Can Spotify Ever Meet Investors’ Expectations?

Spotify just posted another solid set of results, adding four million subscribers and beating profit and revenue estimates, yet its share price fell. What’s going on? Spotify is on track for where it should be, slightly below, but on track. Before Spotify went public MIDiA laid out three growth scenarios (low, mid, high). Our mid forecast put Spotify at 87.8 million subscribers for Q3 2018, it reported 87 million. So, Spotify is pretty much exactly where it should be. It’s not exceeding expectations, nor missing them, but is plotting a strong, solid course, all the while improving operational metrics such as churn and profitability. Yet still, this is not enough for investors. The reason is simple: misaligned expectations.

Investors want more

Spotify has pretty much had this problem all year, delivering good, steady growth that is good enough for the music industry, but isn’t good enough for investors. Record labels measured Spotify’s success relative to the performance of their revenues, which were coming out of a tailspin. Investors have a higher bar for success. They want faster growth, profitability (never really a label priority – it was Spotify’s problem to fix) and market disruption. Spotify is building its business at a decent rate that meets / exceeds music industry expectations, but not investor expectations. It is also laying the foundations for future self-sufficiency (artists direct, podcast etc.) but investors want more, now.

Tech stocks are the benchmark

The problem with going public as music company is that your investors are not music specialists; most aren’t even media specialists. Consequently, they don’t have the same situational industry expertise that music industry specialists have. They don’t get bogged down with the minutiae of collection society reciprocal agreements, mechanical rights, label marketing strategies, publisher concerns or artist contracts. They can’t. Music is too small a part of an institutional investor’s portfolio to commit the time required to truly understand what is a very complex industry. So instead they look at the big picture and benchmark against Netflix and other tech stocks.

I remember a comment Pandora’s founder Tim Westergren made to me on a panel last year, to the effect that Spotify better be careful what it wished for by going public. Tim learned first-hand that investors didn’t have the appetite to understand the nuances that shaped his business and eventually he paid the ultimate price, foisted out of his own company.

Game changer or industry ally?

In music industry terms Spotify is doing a great job, in tech stock terms, less so. Either it has to start performing even more strongly – no easy task in a maturing market – or it has to start talking up the disruption angle. Tech investors like backing game changers, betting big on something that is going to change the world. In the way that Facebook, Google, Netflix, Amazon (and for a while, Snapchat) did. Thus far Daniel Ek has trodden a difficult middle ground, remaining the firm ally of the music industry but also promising disruptive change. If the stock continues to underperform, he and his exec team might just be forced to start talking up disruption. At that stage it will be gamble time, because Spotify will be swapping allegiances that could make or break the business.

Making Free Pay: Finetuning Freemium

Streaming is transforming music and TV business models, driving growth in both audiences and revenue. A balance between free and paid tiers and services has been key to this success, but, growth is not always balanced, and as we approach maturity in many western markets, more may be needed of free, ad supported options. Likewise, for unlocking longer-term, larger-scale growth in emerging markets.

MIDiA Making Free Pay

We know these issues matter, but we also know it can be hard to plan for the next phase when there is so much activity and resource requirement being delivered by the current phase. Therefore, to help media companies and streaming services alike, we have put together a curated insight event to provide the definitive evidence base for setting the balance between free and paid.

Join us for this free event, to see exclusive, previously unseen MIDiA data presented by our Research Director Tim Mulligan and a panel of industry experts tackle the burning questions. This event will help you understand:

  • Just how big will streaming music and video advertising get?
  • What is the right balance to strike between free and paid?
  • How will this balance vary across different regions across the globe?
  • How many more consumers will make the path from free to paid?
  • Why are streaming audiences so interesting to advertisers and how can they reach them?
  • What impact will the tech majors’ domination of global ad revenues have on streaming services?

The event is free to attend, and will be in central London on the 17thOctober. Places are limited though and going fast, so be sure to sign up soon if you plan to come.

As a sneak peak, here is one snippet from Tim’s presentation:

midia making free pay data

TV and music have a long history in ad supported via broadcast TV and radio. Both also have had the opportunity to convert an unprecedented volume of consumers to subscription relationships through streaming. The focus right now is all on subscriber growth, but the flatten out phase of the s-curve will come and when it does, ad supported can, and should, pick up the baton and run with it. The challenge is how to do that without unravelling subscription revenue.

Both music and video will follow a similarly shaped growth trajectory over the coming years in terms of advertising’s share of total revenue. However, music will lag far behind with just 38% of streaming revenue coming from ad revenue in 2025, compared to 56% for video. This will reflect both the positive and the negative. On the plus side, music will be generating strong subscription revenue in 2025, thus commanding much of the revenue share. However, it will also be generating much less annual ad revenue per user (ARPU) in 2025 than video: $4.69 compared to $20.37. In fact, video will see ad supported ARPU nearly double by 2025 from 2017, while music will add just one dollar.

This reflects multiple factors, including:

  1. Social video (YouTube, Instagram, Snapchat, Facebook) will generate far more ad supported video revenue than it will ad-supported music revenue
  2. Video ads command a higher ad rate than audio ads
  3. TV ad budgets are much bigger than radio ad budgets, and their transition to streaming will accelerate video ad revenue growth
  4. Few music services have scaled their ad sales outside of the US (though some encouraging signs are occurring there)
  5. Emerging markets will be key drivers of ad-supported music audiences, but digital ad markets will take time to get established

Ultimately, streaming ad growth will be shaped in equal measure by traditional ad market dynamics, and the tech and ad sales capabilities of the streaming services in each and every respective market. This means that in many markets we will see free audience growth far outstrip ad revenue growth. Just one of the many challenges posed by a growing ad supported streaming sector.

Join us on the 17thfor this and much more – see you there!

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’.

How Streaming is Changing the Shape of Music Itself [Part I]

[This is the first of two thought pieces on how streaming is reshaping music from creation to consumption] 

The streaming era has arrived in the music business, but the music business has not yet fully arrived in the streaming era. Labels, publishers, artists, songwriters and managers are all feeling – to differing degrees – the revenue impact of a booming streaming sector. However, few of these streaming migrants are fundamentally reinventing their approach to meet the demands of the new world. A new rule book is needed, and for that we need to know which of today’s trends are the markers for the future. This sort of future gazing requires us to avoid the temptation of looking at the player with the ball, but instead look for who the ball is going to be passed to.

Where we are now

These are changes that represent the start of the long-term fundamental shifts that will ultimately evolve into the future of the music business:

  • A+R strategy: Record labels are chasing the numbers, building A+R and marketing strategies geared for streaming. The bug in the machine is the ‘known unknown’ of the impact of lean-back listening, people listening to a song because it is in a pushed playlist rather than seeking it out themselves. Are labels signing the artists that music fans or that data thinks they want?
  • Composition:Songwriters are chasing the numbers too. The fear of not getting beyond the 30 second skip sees songs overloaded with hooks and familiar references. The industrialisation of song writing among writing teams and camps creates songs that resemble a loosely stitched succession of different hooks. Chasing specific playlists and trying to ‘sound like Spotify’delivers results but at the expense of the art.
  • Genre commodification:The race for the sonic centre ground is driving a commodification of genres. The pop music centre ground bleeding ever further outwards, with shameless cultural appropriating par for the course. Genres were once a badge of cultural identity, now they are simply playlist titles.
  • Decline of the album:iTunes kicked off the dismembering of the album, allowing users to cherry pick the killer tracks and skip the filler. The rise of the playlist has accentuated the shift. Over half of consumers aged 16–34 are listening to albums less in favour of playlists. The playlist juggernaut does not care for carefully constructed album narratives, nor, increasingly, do music listeners.
  • Restructuring label economics:Achieving cut though for a single takes pretty much the same effort as for an album. So, it is understandable that label economics still gravitate around the album. But streaming is rapidly falsifying the ROI assumption for many genres, with it being the tracks, not the albums that deliver the returns in these genres.
  • Decline of catalogue:Streaming’s fetishisation of the new, coupled with Gen Z’s surplus of content tailored for them, deprioritises the desire to look back. Catalogue – especially deep catalogue, will have to fight a fierce rear-guard action to retain relevance in the data-driven world of streaming.
  • Audience fragmentation: Hyper targeting is reshaping marketing and music is no different. While the mainstream of A+R chases the centre ground, indies, DIY artists and others chase niches are becoming increasingly fragmented. Yet, most often, this is not a genuine fragmentation of scenes, but an unintended manifestation of hyper- focused targeting and positioning.
  • End of the breakthrough artist:Fewer artists are breaking through to global success. None of the top ten selling US albums in 2017 were debut albums, just one was in the UK. Just 30% of Spotify’s most streamed artists in 2017 released their first album in the prior five years. Streaming’s superstars – Drake, Sheeran etc. – pre-date streaming’s peak. Who will be selling out the stadium tours five years from now?
  • Massively social artists:Artists have long known the value of getting close to their audiences. Social media is central to media consumption and discovery, and its metrics are success currency. Little wonder that a certain breed of artist may appear more concerned with keeping their social audiences happy than driving streams.
  • Value chain conflict:BuzzFeed’s Jonah Peretti once said “content may still be king but distribution is the queen and she wears the trousers”. Labels fear Spotify is out to eat their lunch, Spotify fears labels want to trim its wings. Such tensions will persist as the music industry value chain reshapes to reflect the shifts in where value and power reside.

Next week: where these trends will go.

To paraphrase Roy Amara:“It is easy to overestimate the near-term impact of technology and underestimate the long-term impact.”

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.

From Ownership to Access

MIDiA PanelLast Wednesday we held the third MIDiA Quarterly forum, exploring the shift from ownership to access across different media industries. In addition to MIDiA analyst presentations we had panellists from Sky, The Economist, Beggars Group, Reed Smith and Readly. The event was held at The Ministry in London and was a great success. Be sure to make it to our next one! Here are some of the key themes we explored.

Change is a coming

We opened with three quotes that summarise the tensions and transformations taking place in the digital content marketplace:

 ‘The fine wines of France are not merely content for the glass making industry’, Andrew Lloyd-Webber

‘We’re competing with sleep…sleep is my greatest enemy’, Reed Hastings, Netflix

‘Content may still be king but distribution is the queen and she wears the trousers’, Jonah Peretti, BuzzFeed

All three quotes represent very different worldviews and illustrate how different things can look from the perspective of the companies being disrupted, those doing the disruption and those building businesses to harness the disruption. All three viewpoints are simultaneously valid, but the media landscape is changing at rapid pace, and fighting a rear-guard action against change only gives the disruptors a freer rein to, well, disrupt.

access slide 1Across most media industries – music, video and news especially, the future of content monetisation will be built around advertising for the mass market and subscriptions for the aficionados, while additional opportunities exist for one-off transactions within both environments (e.g. Tencent live streaming  Chinese boyband TFBoysand Epic Games selling $100 million a month of virtual items in Fortnite). What is going as a mainstream proposition is selling physical media, though niche markets for collectables will thrive—ironically exactly because of the demise of physical media. In an age without shelves full of CDs, DVDs and games, collectors want a physical manifestation of their tastes.

Music and video are plotting the most directly comparable paths towards access-based models, though there are also some very telling differences:

  • Scale:Globally there were 206 million music subscribers at the end of 2017, compared to 452 million video subscribers. But while subscriptions represented 45% of retail music revenues, it was just 12% of pay-TV revenues. Music though is a far smaller industry than pay-TV (11% of the size), so like-for-like comparisons aren’t always that useful.
  • Concentration:What is worth comparing though, is the degree of market concentration. In music, the top four subscription services account for 72% of subscribers, compared to just 54% for video. And while the long tail for music services isn’t very, well, long, in video there is a vast number of smaller services: there are around 60 different services in the US alone.
  • Variety:While music services largely offer the same catalogue, with the same usage terms at the same price, video is defined by diversity and exclusives. Using the US as an example again, more than half of the services are niche – such as Korean drama, 4K nature, horror, reality – and there are 23, yes 23, different price points.

Aside the different heritages of these industries – consumers are used to paying for different slices of TV content, there is another key reason for the differences: rights holder distribution. In music three big companies account for the majority of revenues; in TV there are dozens of key studios and networks. This means that in video, the distribution companies can play rights holders off each other and effectively set the pace of change. In music, the major record labels shape the market.

This dynamic is what Clayton Christensen outlined in the Innovator’s Dilemma. There are two key types of innovation:

  1. Sustaining innovations:the smaller, more evolutionary changes that companies make to improve their existing products. Every company does this if they can, it’s how to maintain the status quo and grow revenues predictably
  2. Disruptive innovations:these are dramatic, industry-altering changes that rarely come from the incumbents but instead from disruptive new entrants. P2P file sharing was the big one that shook the TV and music industries. TV responded by fighting free with free, by launching services like iPlayer, ABC.com and Hulu. The music industry responded by licensing to the iTunes Music store. One embraced disruption, one fought it.

Talking of disruption, the big existential threat media companies will have to face over the coming decade, is ceding power, willingly or otherwise, to the tech majors (Alphabet, Amazon, Apple and Facebook). Europe’s Article 13aims to offset some of the growing reach of the tech majors, but ultimately these companies will shape the future of media, across both ad supported and subscription models.

The tech majors generated $40.7 billion in ad revenue in Q1 2018 alone, including around $2 billion for Amazon, the global advertising revenue powerhouse that many still aren’t paying enough attention to. The tech majors have already sucked away much of the news industry’s audience and ad revenues; with assets such as YouTube and IGTVthey are competing for radio and TV too. But it is the content and services revenue that media companies need to pay most attention to. With $16.9 billion in Q1 alone – nearly the same as the recorded music market for the entirety of 2017, this is a sector that all four tech majors are taking seriously, very seriously. And even though Facebook is a late arrival to the party, it is making up for lost time with its new music offeringand evolving video strategy.

The reason all this matters for media companies is that the strategic objectives of the tech major are rarely aligned with those of media companies. The tech majors each use media as a means to an end, a tool for driving their core strategy. Access based models underpin the content strategies of these companies who often control distribution and access to consumers via tools such as app stores, mobile operating systems, search and social platforms. Thus, the shift from ownership to access could also translate into a shift towards a tech major dominated media world.

The Outlook for Music Catalogue: Streaming Changes Everything

Friday’s news that catalogue acquisition business Hipgnosis Songs Fund is set to float on the London Stock Exchange,having already raised around $260 million, reflects a booming market for music catalogues. However, the outlook for catalogue is not quite as straight forward as it at first appears. MIDiA Research has just published a major new report looking at the state of catalogue and its future: The Outlook for Music Catalogue: Streaming Changes Everything. This report was six months in the making and pulls data from a wide range of industry sources to provide a definitive view of the global catalogue market, both in terms of revenues and also mergers and acquisitions (M&A). The report is immediately available to MIDiA subscription clients and is also available for individual purchase on our report store here. Here follows a brief overview.

Album unbundling is now hitting catalogue

Music catalogue sales is fundamentally about nostalgia, enabling us to relive our younger years through rediscovering music that mattered to us. In the old sales model, record labels could release a greatest hits album every eight–10 years and convince consumers to pay for a dozen or more songs, when in reality they only ever wanted a handful of them. If you think about the artists that sound tracked your younger years but are not among your favourite artists, there are probably only around five songs that you can actually recall as liking. In the old sales model you would have listened most to those tracks on the full album, and even then, probablyonly a dozen or so times before lessening your listening. Now, with streaming, you can get straight to those five tracks, skipping the others, and probably still only listen to them a handful of times each, perhaps adding them to a playlist that you’ll listen to occasionally. The old model would have generated, say $5 gross revenue for the label. In the streaming model, five songs listened to ten times each would generate 28 cents for the label. It is the album unbundling dynamic all over again.

Younger audiences look forward, not back

Younger Millennials and Gen Z – those born between 1995–2014 – have more content pushed to them that is tailored specifically for them than at any other stage in history. This is digital’s baby boomer generation. They have never had it so good. With Instagram and Snapchat feeds perpetually filled with new content, they have little need or want to look back. The music industry isn’t helping things either with hundreds of thousands of tracks released every month, leaving little time for older music.

Even within streaming catalogue listening, the focus is very much on the new rather than the old. In the UK, according to the BPI, more than 70% of all catalogue (24-plus months old) streams are from on or after 2000. If we go back to the 1960s, where some of the most iconic catalogue artists were at their peak – e.g. the Beatles and the Rolling Stones – this decade accounted for just 3.6% of UK catalogue streams in [year]. In traditional catalogue valuations, the likes of the Beatles and the Stones will account for a major portion of valuations. In the streaming era, their value diminishes markedly.

 

midia research catalogue forecastsCatalogue is caught between the two extremes of streaming and physical, with current revenue boosted by older CD and vinyl buyers coalescing around old favourites. These physical formats are often high-priced premium products and therefore create a skewed picture when comparing the consumption business of streaming to the sales model. Catalogue’s outlook is nuanced. Music catalogue generated $11.5 billion in retail revenues in 2017, which was up from 2016 and it will continue to grow through to 2025. Yet catalogue’s share of recorded music revenues will diminish.

Many strings to catalogue’s bow

Catalogue also looks different depending on where you sit in the value chain. If you are an influential indie label group like Beggars, you’ll see catalogue still performing strongly on streaming because you have the influential music that fans want to discover. Meanwhile, publishing catalogues are commanding large fees, not least Sony ATV’s $2.3 billion acquisition of 60% of EMI Music Publishing. Music publishing has felt the impact of streaming much more slowly than labels, but it is happening. Mechanical royalties from sales are plummeting, sync revenues are stable but a far larger volume of syncs are happening thus reducing average synch incomes. Meanwhile on streaming, publishers get a much smaller share of revenue than labels. And of course, streaming is killing off radio, another key publishing income source. So what labels are beginning to experience now, publishers will too.

The future needs rewriting

None of this means that catalogue is dead, but it does need an overhaul if it is to retain relevance. Selling people nostalgia is no longer enough on its own (though of course a solid market still exists for selling digital remasters to aging rock fans). The Guardians of the Galaxy is a great example of how to make catalogue work in the current market. For young fans of the movie, the music is simply the soundtrack to part of their culture that just happens to be decades old. The music is given new cultural context for a new generation. This is the sort of thinking catalogue needs to thrive in the streaming era.

A catalogue bubble

There is a risk that we are in a catalogue bubble. Acquisitions are on a rapid rise – check out the reportfor our year-by-year catalogue M&A activity – and will likely continue to rise over coming years, as illustrated by Hipgnosis, though given that the average transaction value for catalogues is $140 million the initial $260 million may not go that far.

The risk with the current market is that valuations are being built using the models that were shaped in the distribution era and that don’t properly reflect the dynamics of streaming. Also, there is a finite number of decent sized catalogues for sale, which means it is a sellers’ market, thus driving prices up further still. 

With these dynamics and streaming’s emphasis on the new set to create a world of mega hits and audiences with less inclination towards looking back, catalogue is at a tipping point. Either it changes to meet the market or the market leaves it behind.

Spotify’s New Rules of Engagement

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

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

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

 

A rabbit out of the hat

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

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Investors want the new world now

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

Spotify needs to speak boldly but act responsibly

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