Spotify: An Ecosystem Powered by Network Effects

I first discovered Spotify during the summer of 2011. I was living in London at the time and had run into a couple of Swedes at a tech meet-up who had convinced me I must join. I could, they told me, leave my music downloading days behind me and gain unlimited, legal access to all of my favorite tunes.

So I joined, and I loved it. Within weeks, I became a premium user ($9.99/month), recognizing the value in certain premium perks: ad-free music and the ability to listen to playlists offline, in particular.

The thing, though, was that none of my friends back home in the U.S. were on the platform yet. At the time, Spotify hadn’t been able to negotiate finalized contracts with the US-based music labels, the majority of which were still resisting the new streaming business model. Therefore, I continued to use other music platforms (i.e. iTunes, Hype Machine, Soundcloud), which enabled easy sharing and discovery among my friends. Spotify had value to me, but it was not by any means the most valuable music platform.

Fast forward, and almost everyone I know is now on the Spotify platform. Spotify’s value to me has subsequently increased exponentially and has become my all-time favorite music platform. Why?

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The Spotify Ecosystem:

Spotify has undoubtedly changed the music business. During a time when the traditional music business model was collapsing as a direct consequence of illegal music downloading, Spotify swooped in with a new model that would enable users to listen to music (for free, if they wished), but also enable music labels and artists to recapture value via streaming royalties. I think of the ecosystem as such:

Spotify: A digital platform through which artists and labels can publish their music. Spotify operates on a freemium business model, comprised of a free tier (subsidized by advertisements) and a premium tier (user pays a monthly fee). Key Spotify platform products include: friend-to-friend messaging and sharing, Facebook integration, playlist curation and collaboration, artist and user pages (which users can follow and track).

Artists: Often represented by music labels. Spotify has a contracted royalty split with the music labels, which the company pays out on a regular basis. The labels then have their own contracts with individual artists, who are paid accordingly. Spotify’s value to bigger superstar artists is primarily streaming royalties (the more popular artists, understandably, receive the most streams on the platform). Value to up-and-coming indie artists is increased exposure to future fans and listeners (Spotify has been known to “break” new artists through curated playlists and tastemakers). 

Music Labels: Music streaming has perhaps saved music labels. Labels can now leverage their giant libraries to which they have rights and monetize accordingly.

Users: Anyone and everyone in Spotify-approved geographic regions; the Spotify demographic becomes more and more global each year. Users on the free tier can listen to unlimited amounts of music, but are served ads periodically. Users on the premium tier can do this, but are never served ads and can also listen to all of their saved and curated playlists off-line (amazing for traveling).

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Network Effects:

One of the most valuable aspects of the Spotify platform, for all parties, is music discovery. I, for example, am always looking for new music to listen to–beyond just the usual Top 40 hits we all hear over and over again. I’ll hop onto Spotify multiple times a day and check out my friends’ recent playlist additions.

The platform therefore ultimately becomes more valuable to users as more users join. Spotify curates and creates its own playlists, but much of the value comes from other users’ tastes. As more music listeners, bloggers, organizations get on Spotify, the more valuable it becomes to a listener as they have more curated music.

To simplify — The more users, the more playlists. The more playlists, the better the music discovery.

Simultaneously, the more users on Spotify, the better it is for artists (increased streaming royalties and exposure). The more artists, the better for users (larger library, greater choice, better music discovery).

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What’s Next for Spotify?

With the advent of new music services (i.e. Apple Music), Spotify will need to do all it can to retain users. Luckily, the switching costs, at the moment, are higher than one might think — primarily because of playlists! Users have built up their music libraries on Spotify, and the time required to re-curate on a different platform isn’t likely worth the effort.

Spotify also has a wealth of listener data–more so than other competitors, since it’s been around longer–which the company can most likely use to monetize and enhance the platform in the future. Artists have been known, for example, to use Spotify data to choose which cities to include in a worldwide tour. Much more to come, I’m sure!