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.

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

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

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

sweden growth

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

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

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

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

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

IFPI Reports $17.3 Billion for Recorded Music in 2017  

Today the IFPI released its estimates for global recorded music revenues in 2017. That figure was $17.3 billion representing an 8.9% growth on the $15.7 billion it reported last year. The numbers are bang in line with the numbers MIDiA reported last week ($17.4 billion / 8.5% growth – see here for more) and reflect a year of fantastic growth. The headlines are:

  • Streaming is the fuel in the engine: Streaming revenues were up 37% to hit $6. Billion (this however underrepresents the value of the market as the IFPI groups Pandora under ‘mobile personalization and other’ wiping out the best part of a billion dollars of streaming revenue). MIDiA’s broader definition of streaming puts 2017 revenues at $7.4 billion. Whichever definition you go with, the narrative is clear: streaming is dragging the entire recorded music industry back into growth (all other sales formats are in decline). The recorded music industry is on track to become a streaming industry in all but name.
  • Legacy format decline is slowing:Physical and download sales fell at a slower rate in 2017 than they did in 2016. This, in turn enabled streaming growth to have a bigger impact on overall revenue growth. The legacy formats will decline steadily now until the channel stops stocking them. The first big step will be when Apple turns off the iTunes Music Store. This is something we predicted back in 2015, forecasting that it would happen by 2020. That bet is still looking good.
  • UMG still leads the pack: As major label revenues are a matter of public record via company reports we can calculate 2017 market shares against IFPI 2017 total. UMG comes in at 29.8%, Sony 22.2%, WMG 18.0%, Indies 27.7% and artists direct 2.7%. These numbers are all within a 10thof a percentage point of the results MIDiA published last week. As we reported then, the key takeaways are that UMG still leads the pack, WMG has grown faster than the other majors while artists direct were the single biggest growth driver in 2017. (Note it appears that artists direct now appear in the IFPI numbers though the $100 million difference between IFPI’s and MIDiA’s numbers mean that has come off either the artist direct or indie numbers)

All in all, a stellar year for recorded music revenues, with plenty of growth yet to come, especially as emerging markets start to deliver at scale.

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.

MRM1804-fig0.5.png

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

 

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

A Growing and Diversified Market

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

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

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

Spotify D(PO)-Day

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

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

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

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

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

The Spotify Numbers You Won’t Have Seen

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

spotify metrics

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

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

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

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

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

The Narrative Of Spotify’s Filing Is That The Best Is Yet To Come

Spotify just filed its F1 for its DPO. The most anticipated business event in the recorded music industry since, well…as long as most can remember, is one big step closer. The filing is a treasure trove of data and metrics, and while there won’t be too many surprises to anyone who follows the company closely, there are none the less a lot of very interesting findings and themes. The full filing can be found here. Here are some of the key points of interest:

  • Most of the numbers are heading in the right direction: MAUs, subscribers, hours spent etc are all going up while churn and cost ratios are heading down. Premium ARPU was an exception, declining: 2015 – €7.06 / 2016 – €6.00 / 2017 €5.24, which reflects pricing promotions. But Spotify was never going to have fixed every aspect of its business in time for its listing, that was never the point. What Spotify needs to convince potential shareholders is that it is heading in the right direction. The narrative that emerges here is of a company that has helped create an entire marketplace, that has made great ground so far and that is poised for even bigger and better things. That narrative and the clear momentum should be enough to see Spotify through. As I’ve previously noted, investor demand currently exceeds supply. If you are a big institutional investor wanting to get into music, there are few options. Pandora aside, this is pretty much the only big music tech stock in town. As long as Spotify can keep these metrics heading in the right direction, it should have a much smoother first few quarters than Snap Inc did, even though a profit is unlikely to materialise in that time.
  • Spotify is baring its metrics soul: Spotify has put a lot of metrics on the line, setting the bar for future SEC filings. While competitor streaming services will be busy plugging the numbers into Excel so they can compare with their own, the rest of the marketplace now has a much clearer sense of what running a streaming service entails. One really encouraging development is Spotify’s introduction of Daily Active User (DAU) metrics. As we have long argued at MIDiA, monthly numbers are an anachronism in the digital era, a measure of reach not engagement. So, Spotify is to be applauded for being the first major streaming service to start showing true engagement metrics.
  • Users and engagement are lifting: Spotify had 159 million MAUs in 2017, with 71 million paid and 92 million ad supported. Europe was the biggest region (58 million total MAUs) followed by North America (52 million), Latin America (33 million) and Rest of Word (17 million). The latter two are the fastest growing regions. Meanwhile, 44% of MAUs are DAUs, up from 37% in Q1 2015, which shows that users are becoming more engaged, though the shape of the curve (see chart below) shows that when swathes of new users are on-boarded, engagement can be dented. Consumption is also growing (a sign of both user growth and increased engagement): quarterly content hours went from 17.4 billion in 2015 to 40.3 billion in 2017. There are some oddities too. For example, ad supported MAUs actually declined in Q2 2017 by 1 million on Q1 2017 and in Q4 2017 only increased by 1 million on the previous quarter to reach 92 million.
  • The future of radio: Spotify puts a big focus on spoken word content and podcasts in the filing, as it does on advertiser products. It also lists radio companies first and subscription companies second as its key competitors. Meanwhile ad supported flicked into generating a gross profit in 2017 (ad supported went from -12% gross margin in 2016 to 10% in 2017. Premium gross margin up from 16% to 22% over same period.) As MIDiA predicted last year, free is going to be a big focus of Spotify in 2018 and beyond. The first chapter of Spotify’s story was about becoming the future of retail. The next will be about becoming the future of radio. And the increased focus on spoken word is not only about stealing radio’s clothes, it is about creating higher margin content than music. None of this is to say that Spotify will necessarily execute well, but this is the strategy nonetheless.
  • Spotify is still losing money but is trending in the right direction: Spotify’s cost of revenue in 2017 was €3,241 million against revenue of €4,090 with an operating loss of €378 million. However, losses are not growing much (€336 in 2016) and financing its debt added a whopping €974 million in 2017, from €336 million in 2016. Part of the purpose of the DPO is to ensure debt holders, investors and of course founders and employees get to see a return of their respective investments in money and blood, sweat and tears. Once that is done, financing costs will normalize. Also, Spotify’s new label licensing deals are kicking in, with costs of revenue as a share of premium revenue falling from 84% in 2016 to 78% in 2017. Spotify is not yet profitable but it is getting its house in order.

All in all, there is enough in this filing to both convince potential investors to make the bet while also providing enough fodder for critics to throw doubt on the commercial sustainability of streaming. Spotify’s structural challenge is that none of the other big streaming services have to worry about turning a profit. In fact, it is in their collective interest to keep market costs high to make it harder for their number one competitor to prosper.

But in the realms of what Spotify can impact itself, the overriding trend in this filing is that Spotify is well and truly on the right track. For now, and the next 9 months or so, Spotify will likely remain the darling of the sector. But after that, investors will start wanting a lot more if they are going to keep holding the stock. Spotify is promising that the best days are yet to come. Now it needs to deliver.

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spotify f1 b