by : Business, Dec.'12

An Update on Spotify

An Update on Spotify

Spotify began as a Swedish online music streaming application that launched in Europe in October 2008. By integrating years of technology advances into their product, the company quickly grew to be one of the world’s most popular cloud-based music services. After becoming the second largest digital music revenue generator in Europe, after iTunes, Spotify was ready to take the next step.1 In July 2011, the company entered the U.S. market.

Since then, the company has experimented with more aggressive business strategies. Subscribers grew thirty-three percent last year, reaching a total of fifteen million users worldwide, with four million of them paying a monthly fee.2 Yet, the service is still facing challenges in developing a profitable business model and in convincing some people that it is helping, not hurting, the music industry.

At first, the U.S. version of Spotify imitated the steps that it took when it launched in Europe. It offered free accounts by invitation only, and offered paid subscriptions to anyone. After a few months, the service evolved into what it is now: Spotify’s free version is available to everyone and plays audio advertisements approximately every three songs. Spotify Unlimited ($4.99) and Spotify Premium ($9.99) are also available. These paid subscriptions are both exempt from ads; other benefits include access to exclusive content, a mobile service, and the Premium version comes with an off-line locker service.

For skeptics, the model still does not make sense. Spotify’s U.S. launch required almost two years of negotiations with, what were back then, the four major labels: Universal, Sony, EMI and Warner. American label executives were concerned that the company was (i) giving away too much music for free, and (ii) that its conversion rate from free to paid users was too low.3  Spotify responded to the first complaint by limiting users’ listening time in Europe and assuring the labels that those same limitations would be applied in the U.S.   To deal with the second issue, the company is offering a variety of options, including unlimited free samples, with caps being applied later to compel users to return as paid customers, and the provision of exclusive content with international access.4  Spotify claims particular success in converting young fans, and one third of its U.S. paying subscribers is under the age of twenty-four.5 But current conversions are, worldwide, about fifteen percent, a paltry number.

New developments

A big move for the company this year was partnering with Facebook, allowing users to access friends and other public playlists. However, Spotify had to step back and re-evaluate its method. Users could only login if they had a Facebook account, a requirement that could potentially alienate non-Facebook users.6  It then offered again the option to login via email. Spotify also added an off-line “private session” mode for Spotify-Facebook users who wanted to protect their privacy.

Spotify’s next target was Internet radio. While many users of online streaming services enjoy listening to music actively – meaning that they search for a specific artist or build their own playlist – there is a significant market of music consumers who listen to music passively, preferring to let the online service take the function of a DJ. Pandora dominates this market, but it has been subject to competition from Spotify since June 2012, when the company began offering its own free radio service. Spotify radio is also accessible to mobile users of Apple and Android devices.7

One of the most intriguing recent features of Spotify is its platform of music discovery apps.8 Some of these apps function as curators for Spotify’s vast selection of songs. Apps created by Pitchfork, Rolling Stone, Billboard and The Guardian list charts and review the latest releases. Other apps track artists from a user’s library and provide a list of concerts near the user’s town. There are also apps designed to make playlists according to moods.  Potential dating partners can be suggested for people of similar tastes.

This November, the company also announced that it would launch a browser-based music player in a beta version.9 Up until now, the only way to use Spotify was to download and install the application on a computer or mobile device. In offices and on public computers, where downloading apps is not possible, people could not use the service. This new development puts Spotify on the same level as Pandora, Rhapsody and Rdio, which already offer both apps and web-based browsing.

Finally, Spotify plans to expand into Latin America and Eastern Europe.10 It recently raised about $100 million from Goldman-Sachs and Coca-Cola. The company has been valued at three billion dollars and it expects $900 million in revenue for 2012.  Spotify however, is still not profitable. According to its founder, Daniel Ek, the company would be happier to have higher growth multiples before considering an initial public offering. In truth, market conditions have never been ideal after Facebook’s storied IPO.

Challenges

One of the most talked-about issues concerning Spotify is how much it is paying artists. According to the company’s webpage, it has direct agreements with record labels, publishers, digital distributers, aggregators and collection societies.11  Royalties are generated every time a song streams. However, it is difficult to come by the data. Agreements are subject to strict confidentiality requirements and there is no standardized royalty rate or official data. This generates unease. Some artists have gone as far as making their royalty statements public trough blogs and social media in an effort to educate their peers. Lady Gaga’s case became emblematic when, in 2010, The Guardian published a story claiming that her hit “Poker Face” earned $167 for one million Spotify plays in 2009. Each stream was worth 0.02 cents.

Pitchfork recently published anarticle by songwriter Damon Krukowski that presents the uncertainties and complexity of royalty calculations.12 Krukowski writes that “it seems this rate is adjusted for each stream, according to an algorithm (not shared by Spotify, at least not with us) that factors in variables such as frequency of play, the outlet that channeled the play to Spotify, the type of subscription held by the user, and so on”. Krukowski’s own math from his paycheck returns 0.5 cents per stream– which would be substantially more than Lady Gaga and confirm the volatility of royalty returns to artists.

It is important to note the difference between a stream and a digital download or physical album sale.13 A Spotify user does not own the songs, but has access to listen to them whenever he or she wants. While the individual payment for a stream is lower than a download, the cumulative payment triggered by a consumer repeatedly listening to an album or track may be higher over a longer period. That is why the topic of artist collections from the service will loom so large in the future.

Some artists and indie labels have said that they would rather suffer piracy than have their music on Spotify. Many have withdrawn their songs from the service. Taylor Swift’s Red album is still unavailable.14  Her label, Big Machine Records, argues that the model does not make sense for a small record company with limited releases, but it may work for a major label that has a roster of hundreds of artists and records.

In an effort to portray itself as an artist-friendly company, Spotify has been trying to leverage its international reach to step into the A&R world and promote unknown artists.

In particular, it has experimented with a band named Cazzete.15  Spotify is actively sponsoring the band by building an attractive and interactive app that looks like a cassette player and also by featuring them in the “What’s New?” section.  The band says that album sales are secondary for them, and all the promotion will eventually be reflected in better album sales; they’re ‘accessibility and exposure’. It is unlikely more established artists will agree. Moreover, sites like Pitchfork have built a reputation for selecting good new music over many years, and do not have a financial stake in the proceeds—all of which removes the appearance of impropriety that Spotify may create.

Overview

Spotify deserves credit, nevertheless, for developing a new business model that is based on recorded music plays and is entirely legal. Its applications are attractive and some of its discovery and review apps are useful. Its Facebook connection is a plus.

For labels to turn around and give Spotify the license for their entire music catalogs, like was done with Apple’s iTunes in 2003, much more subscriber growth will be needed. That growth, for that matter, is dependent on the quality of content—a catch-22 problem.

In the meantime, bad publicity over rights’ payments is hindering artists from fully embracing the service, while the juncture is not ideal for more venture financing. An initial public offering in the United States seems unlikely any time soon. This could change, but the extraordinary valuation that investors have already placed on Spotify begs an explanation. And if money talks, perhaps the music industry should listen.

 

By Mariana Migliore

 

Endnotes:

1.  Vilpponen, Antti. “Spotify Second Largest Source Of Revenue In Europe For Labels.”Spotify Second Largest Source Of Revenue In Europe For Labels. N.p., 9 Feb. 2011. Web. <http://www.arcticstartup.com/2011/02/09/spotify-second-largest-source-of-revenue-in-europe-for-labels/>.

2.  Pham, Alex. “Spotify Subscribers Grew 33% in Last Year.” Los Angeles Times. Los Angeles Times, 01 Aug. 2012. Web. <http://articles.latimes.com/2012/aug/01/entertainment/la-et-spotify-now-has-15-million-active-users-worldwide-20120731>.

3.  Sisario, Ben. “New Service Offers Music In Quantity, Not by Song.” The New York Times. The New York Times, 14 July 2011. Web. <http://www.nytimes.com/2011/07/14/technology/spotify-music-streaming-service-comes-to-us.html?pagewanted=all>.

4.  Bradshaw, Tim. “Spotify Hits 3m Subscribers to Improve Conversion Rate.” Tech Blog. The Financial Times, 26 Jan. 2012. Web. <http://blogs.ft.com/tech-blog/2012/01/spotify-hits-3m-subscribers/>.

5.  IFPI. Digital Music Report 2012. Rep. IFPI, 2012. Web. <http://www.ifpi.org/content/library/DMR2012.pdf>.

6.  Peoples, Glenn. “How Spotify and Rdio Are Desocializing Music Streaming.” How Spotify and Rdio Are De-Socializing Music Streaming. Billboard Biz, 5 Sept. 2012. Web. <http://www.billboard.biz/bbbiz/others/how-spotify-and-rdio-are-de-socializing-1007933952.story>.

7.  Bertoni, Steven. “Spotify Launches Another Torpedo At Pandora.” Forbes. Forbes Magazine, 19 June 2012. Web. <http://www.forbes.com/sites/stevenbertoni/2012/06/19/spotify-launches-another-torpedo-at-pandora/>.

8.  Bartz, Andrea. “3 Spotify Apps for Music Geeks.” CNN. Cable News Network, 11 July 2012. Web. Nov. 2012. <http://www.cnn.com/2012/07/11/tech/web/netiquette-spotify-music-apps/index.html>.

9.  Billboard Staff. “Spotify Rolls Out Browser-Based Music Player in Beta.” Spotify Rolls Out Browser-Based Music Player in Beta. Billboard Biz, 15 Nov. 2012. Web. <http://www.billboard.biz/bbbiz/industry/digital-and-mobile/spotify-rolls-out-browser-based-music-player-1008016352.story>.

10.  Adegoke, Yinka. “Spotify Raising $100m for Expansion, Opening in Latin America, Eastern Europe Next Year.” Billboard Biz. Billboard Magazine, 11 Nov. 2012. Web. <http://www.billboard.biz/bbbiz/industry/digital-and-mobile/spotify-raising-100m-for-expansion-opening-1008010152.story>.

11.  “How Do I Get Paid from Spotify?” How Do Artists Get Paid on Spotify? Spotify, 2012. Web. <http://www.spotify.com/us/work-with-us/artists/get-paid-from-spotify/>.

12.  Krukowski, Damon. “Making Cents.” Pitchfork. N.p., 14 Nov. 2012. Web. <http://pitchfork.com/features/articles/8993-the-cloud/>.

13. Choquette, Frederic. “Reassessing Spotify.” The Music Business Journal. Berklee College of Music, May 2012. Web. <http://www.thembj.org/2012/05/reassessing-spotify-2/>.

14. Peoples, Glenn. “Why Taylor Swift’s ‘Red’ Is Absent From Subscription Services.”Billboard Biz. Billboard Magazine, 23 Oct. 2012. Web. <http://www.billboard.biz/bbbiz/industry/digital-and-mobile/business-matters-why-taylor-swift-s-red-1007988042.story>.

15. Jurgensen, John. “A New Way To Break a Band.” Wall Street Journal – Eastern Edition 09 Nov. 2012: D7. Business Source Premier. Web. 18 Nov. 2012.

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