Following Their Own Beat: Spotify’s Ambitions Outsize Anyone in Digital Music

In December of last year Spotify held a press conference to announce the service had finally bagged a big one: longtime-streaming holdout Led Zeppelin. The service now had the band’s legendary catalog of albums, clearing one of the last major artists not on streaming services. The press fell all over themselves raving about what a big deal it was to finally woo the elusive holdout.

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Spotify Founder and CEO Daniel Ek has global ambitions.

In the same press conference Daniel Ek announced something even more important to those involved in digital music. After months, if not years, of negotiations with labels, Spotify announced shuffle play—the ability to play any artist in the Spotify catalog for free on mobile devices. Shuffle play is exactly what it sounds like: a customer can play songs from an artist’s catalog only randomly instead of on-demand. But it does mark the first time that rights holders had allowed a free product on mobile after years of insisting that mobile access was, and always would remain, a paid product.

Spotify was not about to take no for an answer. Daniel Ek clearly has seen the trends in mobile and knows that the world is increasingly connected through their phones. Maybe you can reach scale with free on desktop in Europe and the US. But most of the world only has mobile access. The company had to have a free mobile offering to execute the company’s overall strategy. So Spotify cajoled, threatened, begged, and–most assuredly–wrote a big freaking check, to get free access on mobile.

It’s not the first time that Spotify has done something very difficult that other streaming companies couldn’t get done. It actually has made a habit of it. When Spotify was ready to come to the US, it won over execs nervous that free music would wipe out the world’s richest music market. After a couple years of trying in vain to best The Echo Nest in recommendations, the company bought it outright.  When Spotify couldn’t gain label okay for their bundled Sprint deal, it went ahead and launched without all the agreements in place.

Nobody in digital music has the determination, guile, brass and—maybe most importantly—the ability to raise money by the boatload to execute their vision.  And on the heels of Apple’s rumored purchase of Beats Electronics, it’s I’m important to understand the difference between a me-too streaming service and a firm as disruptive as Spotify.

A Global Media Channel

Spotify isn’t comparing itself to other music services, or even other digital media companies. Ek sees the company as a worldwide channel of music listening.  If someone is listening to music, from Beijing to Auckland to Los Angeles to Nairobi to Stockholm to Rio, Spotify wants to be the customer’s solution.

To execute that strategy the company has created two offerings–a free and a subscription service. Both are extremely challenging businesses build and manage, but just like overcoming label qualms, Spotify is undeterred. Imagine a company deciding to build both Pandora and Beats Music from scratch at the same time and rolling it out around the world.

The services work in tandem.  Spotify needs a huge base of free users in order to identify those customers to pay for music and build an audience for advertising. And once a customer uses the product for a fair amount of time, they are hooked. So if they are paying, or just convert into the free tier for a while, it just means another impression for brand advertising.

The company believes in this double-barreled approach to revenue and users will make it the dominant channel of music playback around the world. After rumors the Beats/Apple news floated last week, some in the media wondered if Google would now acquire Spotify. Spotify doesn’t see it that way. The company believes that their main competition is YouTube, the only other global digital media channel.

Faith In Free

Of the two services, the one that requires more of a leap of faith is the free service. Spotify believes that a worldwide audience of music lovers will loosen the pocketbook of global brands who will pay a premium to advertise to the audience. Spotify has already had some success in this arena with a global Coke deal. While most advertising businesses in music focus on local ads, Spotify is different. The company intends to continue to carve off a certain number of customers into the paid tier. And it will need to because the costs of the free service are astronomical.

Why so expensive? It’s all about the content rights. To launch in the United States, Spotify had to work on the labels for a long time, nearly a year, to get the licenses for music. In the end, Spotify agreed to pay for every free play and paid a significant advance—rumors had it around $200 million—to launch in the US. Compare this to YouTube, who has virtually no content costs. But Spotify believes the blend of converting a number of free users to paid, along with the advertising revenue will cover the costs.

Here’s where it gets tricky. While it might make good sense to spread the costs of the free service with paid customers, most folks running subscription music businesses have had a hard time making the model work, due to massive subscriber acquisition costs (SAC) and, maybe most importantly, the rate at which customers leave a service, otherwise known as churn. While Spotify’s SAC is covered in the free product, Spotify will, eventually, have to get their churn to a reasonable level.

But that’s for another day. Today the market is strongly favoring those who can show growth. And Spotify’s growth, in particular with its paid subscribers, has been astounding. The company is privately saying it’s at 10 million subs, though not  officially announcing that number.

IPO, Belly-Up or Bailout?

Even with the company’s great vision and uncompromising execution, it’s not clear that Spotify will succeed.  The company has raised nearly $600 million in venture funding and remains nowhere near profitable. Spotify is readying an IPO for later this year which will be required as it will need to make more investments to launch into Russia, India and China, territories that are necessary to be a worldwide music channel. But getting an IPO out later this year looks suspect, as there is growing concern that we’re in another tech bubble. If Spotify can’t use the public markets to complete their expansion, it will have to make very painful decisions.

A former colleague, who always was skeptical about their financials, said that Spotify’s future was either to be one of two troubled company’s–Lehman Brothers or General Motors. Once Spotify reaches significant scale of, say, 20 million paying subs and 60 million free users, the company will control enough of label revenues that it’ll be able to demand a much lower rate. At that point the record labels will need to decide if they provide a bailout or let Spotify go belly-up.

One thing is clear. Regardless of the high stakes, Spotify will continue to play their game.

The Magic Numbers: How Apple Beats The Demise of Music Downloads

There are two numbers that you need to pay attention to in order to make sense of Apple’s breathtaking acquisition of Beats Electronics. Neither of them is the rumored $3.2 billion price. They are 13.3 and 800 million.

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Apple’s saint Steven P. Jobs  said customers wanted to own their music. Not anymore.

The first number is the percentage that music downloads have decreased in Q1 of this year compared with 2013. This is on the heels of a 5% decrease last year, so it’s looking like the decline is picking up speed. It’s pretty clear that the download era is waning and Apple knows this better than anyone. I’m sure the company has a phalanx of data analysts poring over projections and understand that the rate that customers buy downloads might not be in a freefall, but it could be coming quicker than anyone expects.

It’s pretty clear when it comes to the choice between buying downloads or using a streaming service, customers are beginning to choose streaming. But so far, Apple has sat out of the subscription music trend. After all, the Book of Jobs says that customers wanted to own rather than rent music.

Those days have passed. Apple needed to hedge their bets and get into streaming. But instead of building another bolt-on to iTunes as the company did with their underperforming radio service, Apple decided to speed their way to market by purchasing a hot new service that had a lot of buzz, but hadn’t scaled so much that it was prohibitively expensive. Beats is the most viable of all acquisition targets.

While music purchases may be falling, it’s still a big business for Apple. So instead of creating another option in iTunes that would potentially cannibalize download sales, why not just buy a service and keep it separate? Streaming blows up: Apple wins. Streaming doesn’t pan out, well, it will still have the iTunes store chugging along.

In The Cards

The second number refers to the 800 million iTunes accounts, most with credit cards on file.  Those credit cards are the keys to the kingdom for anyone who wants to sell something in the store. Apple charges a 30 percent premium for companies to use their in-app purchasing system, where a customer can subscribe directly from the native app.

After Beats Music’s troubled launch period didn’t produce many subscribers from the 7-day trial, company executives were calling around to see how other firms dealt with the 30 percent Apple tax (answer—you eat the $3 per customer a month).  In late April, Beats launched in-app purchase and the results were stunning. Their iOS app became the number one overall free app.

Just as important as in-app purchase is getting featured in the iTunes store. Placement in the iTunes store can make a hit out of an app and can mean hundreds of thousands of downloads. Combined with in-app purchase, the store is a kingmaker that can make or break a company. So once Apple integrates the Beats app, it wouldn’t be surprising that the app will get a permanent featured position in the store. Cha-ching.

Oh, and that $3.2 billion price tag? With Beats Electronics’ hardware business already creating significant profits, Apple’s purchase price could be covered within a couple years. So in essence the company is getting into streaming music for a song.

More Acquiring Minds

FT: Apple In Talks to Acquire Beats

Re/Code: Why Apple Is Betting Big On Beats

Om.co: On Streaming: Apple, Beats & Spotify

Apple Insider: Jimmy Iovine Set To Join Apple?

The Tipping Point: Streaming Music Finally Delivers The Goods

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Source: RIAA, reports from Pandora, YouTube and NPD plus a healthy amount of guesswork (see note on numbers at end of article)

The RIAA recently released US music industry statistics for 2013 and it’s good news for the streaming services. More than six million customers subscribe to a service like Spotify, Rdio, Rhapsody and others. And these companies are providing a massive amount of money for the industry. Those six million created over $600 million in revenue. These are far and away the most valuable music customers, dwarfing the amount of money that each CD purchaser, ad supported (e.g. YouTube) or digital radio user contributes.

Based on the number of purchasers from NPDs 2013 Annual Music Report and available estimates of YouTube and Pandora users, subscription users are worth more per user than all the other major categories combined.

A Mixed Bag

I’m sure many artists and management firms are saying ‘that’s great, but why am I not seeing the money?’ Two reasons: scale and deals. First, only 6.1 million customers subscribe, which is the smallest reach of any other recorded music product. How does it compare? Well Pandora reports 140 million active users on mobile. YouTube says it has 156 million actives per month, with nearly 40 percent consuming music. NPD estimates that 44 million bought at least a single track in iTunes. Six million pales in comparison.

What’s also unclear are the rates by which artists are compensated by streaming services. A vast majority of the streaming deals for master recordings are with major label groups and indies. While many indies have said they split revenues 50/50 with artists, understanding what an artist receives from a major label deal, often executed well before streaming services existed, is a dark art. The industry could do much better by committing to transparent and standardized reporting, where every deduction is laid out and an artist can see how many plays of their repertoire were on Spotify and understand what it means to their pocketbook.  But then again, mysterious accounting has been the labels’ modus operandi for many decades.

Varying The Product Portfolio

WME’s Marc Geiger mentioned at MIDEM this year that all we have to do is build scale. This is the one flaw in his excellent speech. Instead of expecting everyone will pay $10 a month, the industry needs to consider many more options that focus on different ways fans listen and value music.

Source: RIAA
Source: RIAA

I have been beating the drum for subscription services to diversify their products. While 6.1 million people paying $10 a month for all you can listen to music products is great, we need to grow the number of people who pay for a music subscription. The truth we must accept is that the average person does not–and will not–spend $10 per month for infinite music.  They just won’t. There are too many free options and most people are happy with a much smaller slice of the music universe. Instead, we need to redefine how we package and market digital music. What’s the music app that 30 million people will pay $1 a month? How about a $3 and $5 price point?

To grow the number of people who will pay for services, diversification of product offering must take place, even if the revenue per user drops closer to retail levels. Success is getting 50 million customers paying a range of prices that fit tastes and budgets. Not selling a one-size-fits-all product.

A note on the numbers: while the RIAA numbers for the revenues as well as the streaming subscriber count are accurate , I had to guesstimate on the other user counts. By cobbling together estimated revenue that each company contributes and comparing it to the active customers of each, I came up with a rough number, but without reliable information and transparent accounting, it’s just that–rough.

More Variable Priced Links

MIDEMMarc Geiger’s Keynote (Video)

RockonomicsIs a Spotify Free User Worth $1.50

Too Much Joy: My Hilarious Warner Bros. Statement

NPD: 2012 Annual Music Study

Robinson Cano

Televised Sports Meets Its Moneyball Moment

Sadly, non-subscribers can only read the excerpt of Ken Auletta’s amazing piece on Netflix and the television industry in last week’s New Yorker. I’d suggest you get a copy to read all kinds of amazing tales from the company, including a juicy little story about sitting down with the rental giant Blockbuster in the year 2000. You can check out Auletta explaining why television is not totally screwed on Charlie Rose.

I’m not sure if I completely agree with Auletta’s assessment that television (cable in particular) may not suffer the fate of music or newspapers. There are several icebergs of problems just waiting to crash against its hull. Like the fact that folks who don’t watch one lick of sports end up paying a fair amount of their bill every month for the programming. And then there’s the bundle problem where most customers are forced to pay despite the fact that they never watch most stations.

Cable and networks have seen their opportunity to attract huge audiences and sell expensive advertising spots whittle down to just live sports programming. Sports leagues are now extracting huge fees for the rights, and networks and carriers pass on the costs to all their customers.

Now even teams are getting in on the action. Time Warner Cable recently signed a deal with the Dodgers that is expected to add $5 to the cable bills of their Los Angeles customers, regardless if they ever watch the NL West champs or not.

While the NFL has delivered the numbers for television (Sunday’s Super Bowl reached an astounding 111.5 million viewers, the most watched show ever televised), other sports may have more of a problem, leading to the belief that there’s a sports TV bubble that will someday soon to pop.

Robinson Cano
The Mariner’s huge contract with its regional sports network allowed the team to sign Robinson Cano to a $240 million deal, but will the money keep flowing?

Many baseball teams have followed the Dodgers’ lead and are attempting to build regional sports networks that will bilk cable and satellite operators for massive fees. Both the Seattle Mariners and Texas Rangers signed huge deals with their regional networks, giving those franchises massive spending ability.

But now the carriers are getting smarter. Wendy Thurm in FanGraphs wrote last summer that three Houston carriers are now refusing to pay the fees to show both the Comcast Sports Network Houston, which carries both the Astros and Rockets. DirecTV and AT&T are using advanced metrics to judge the value of the watching, and they’re finding these metrics wanting. Neither of the services offer CSN Houston, leading to 60 percent of the city without either teams on TV. CSN Houston is partially owned by the Astros and Rockets. When the Astros first signed the deal in 2010, it called for the team to be paid $80 million a year.  Thurm reports that the team only received $25 million because of revenue shortfalls.

Jeff Weber, president of content and advertising for AT&T told the Wall Street Journal “You start to think about not just viewership, but a broader phrase—viewership intensity.” So how long a TV set is tuned in and how many times in a seasons a household watches a sports team goes a long ways towards determining if it’s worth the price. Call it the Moneyball of Sports Television, where the data geeks drive business decisions.

There has been much hand-wringing in the past couple years about cord cutters–folks who just had enough and use Netflix, Hulu, iTunes and about 100 other services for all of their entertainment.  Moffett Research reported that pay television industry lost 360,000 from June 2012 and June 2013. It’s the first time there’s been a loss in pay television subscribers. Expect it to increase as costs continue to rise.

These two disruptive changes: the adoption of devices and video services and the rise of big data analysis is now finally starting to rationalize what the consumers have been telling us for years. Television is too expensive and consumers only want to pay for what they use. This seems like a fairly intuitive, simple lesson that technologists continue to address. The side benefit is that the bundle is starting to fray.

Read On

The Atlantic: Sports Could Save the TV Business-or Destroy It

NY Times: Rising TV Fees Mean All Viewers Pay to Keep Sports Fans Happy

Fan Graphs: Dodgers Could Be Last Team To Strike Gold With Local TV Deal

Wall Street Journal (subscription required): Cable Providers Revolt Over Sports Costs

Defense To The Rescue

At the conclusion of Sunday’s dismantling of the Denver Broncos, Seahawks linebacker Malcom Smith stepped onto the weird post-Super Bowl stage and accepted the MVP award for the game. Smith had an awesome game, returning a pick 69 yards for touchdown, recovering a fumble and racking up nine tackles. But they might as well have given the MVP to the entire defense, as it’s been an amazing group all year long.

Sunday’s bloodbath made Peyton Manning’s remarkable offensive year seem besides the point and it really makes it seem like we’re finally seeing the tide turn in the NFL. After 10 years of getting the West Coast offense shoved down our throats thanks to aggressively shackling of defenses, we’re finally back to an era where defenses define the sport.

The NFC and in particular, the NFC West, is where the trend is really on display. Three of the top seven teams live in the West and have been busy beating the crap out of each other. The only team to beat the Seahawks at home in two years is the massively improving Arizona Cardinals, who boasted a great defense. The Niners also featured a dynamic defense, they ranked third in football after the Carolina Panthers and Seahawks and when  they got a few of their key defenders back on the field at the end of the season, they amped it up. The Niners were playing best in the league down the stretch and who knows how that amazing NFC Championship game would have turned out if the Niners had home field. A rematch between the teams would have been much more intriguing instead of watching Denver fall apart.

Any of the top four defensive teams (Seahawks, Niners, Carolina and Saints) in the NFC would have cleaned the Broncos’ clocks on Sunday. Many had criticized Russell Wilson’s quarterback play down the stretch. But he faced some of the toughest defensives in the league late in the season and in the playoffs. Having to face the Niners’ Justin Smith, Ahmad Brooks, NaVarro Bowman and the likes will make any good young quarterback look average, if not worse.

The Seahawks defense was beyond super all season. On Sunday they took it to another level by getting pressure on Broncos offense from the first snap. The heart of the defense is its secondary and they took away anything deep and left only short passes that ended up getting defended immediately. And then the defensive line just bullrushed Peyton, leading to a couple of the famous ‘ducks’ that Richard Sherman pointed out this past week.

Coach Pete Carroll is a deep thinker about defense, and there are a couple remarkable deep dives into how he thinks about implementing the plan and his approach to the game. “There is no offensive play calling or defensive scheme that is going to win national championships for you,” Carroll stated at a Nike coaching clinic from a few years back. “It is how you can adapt and adjust to making the schemes work. The only way you can do that is to have a strong belief system. If you can’t say what your philosophy is or tell others what you believe in then you don’t have a philosophy.”

Looks like his philosophy reigns in the NFL.

Other Thoughts

Seattle’s Win Could Transform the NFL

Breaking Down The Dismantling of the Denver Broncos

Pete Carroll’s Defensive Philosophy

The 4-3 Under Defense