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’.

State of the YouTube Music Economy 2.0: A Turning Point for All Parties

YouTube is the most widely used streaming music app globally but it is also the most controversial one, locked in a perpetual struggle with music rights holders, with neither side quite trusting the intent of the other. 2018 has already seen YouTube’s renewed focus on subscriptions as well as a European Parliament vote that could potentially remove YouTube’s safe harbour protection. Meanwhile, oblivious to these struggles, and despite the rise of audio streaming services, consumers are flocking to YouTube in ever greater numbers and, crucially, using it for music more than ever before. Back in 2016, at the height of the value gap / grab debate, MIDiA published its inaugural State of the YouTube Music Economy report. Now two years on we have just released the second edition of this landmark report. MIDiA clients have immediate access to the ‘State of the YouTube Music Economy’ report, which is also available for purchase on our report store. Here are some of the highlights from the report.

state of the youtube music economy midia research

2016 proved to be a pivot point for YouTube. Rights holder relationships were at an all-time low with value gap / value grab lobbying reaching fever pitch. Meanwhile, vlogger hype was also peaking and longer-form gaming videos were beginning to get real traction. If there was ever a point at which YouTube could have walked away from music, this could have been it. The picture though, has transformed, with YouTube doubling down on music and in doing so, making itself an even more important partner for record labels.

With young consumers abandoning radio in favour of streaming, YouTube is the biggest winner among Gen Z and Millennials; penetration for YouTube music viewing peaks at 73% among 16–19 year olds in Brazil. But its reach is even wider: YouTube is the main way that all consumers aged 16 to 44 discover music.

Doubling down on music

YouTube has responded by improving its discovery and recommendation algorithms and gearing them more closely to music. The combined impact of demographic shifts and tech innovation is that YouTube is making hits bigger, faster. Billion-views music videos used to be an exceptional achievement, now they are becoming common place. By end July 2018, Vevo reported that there were already ten 1 billion views music videos for tracks released that year, accounting for 17.2 billion views between them. One billion view music videos that were released in 2010 took an average of 1,841 days to reach the milestone. Videos released five years later took an average of just 462 days, while those from 2017 took an average of just 121 days to get to one billion views. Over the course of eight years, YouTube has become more than ten times faster at creating billion-view hits.

Under indexing

The impact on revenue is less even. Music videos are the single most popular video category on YouTube, accounting for 32% of views but a smaller 21% of revenue. Music is still the leading YouTube revenue driver with $3.0 billion in 2017 but many other genres, gaming especially, over index for revenue. (Many YouTube gamers have multiple video ads placed at chapter markers throughout their videos. Because music videos are shorter they get a smaller share of video ads.) Emerging market audiences are also pulling down ad revenues. The surge in Latin American markets has pushed artists like Louis Fonsi to the fore, but the less-developed nature of the digital ad markets there means less revenue per video. This trend is accentuated with the rise of emerging markets music channels like India’s T-Series becoming some of the most viewed YouTube channels globally.

The net result is that effective per stream rates are going down on a global basis, but are going up in developed markets like the US, where the digital ad market is robust. This brings us to one of the existential challenges for YouTube. What does the music industry want YouTube to be? After years of nudging by labels, YouTube is now embarking on a serious premium strategy, but is that really what YouTube is best at? What YouTube does better than anyone else in the market is monetise free audiences at scale on a truly global basis (China excepted).

A turning point

2018 is a turning point for YouTube. The accelerated success it and Vevo have enjoyed since 2016 over indexes compared to YouTube as a whole, which means that music is a more central component of the YouTube experience than it has ever been. However, driving impressive viewing metrics was never YouTube’s problem, convincing music rights holders that it is a good partner is. The value gap war of words may have died down a little but that is as much a reflection of the rise of audio streaming and a return to growth for record labels than anything else, as the European Parliament’s Article 13 vote highlighted. Safe harbour was never designed to be used the way YouTube does for music, and the fact it does so creates a commercial disincentive for other streaming services to play by music rights holders’ rules. The fact that YouTube can get a greater volume of rights and more cheaply than other services andbe the largest global streaming service unbalances the streaming market. Though against this must be set the fact that YouTube has been able to create a more rounded value proposition without operating within the same confines as other streaming services.

The music industry needs the YouTube-Vevo combination, especially while Spotify scales its global free audience. The road ahead will be rocky, especially if Article 13 is eventually passed and also if rights holders continue to be disappointed by engagement growth out accelerating revenue growth due to the growing role of emerging markets. But it is in the interests of all parties to make the relationship work because neither side wants a YouTube shaped hole in the streaming marketplace, even if a Facebook / Vevo partnership was to try to fill some of it.

Screen Shot 2018-08-24 at 16.54.06Click here to see more details of the 29-page, 6,000 word, 11 chart reporton which this blog post is based. The report is based upon months of extensive research, industry conversations, MIDiA data and proprietary company data and represents the definitive assessment of the YouTube Music Economy.

Are Record Labels Facing an A&R Crisis?

A succession of conversations with record labels over the last couple of months has made me start to ponder whether we are approaching a tipping point in streaming era A&R. At the heart of the conversations is whether the growing role of playlists and the increased use of streaming analytics is making label A&R strategy proactive or reactive? Is what people are listening to shaped by the labels or the streaming service? To subvert Paul Weller’s 1980s Jam lyrics: Does the public get what the public wants or does the public want what the public gets?

An old dynamic reinvented

Radio used to be the main way in which audiences were essentially told what to listen to. Labels influenced what radios would play through a range of soft tactics – boozy lunches, listening sessions etc. – and hard tactics – pluggers, payola etc. Now radio is in long-term decline, losing its much-coveted younger audience to YouTube and audio streaming services. Streaming services have learned to capture much of this listening time by looking and feeling a lot more like radio through tactics such as curated playlists, stations, personalisation and podcasts. Curated listening is increasingly shaping streaming consumption, ensuring that the listening behaviours of streaming users resembles radio-like behaviour as much as it does user-led listening. The problem for the record labels is that they have less direct influence on streaming services’ playlists than they did on radio.

Chasing the data

All record labels have become far more data savvy over recent years, with the major labels in particular building out powerful data capabilities. This has resulted in a shift in emphasis from more strategic, insight-led data, such as audience segmentation, to more tactical, data such as streaming analytics.

At MIDiA we have worked with many organisations to help them improve their use of data and the number one problem we fix, is going to deep with analytics. It might sound like a crazy thing to say, but we have seen again and again, companies fetishize analytics, pushing out endless dashboards across the organisation. Too often the results are:

  1. decision makers paradoxically pay less attention to data than previously, not more, because they assume someone else must be ‘on it’ because of all the dashboards
  2. strategic decisions are made because of ‘blips’ in the data.

There is a danger that record labels are now following this path, relying too heavily on streaming analytics. It is interesting to contrast labels with TV companies. Until the rise of streaming, TV networks were obsessed with ‘overnight ratings’, looking at how a show performed the prior night. Now streaming has made the picture more nuanced, TV networks are turning to a diverse mix of metrics, incorporating ratings, streaming metrics, social data and TV show brand trackers. Streaming made the TV networks take a more diverse approach to data, but has made record labels pursue a narrower approach.

The risk for record labels is that doubling down on streaming analytics can easily result in double and fake positives and create the illusion of causality. Arguably the biggest problem is making curation-led trends look like user-led trends, mis-interpreting organic hits for manufactured ones.

Lean-back hits

One major label exec was recently telling me about how one of his label’s artists had ended up in Spotify Today’s Top Hits and racked up super-impressive stats. The success surprised the label as everything else they knew about the artists suggested it would not be such a big breakthrough performer. Nonetheless the label decided to rewrite its plan and threw a huge amount of marketing support behind the next single. Yes, you guessed it, it flopped. When the label went back to the streaming stats, it transpired that the vast majority of plays were passive. It was a hit because it was in a hit playlist that users tend not to skip through, which created an artificial hit, albeit a transitory one.

This case study highlights the two big challenges we face:

  1. Streaming analytics stripped of the context of insight can mislead
  2. Lean-back hits are not real hits

Chasing the stats

The two points are now combining to create what may yet be an A&R crisis. By chasing streaming metrics, the more commercially inclined record labels – which does not exclusively mean major labels – are creating a data feedback loop. By signing the genre of artists that they see doing best on playlists, they push more of that genre into the marketplace which in turn influences the playlists, which creates the double positive of that genre becoming even more pervasive. This sets off the whole process all over again. And because the labels are chasing the same genre of artists, bidding wars escalate and A&R budgets explode. This leads to labels having to commit even more money to marketing those genres because they can’t afford for their expensively acquired new artists not to succeed. All of this helps ensure that the music becomes even more pervasive. And so on, ad infinitum. Five years ago, this probably wouldn’t have been a problem but now record labels are flush with cash again, they are throwing out advances that they can now afford on a cash flow basis, but not on a margin basis. Because record labels – majors especially – remain obsessed with market share, none are willing to jump off the spinning wheel in case they jump too soon. It is a game of chicken. As one label exec put it to me: “In the old days we were betting on the gut instinct of an A+R guy who at least knew his music, now we’re chasing stats rather than tunes”.

Not so neutral platforms

Of course, none of this should be happening. Streaming platforms should be neutral arbiters of taste, simply connecting users with the music that best matches their tastes. But streaming services are locked in their own market share wars, each trying to add the most subscribers and drive the most impressive streaming stats – just look at how Spotify and Apple fell over each other to claim who had streamed Drake’s Scorpion most. In such an intense arms race, can any streaming service risk delivering a song to its users that might result in fewer streams than another one? Therefore, what we are now seeing is a subtle, but crucial, change in the way recommendation algorithms work. Instead of simply looking a user’s taste to estimate what other music she might like, the algorithms test the music on a sample of users to make sure they like it first before pushing it to a wider group of users that match that profile. In short, the algorithms are playing it safe with hits, which means surprise breakouts are becoming ever less likely to happen. Passenger’s slow burning ‘Let Her Go’ simply might never have broken through if it had been launched today. And yes, if you didn’t skip that Scorpion track in Today’s Top Hits then you are now that bit more of a Drake fan, even if you actually aren’t.

Where this all goes

Something needs to change, and ideally someone will have the balls to jump off the wheel before it stops spinning. Right now, we are on a path towards musical homogeneity where serendipitous discovery gets shoved to the side lines. And with listeners having progressively less say in what they like because they are too lazy to skip, record labels will become less and less able to determine whether they are getting value for money from their marketing and A&R spend.

Pop will eat itself.

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 $318.8 million for the 12 months to Q2 2018, one year earlier the cost was $181.4 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.

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.

youtube spotify.png

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

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

Yonder And Streaming’s Less Travelled Path

Back in 2012, a music service that had raised $174 million in funding closed without yet having launched to consumers. That service was Beyond Oblivion, a company that intended to transform the music market with music bundled into handsets and phone packages at no extra cost to consumers. Five and half years later, Beyond Oblivion’s founder is finally seeing his latest iteration of the bundled music service model gain traction. Yonder, his new(ish) company, has started off 2018 with a million monthly active users (MAUs) under its belt, with the majority of that growth coming in the fourth quarter of 2017. Yet Yonder is not on many people’s radar, in large part because it is building its business in markets that are off streaming’s beaten track.

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Yonder’s main market is Bangladesh, which makes up just over half of its MAU base, followed by Indonesia and Sri Lanka. It even has tens of thousands of users in Nepal and the Maldives and plans to roll out to markets such as Myanmar, Cambodia, Iraq and Ghana in 2018. These are not markets famed as booming digital music markets, and they’re certainly not priority markets for any of the top streaming services. So, in many respects Yonder is competing around, rather than with the likes of Spotify.

Low ARPU markets

But there is more to it than just that. These are markets with mostly large populations and very low GDP per capita and mobile ARPU. In many of these territories mobile ARPU is significantly lower than the cost of a western streaming subscription. For example, total mobile ARPU in Bangladesh is around $4 a month. This makes fitting the economics of a streaming music bundle into a tariff challenging in the extreme. The standard wholesale tariffs record labels provide streaming services in these regions struggle to fit these wafer thin margins. So, making music bundles work needs a very specific and localized approach. The same principle applies to localization, with music programming requiring a much higher degree of local specialization than many other markets.

More than one way to skin a cat

2018 will likely see a slowdown in music subscriber growth in many western markets. In the meantime, majority of the 9.99 price points will be addressed. Ad supported and discounting will be key to sustaining growth in these markets, but the scale of opportunity for digital music lies in emerging markets. 2017 was the year we really started to see Latin American markets begin to make their mark, while China established itself as a major contributor to subscribers, if not revenue. Services like Yonder are important for the music business, not just because they address new markets but also because they represent another approach. The 9.99 AYCE model will remain the core opportunity, but sticking too tightly to it will limit the scope of the wider market.

Yonder’s model is not without challenges – not least the concept of making premium music feel like it’s free to its users – but it represents one of what should hopefully become a wider selection of alternative paths to making streaming pay.

Free Report: Lyrics Take Centre Stage In Streaming Music

We are pleased to announce the publication of a brand new, totally free, Streaming Music report. In this report, we present the findings of an exclusive consumer survey fielded in November 2017 to consumers in the US, UK and Germany, deep diving into streaming behaviours and the growing role that lyrics is taking. The report download link can be found at the bottom of this post.

The report includes data on:

  • Overall music consumption and streaming behaviours
  • Weekly Active User (WAU) penetration of all key streaming music apps
  • Tenure splits of streaming users by streaming service
  • Consumer attitudes towards lyrics
  • Lyric users by tenure length of individual streaming services
  • The relationship between lyrics users and streaming loyalty
  • Key drivers for using lyrics, with gender splits

Here is an overview of some of the findings of the report that we wrote on behalf of LyricFind.

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Streaming music has put the audience in control, letting music fans choose what, when and where they listen. One of the most dramatic changes that streaming has enabled is the expansion of music from a lean-back, linear experience into something far more engaging and interactive. Now fans lean forward to choose the songs they want, build playlists, comment and share. Lyrics are centre stage in this shift, transforming from static-print-hidden-away-inside-album-sleeve notes, to a dynamic extension of the music itself. Lyrics permeate the streaming music ecosystem, from websites, through YouTube and Vevo to the streaming services themselves.

Whereas lyrics in the analogue era used to be domain of music aficionados, in the streaming era they are a mainstream behaviour for audiences as diverse as they are widespread. The motivations are similarly varied, with the most cited being to know the words (81%) followed by being able to sing along (72%). Among streaming services users who are music subscribers, penetration of lyrics usage rises to 88%. What is more, lyrics have a strong link with music subscriber loyalty among 91% of all music subscribers that have been using lyrics for more than three years.

However, many lyrics users want more out of their lyrics experiences, with 56% of subscribers wanting lyrics to be in time with songs. Younger users, in particular, are raising their expectations, with 16-24 year olds the most likely to want new lyrics features.

Streaming is transforming music consumption across the board

Music consumption is in the midst of a transition period, with streaming rapidly ascending to become the dominant format. As with any transition, the old world coexists with the new, due to old habits dying hard and older groups of consumers changing behaviours slower. Thus, we see radio (66%) and free streaming (43%) as the two dominant forms of music consumption. Crucially, a strong overlap exists between the two: 72% of streamers listen to radio and 47% of radio audiences stream music. This indicates: a) that the transition will pick up pace, as nearly half of radio listeners are already swapping out some of their radio listening time for streaming; and b) that there currently remains enough that is different between radio and streaming for the two to coexist. The biggest takeaway though, is that streaming has a massive amount of growth potential ahead of it.

Lyrics are an integral part of the streaming experience

Lyrics are at the centre of the streaming music experiences: 79% of all music streamers use lyrics, rising to a comprehensive 88% of music subscribers. Wanting to know the words to songs is the main driver, with 65% of music subscribers stating this as their reason for using lyrics. Next, 55% of subscribers and 51% of free streamers said they wanted to be able to sing along with their favourite song. More social activities like singing with friends and karaoke score relatively lowly, indicating that lyrics are a very personal and integral part of how music fans interact with music.

Lyrics have a clear correlation with music subscriber tenure and with churn. The longer that consumers have been music subscribers, the more likely they are to use lyrics, while consumers that have cancelled their subscriptions are much less likely to use lyrics. Across Deezer, Spotify and Google Play, an average of 98% of subscribers with three plus years tenure use lyrics. This contrasts with lyrics penetration among churned out subscribers, with an average of just 60% across the same three streaming services. The importance of lyrics features is further underscored by the fact that 55% of streaming lyrics users say they are more likely to pay for a streaming service that ‘has great lyrics features’. For music subscribers overall, the rate is 43%, rising to 48% of Deezer users and 52% of Tidal users.

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Lyrics Take Centre Stage In Streaming – LyricFind – Report

Shazam Is Apple’s Echo Nest

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Shazam finally found a buyer: Apple. Ever since its affiliate sales revenue model crumbled with the onset of streaming (there’s no business in an affiliate fee on a $0.01 stream), Shazam has been trying to find a new business model. It doubled down on providing tools for TV advertisers but never got enough traction for that to be a true pivot. Shazam’s problem has always been that it was a feature rather than a product – as so many VC funded tech companies are. The fact that it sold for $400 million – just 2.8 times its total investment ($143 million) and well below its previous pre-money valuation of $1 billion, illustrates how much value has seeped out of Shazam’s business. The Apple acquisition though, is one of the few ways that Shazam’s ‘hidden’ value can be realised.

Cool tech without a business model

Shazam was a digital music pioneer. I remember getting a demo from one of the founders back in the early 2000s, and I was blown away by just how well the tech worked. However, quality of tech was never Shazam’s problem, and once the app economy appeared it also had a very clear and compelling consumer use case. Despite competition from challengers in more recent years – especially Soundhound, which has also been compelled to pivot but may now decide to double back down on its core competences – Shazam continued to be the standout leader in music recognition. The irony is that its use case is stronger now than it was back in the download era because people are listening to a wider array of music than ever before. The problem was a lack of revenue model.

Shazam tried to position itself as a tastemaker, with its charts becoming useful heat indicators for radio stations and streaming companies. Labels soon learned to game the system with ‘Shazam parties’ but even without that challenge, this still did little to help Shazam build a business model. Apple however, saw beyond the music recognition and Shazam now gives Apple a music recognition engine. Shazam is Apple’s answer to Spotify’s Echo Nest.

Apple Music needs growth and engagement

Apple, which recently passed 30 million subscribers, continues to lag behind Spotify’s growth. Apple Music is adding around half a million new subscribers a month, while Spotify was adding close to two million a month up until it announced 60 million subscribers in July. The fact Spotify hasn’t announced since then may point to slowing growth, but my money is on a big number being announced in the next five weeks.

Apple’s weekly active user (WAU) penetration is far behind Spotify’s, indicating that Apple needs to do a better job of engaging its users. Better playlists, recommendations and algorithm driven curation all help Spotify stay ahead of the curve. Now, Apple will be hoping that Shazam will provide it with the tools to start playing catch up. And that’s not even mentioning the user acquisition potential Shazam could have when it switches to exclusively pointing to Apple Music. Game on.