As Internet and technology has been disrupting all walks of our life in recent years, music inevitably becomes as an important war field of tech startups. Thanks to paid subscription streaming services like Spotify, the music industry is poised to face its third consecutive year of growth in 2017. As the most dominant music App across the world, Spotify seems to be the biggest winner of this hunger game. By continuously playing aggressive user-acquisition strategy, Spotify is expecting a ~40% YOY revenue growth in 2017, and its streaming service now has over 70 million subscribers (as of January 2018) and over 140 million active users (as of June 2017). However, the company still keeps reporting net losses, with 100-200 million euros operating losses in the first half of 2017. Product development costs are still expected to be held steady at ~7% of revenue, same ratio as in year 2015 and 2016.

Undoubtedly, Spotify is the winner of bringing enormous value add to the music world. But I’d rather define its business model as a relative loser compared to other tech firms’. Spotify is losing itself to music.

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The story all starts from the strong historic heritage of the global music industry – singers, musicians and producers are all signed and managed by major music labels. Nielsen SoundScan in their 2011 report named “Big Four” record labels, including Universal Music Group, Sony Music, Warner Music Group and EMI. Just like the rules in Hollywood, major players dominant most resources and talents, and as a result, they bring the best music production to the table, which reinforce their power of dominating the industry. The record labels used to be music distributors as well, until tech firms like Spotify disrupted their distribution arm with providing high quality and user-friendly streaming services to consumers. However, while cassette tapes can be easily replaced by mobiles Apps, music content still plays the most core role in the game. Facing Spotify’s attack, the incumbents chose to defense by leveraging their core asset: “Content is the KING.” they said. Major music labels started to charge high royalty fee of the copyrights of their music contents by asking for 70-75% of Spotify’s revenue per song under on-demand streaming model as return. This leaves extremely thin margin for Spotify to cover its distribution cost and customer acquisition investment but given the core music content assets still belong to the labels’ side, Spotify could do nothing but to compromise this financial model, resulting in consecutive losses under aggressive revenue/user base growth – cause no matter how fast the user base grows or how large the user base is, they are not able to amortize any of Spotify’s cost of goods. There’s barely networking effect created for sake of Spotify’s bottom line through this revenue sharing model.

As Spotify approaches its much-anticipated IPO, I am not convinced of the sustainability of its current revenue sharing model. So, what should we expect if Spotify successfully goes public, and wants to turn around its loser trap? First, gaining investors’ financial backup, Spotify would have deeper pockets to sign more artists and producers to compete with major labels. However, building up a heritage of producing successful music content that could create real meaningful competition against major labels is not a mission that could be accomplished in 3 or 5 years. I wonder how long-term would the market be, and how much patience the investors have for Spotify. Second, could Spotify renegotiate the deals with major labels? I highly doubt that. Spotify has not much leverage on the table, given streaming music service market is highly competitive with iTunes, Amazon, Youtube trying to steal Spotify’s pie. All the other competitors are a part of a multi-business tech venture. Now if Spotify goes public by itself, it has to consider the stock price stability when entering the hard negotiation. Lastly, I think the only way out for Spotify is to go disrupt the core music content – what if technology makes the entry barrier of creating good music no longer that high? What if good music becomes a commodity? However, all the above imaginations are hard to achieve, since music is after all a creativity/inspiration-driven business and there’s long lasting blockbuster effect in all creative business. It is art itself that is hard to be disrupted by technology.

Source:

“Spotify Records Surging Revenues, Continued Losses in First Half of 2017”, BillBoard

“Inside Spotify’s financials: Is There a Path to Profitability or an IPO?” , BillBoard

“Major music label”, Wikipedia