an instant. Add in stream rippers and ad blockers, and you’ve got a like-for-like replacement. Piracy created and filled a demand vacuum. YouTube (and Spotify, Soundcloud, Deezer etc.) have all since filled that same space, pushing P2P to the margins. YouTube, however, has had by far the biggest impact due to its sheer global scale. If YouTube pulls out from music, that YouTube shaped hole will be filled because the demand has not changed. Kids still want their free music, as in fact so do consumers of just about every age.

Piracy could be the winner

The most likely mid-term effect of YouTube shuttering music videos would be piracy in some form or another raising its head, filling the demand vacuum. Probably a decentralised, end-to-end encrypted, streaming interface built on top of a torrent structure, sort of like a Popcorn Time for music. Then it really would be back to the bad old days.

Is this the most likely scenario? Perhaps not. But perhaps it is. I suppose a just-as-possible outcome is that YouTube sticks up the proverbial middle finger and creates its own parallel music industry, using a unified music right and ‘doing a Netflix’. Yes, YouTube could be a next-generation record label, with more reach and bigger pockets than any major record label. If the labels are worried about Spotify disintermediation, YouTube could make that threat look like a children’s tea party.

As one YouTube executive said to me a couple of years ago: “This is how we are as friends. Imagine how we’d be as enemies.”

Too much to handle?

‘Couldn’t Spotify, Deezer and Soundcloud fill the potential YouTube shaped hole?’ I hear you ask. If these companies did take on YouTube’s 1.5 billion music users on the current financial agreements they have with rights holders, and with their currently far inferior ad sales infrastructure, they would be out of money in no time. It would literally kill their businesses. Based on YouTube’s likely music streams for FY 2018 and, say, a minimum per stream rate of $0.002, Spotify and co would need pay nearly $3 billion in rights revenue, regardless of how much revenue it could generate. Let alone the unprecedented bandwidth costs for delivering all that video. Of course the flip side, is that in the mainstream streaming model, that is how much potential revenue is up for grabs. So, more money would flow back to rights holders. But the extra revenue could come at the expense of the survival of the independent streaming services, ceding more power to the tech majors.

The artist and songwriter value gap

Throughout all of this you’ll have noted I haven’t said much about artists and songwriters. That’s because the value gap isn’t really about how much they get paid, even though they get put front and centre of lobbying efforts. It’s about how much labels, publishers and PROs get paid. And none of them are talking about changing the share they pay their artists and songwriters once Article 13 is put into action. That particular value gap isn’t going to be fixed. Even if Spotify picked up all of YouTube’s traffic, on say a $0.002 minimum per stream rate, a typical major label artist would still only earn $300 for a million streams, while a co-songwriter would earn just $150. The new boss would look pretty much like the old boss.

Be careful what you wish for

The laws of unintended consequences tend to proliferate when legislation tries to fix commercial problems without a clear enough understanding of the complexities of those very commercial problems.

It is of course in the best interests of YouTube and rights holders to carve out a workable commercial compromise, and I truly hope they do. But there is a very real risk this may not happen if Article 13 is successfully enacted into national member state legislation. Perhaps the phrase that rights holders should be considering right now is ‘be careful what you wish for’.