So What’s the Deal with Spotify, Anyway?

by on January 3rd, 2013

Chris Sumner reflects on the rapid rise of Spotify .

Spotify first appeared in the United States twelve months ago. A small Swedish import with a ‘freemium’ music streaming model and an interesting group of backers (including ex-Napsterer Sean Parker), Spotify was a highly anticipated new product. Indeed Spotify raised money last week from Goldman Sachs at a cool $3bn valuation – almost as much as the financier Len Blavatnik recently paid for Warner Music Group, the 54 year old label of Led Zeppelin, Eric Clapton, P-Diddy, and Jason Mraz.

And yet, there are many left unsatisfied. Artists such as Lady Gaga complain about the pitiful $160 she received from 1 million plays of ‘Poker Face’ on Spotify. Consumers complain about the $10 per month price tag to get Spotify on their smartphone. Labels haven’t said much. Yet.

The truth is that Spotify is a good revenue generator for labels – indeed many reports suggest Spotify is second only to iTunes in terms of revenue generation, yet at what cost? The Beatles, AC/DC and, more recently, Coldplay have all held content off Spotify, presumably because of the age-old industry fear: cannibalization (especially of traditional iTunes download sales).

The history of the music industry has been typified by a fear of cannibalizing existing sales: vinyl cannibalizing live; CDs cannibalizing vinyl; downloads cannibalizing CDs. Is this simply another case of fear holding back labels and artists from embracing a new model that’s inevitable? As Steve Jobs famously said, “If you don’t cannibalize yourself, someone else will”.

Maybe some numbers will help throw some light on these issues. Growth in industry download revenues was 16% in Sweden, Spotify’s biggest market, with ~50% of the population using the service, from 2010-2011. Download growth in Germany (where Spotify hadn’t launched) was 29%, one of the fastest growing in Europe. If Spotify is depressing download sales, then maybe it caused the lower growth rate in download sales in Sweden; download sales would have been worth an extra $1.1 million to the industry in Sweden in 2011 if downloads had grown at 29% (instead of 16%).

Correspondingly, ‘streaming subscription’ (essentially 100% Spotify) contributed $56 million to the industry in Sweden in 2011. In other words, the industry was ~50 times better off having Spotify than not. Obviously this is simplistic, ignores CD sales, etc. But the scale is compelling.

So this then raises three questions: Firstly, why? Secondly, does this flow through to artists? And lastly, is this sustainable?

The reason Spotify may work at the overall industry level is because of ARPU (Average Revenue Per User). A consumer that’s willing to pay for music is likely to sign up for the Premium tier; this is worth ARPU of $120 per annum versus around half for the average downloader. A user that isn’t willing to pay for music may end up just listening to the free Spotify tier, thereby generating ad revenue for the industry vs $0 on a pirate site.

And yet, artists are still extremely upset: Billy Cyro’s guitarist recently said, “I’d sooner people stole my work than stream it from [Spotify]”. Reading between the lines, I think there are a couple of issues here. Firstly, labels are ATROCIOUS at paying artists efficiently and on time. Secondly, artists receive income from two sources: publishers (for writing the song) and labels (for recording the song). The former is very low in absolute dollars, the latter very large (Lady Gaga for example was talking only about publishing royalties in her $160 check). Lastly, it’s unclear whether some artists ‘win’ while others ‘lose’ on Spotify.  Do the baby bands benefit at the expense of the Coldplays? The jury is still out.

Spotify’s financial viability is a big topic of discussion in the press. The company reported a $59 million loss in 2011, blaming royalties as one of the primary factors. Spotify claims to pay out ~70% of revenue to rightsholders. This is high for software co’s (Microsoft’s COGS are around 80%), though low for a retailer (Walmart/Staples COGS are around 75% of revenue). It all comes down to how much operating cost you can deal with and how much scale Spotify can achieve.  Last week’s $3 billion valuation certainly implies the music’s going to keep playing for a little while longer.

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