The music industry once again is on the tipping point of another digital transformation, this time moving away from CD’s and downloads and into the world of streaming services like Spotify, YouTube, and Pandora. As consumers continue to stream more music over the Internet and on their smartphones, major investors outside the industry are beginning to turn their heads towards a business model that may be the future of how we listen to music.
Spotify, which has more than six million paying subscribers, continues to be the leading company in the increasingly popular world of online music streaming. The subscription service has secured major funding both overseas and within the U.S and the company is valued today at well over $5 billion, a staggering amount. To give perspective to this number, according to PricewaterhouseCoopers the worldwide digital music industry is expected to grow into a $12 billion industry by 2016 at an annual growth rate of 7.5%.1 Points of tension, however, include how the service will turn an annual profit, manage artist royalty payments, and increase its subscription user base.
Spotify seems to be preparing for a multibillion dollar initial public offering in the U.S sometime this fall. Rumors first surfaced in February when the company published a job opening for an External Reporting Specialist to “prepare the company for SEC filing stands and set up all reports necessary to be SEC compliant.” According to sources, the company also received a $200m credit facility from Morgan Stanley, Credit Suisse, Deutsche Bank and Goldman Sachs.
The Stockholm start-up also recently acquired music intelligence company The Echo Nest for an estimated $100m2. This arrangement will give Spotify key tech information and data from a company that powers the majority of Spotify’s competitors, including Rdio, iHeartRadio, Deezer and Rhapsody. It will also provide Spotify with a new source of revenue, through analytics on trending artists and licensing its technology to outside partners for playlist creation.
While the company has only entered informal discussions with investment banks and has yet to release any official statements on the matter, it is clear they are taking all the steps necessary to go public. In order for Spotify to launch a successful IPO however, it must show a healthier income sheet. The company’s revenues more than doubled to €435m in 2012, but losses widened to €59m as receipts had to be paid to record labels and for licensing fees3.
Spotify’s financing rounds include investments from major companies and banks from outside of the music industry including The Coca-Cola Company, Goldman Sachs, Fidelity Ventures, and Technology Crossover Ventures. Clearly, as music-streaming platforms continue to expand around the world, key companies are turning their heads towards a model that appears to be the working when the majority of digital music companies struggle with building sustainable businesses.
Coca-Cola and Spotify first announced their strategic partnership in April of 2012. The deal, which combined the global scale and reach of the worlds largest beverage company with Spotify’s immersive music technology platform, is meant to give consumers around the world unprecedented access to the music they love. The agreement included utilizing Spotify’s technology to power Coca-Cola Music globally and integrating Spotify into the Facebook and Timeline brands, the latter with an audience of over 40 million fans4. The deal also included using the Spotify API to reach new users through different applications – the first being a branded app used for the 2012 Olympics in London. As Spotify continues to tap new markets, these well-known consumer and social media brands plan to continue their unique partnership with Spotify in an effort to connect and share music with people around the world for their own purposes.
In particular, Coca Cola’s new interest in music technology advances and demonstrates a potentially massive new source of investment for digital music companies5. Moreover, the storied VC firm Technology Crossover Ventures made its biggest investment ever betting on the fact that Spotify will either be bought handsomely or go public in the near future.
Spotify first launched in Sweden in 2008, and has since expanded into 56 countries including the U.S and most recently Philippines. Prior to launching in the U.S in 2011, the startup secured funding and popularity in Europe before expanding globally into new markets. The music service additionally landed key licensing agreements with Universal Music Group, Warner Music group, EMI Group, Sony Music Entertainment and Merlin bringing more than 15 million tracks to American users. The five music groups own a combined 17% share in the service6. Equity was traded in lieu of a cash payment for the music licenses.
Digital music companies are increasingly faced with pressure to expand globally and gain market share. Spotify’s competitor Deezer recently announced plans to launch its service in 200 countries including Canada, Latin America, Africa and Asia7. The company has yet to move into the U.S, due to market saturation (Spotify, Rdio, Grooveshark have already debuted there). The race to gain control of new territories will be marked by music streaming services ability to keep a local bend to content they feature on their platform across international borders.
As the digital music industry continues to grow and major investors begin to recognize on-demand streaming services as a progressive step forward for the business, big questions remain. Subscription services like Spotify and Pandora have yet to turn an annual profit, despite being on track to double by 2017. According to a new analysis, the barrier to profitability for streaming music is the 60-70% of revenue each services pays to labels, publishers and artists8.
Musicians have widely criticized Spotify’s service claiming it is hurting the record industry and that both new and established artists are hardly getting paid royalties. In an effort to be more transparent on the topic, the company introduced a new Spotify Artist page, which attempts to break down in detail the business model and how royalties are distributed. Since 2013, the music streaming service has paid $500m in royalties to rights holders and $1bn total since 2009, totaling 70% of its revenue9.
The fundamental problem at hand, however, is the fact that users will still consume large amounts of music for free, but converting them to paying a monthly subscription fee is exceedingly difficult. According to MIDiA Consulting, only 4-5% of music consumers in America and Britain have signed up for subscription streaming. “If just 10% of the people in rich countries were to subscribe, the industry’s fortunes would be transformed,” says Claudio Aspesi of Stanford C. Bernstein10.
The music streaming market is still very young and will increase considerably in 2014. Smarter smartphones, faster Internet connections, and online cloud storage space will make this a very competitive space, especially as tech giants like Apple and Google are expected to roll out their own streaming services. Still, executives in the record industry are looking at this transition as the dawn of a new golden age.
By William Kiendl