Growing Concerns: Does Music Subscriber Growth Cripple Profitability?

I recently wrote about how Rhapsody is facing issues as it expands to a worldwide audience and partners with cellphone carriers in Europe, Latin America and the United States. Part of my analysis centered on shrinking margins from signing up new customers on services and how difficult it becomes to manage the business when you don’t control the customer base. I also pointed out how relying on other companies to do your marketing erodes your brand, leading to a limited retail funnel.

Disclosure: I worked for Rhapsody for nine years before leaving in September 2013.

Rhapsody’s 2014 results were recently released in a RealNetworks’ regulatory filing and there are two conclusions that are easy to draw from the report. (Note: RealNetworks owns 43 percent of Rhapsody and includes the company’s financials in its own 10K SEC filing.)

  1. The growth strategy is working. Outside of the reported two million worldwide customers Rhapsody recently trumpeted, the company also increased revenues by 23 percent in 2014 over the previous year. Rhapsody’s revenues are at $173 million a year, which are rumored to be much larger than those of Deezer, the France-based music service.
  2. The growth is coming at a cost to Rhapsody. The company lost $21.3 million in 2014, up from 14.6 million in 2013. And it’s just not overall losses that are mounting. Rhapsody losses are continuing even when factoring in subscriber growth. Based on its 2014 losses and its reported subscribers, Rhapsody lost $8.53 per subscriber last year, although the company has cut its loss per customer in the past two years.

Growth and Losses

Rhapsody’s losses are a drop in the bucket when compared to Spotify. In 2013 the company reported operating losses of $128 million. While the company didn’t report subscribers, it has been suggested the company had around nine million paying subscribers at the end of 2013, leading to a $14 loss per sub in that year.

Screen Shot 2015-03-03 at 12.38.58 PMIt should be pointed out that Spotify’s paying subs are supporting all the free users who generate very small amounts of money for the company through adverting sales. Spotify says that its average active user (a combination of paid and free) generates $41 per year in 2013, while Rhapsody generated $93 per sub for the same year.

To grow, Rhapsody not only saw losses per sub drift slightly upwards, it also had to eat into its margin. In 2014 revenue per sub sunk to $69. And Rhapsody’s growth isn’t coming anywhere near Spotify. In fact, the Stockholm based streaming giant’s growth is outpacing every company in the industry by a wide margin. It now has over 15 million paying subs and 60 million worldwide users. Spotify picked up six million paying subs to Rhapsody’s one million in 2014.

So what does all this mean? A few conclusions.

  1. Brand Matters: In the excellent MusicREDEF newsletter, my friend Matty Karas recently mused, why when people talk about streaming music, they only refer to Spotify. There are scores of companies with offerings, many of them in business for a long time. But Spotify has broken through and is on-demand streaming’s only household name. Its brand has fueled incredible subscriber and free user growth for the company.
  2. The Model Matters: What makes this so intriguing is the three distinct approaches these companies have taken for on-demand streaming.Rhapsody traditionally focused on all paid customers, utilizing their own retail channel, before pivoting to distribution partners for growth. It has achieved modest growth, but at a significant operational cost.Deezer only operated in territories with carrier partners. The results? Deezer had significant subscriber growth, but the revenues are below Rhapsody. So to the outside world, Deezer looks like a much bigger deal than within the industry. Deezer also is facing competition for carrier deals. In a shift of its model, Deezer launched a high-bitrate service in the US for $20 a month, although the company has not been strongly marketing the product. Despite the massive amount of money raised and worldwide operations, could Deezer be the first huge causality in on-demand streaming?Spotify built its own customer funnel by giving away expensive free music and has found a way to significantly grow free users, paying customers and revenues. The costs have been astronomical, but Spotify is dominating streaming music, dwarfing all its direct competitors and–maybe even more importantly–reaching mass consumer appeal.
  3. Distribution Eats Margin: My last piece on Rhapsody suggested the company’s margins face significant downward pressure because of its cellphone distribution scheme. And now we see the numbers showing that erosion. Rhapsody will have to hope that a) it can sustain or even amplify its growth rate through partners and b) retain its own higher margin customer funnel. If not, Rhapsody’s revenue per sub will continue downward.
  4. The Economics Are The Economics: Regardless of approach or business model, on-demand streaming music is an expensive business to launch and operate. There’s no way around losing millions of dollars just to be one of few who survive. All left standing will require a huge war chest, access to raise even more money and the intestinal fortitude spend a fortune in content, distribution and marketing costs.
  5. More Pain Coming: Apple and YouTube are expected to roll out on-demand music services in 2015. The pressure to grow–and raise more money to pay for the growth–will increase on every company in the market. As the old adage goes: let the beatings continue until the morale improves.

More Growing Problems

Geekwire Filing Reveals $21M Loss for Rhapsody, Despite Jump in Revenue and Subscribers

NY Times As Music Streaming Grows, Spotify Reports Rising Revenue and a Loss

Bloomberg Spotify Hits 10 Million Paid Users. Now Can It Make Money?

Jonmaples.com The Roaring Mouse: Rhapsody Faces Its Future

2015 Digital Music Predictions

The past year was a doozy for digital music. We saw Beats Music come and go with a rush, Spotify grow significantly and digital track sales hit the skids as streaming continued to grow in popularity.

And for everything that happened, 2014 probably will be remembered as a transitional year. Big players like Apple and YouTube have yet to really show their cards. The impact of Spotify as a worldwide music platform has yet to really take hold. Many existing services still continue to solider on, despite significant changes that have impacted the marketplace.

The next 12 months will see a significant reshuffling of the deck of existing companies and new entries. We might also start to see the outlines of the future as the next generation of music companies start to debut. Because one thing that remains constant: there’s always someone who will invest in digital music, regardless of the financial results or past performance.

My picks for the top stories for 2015:

Say Goodbye: At Least Two Services Will Consolidate

We are moving quickly from a startup world into one where the big boys are playing. Apple and YouTube will join Amazon and Google Music Play All Access as the giants. While I have grave misgivings if their product offerings will be very good, it might not matter. With access to their digital stores, consumers might just activate the AppleStream or Music Key apps just because it’s simple.

Other companies will find themselves at risk, especially those who are forced to market their services directly to consumers. Rdio, Deezer, Wimp (Tidal in the US), Rhapsody, Slacker and a host of others will come under pressure to find alternative ways to market to customers, band together or go the way of other failed services.

YouTube Music Key Will Deliver A Flat Note

YouTube has the biggest opportunity to grow paid streaming products. YouTube has a massive audience, which is great. But their audience has been conditioned to consider the service free. There are signs that Spotify has already cannibalized YouTube’s consumers who want to pay for music, which might make it even more difficult for the company to get people to pay.

Because of this, YouTube’s paid subscribers will disappoint the industry during 2014. It might take a year or two for the company to perfect the product and find those who really want to pay for the service.

Apple’s streaming service will be a mess, and it won’t matter

The Cupertino geniuses do many things well. Streaming music has not been one of them. While it has the team from Beats Music to rely on, the company is known to ignore new talent acquired and turn it over to their internal team.

It wouldn’t be surprising to see their streaming service follow the iTunes Radio, which was supposed to be a Pandora killer, but just attracted those who use it because it’s already installed on their device. The company will get it right eventually, but streaming services are a completely different beast than anything it has tried. So expect some serious growing pains.

But because the service will be pre-installed on so many phones, it will sign up loads of customers through in-app purchase. Apple is also pressuring labels to lower the monthly cost of streaming, which could lead to solid growth.

Spotify Will IPO and More Artists Will Window

It is really difficult to judge how the public market operates and many things could happen that could affect Daniel Ek’s IPO prospects. We could see a downturn in the economy. Tech stocks could hit the skids again. The market might not like the prospects of the company’s future when it starts releasing business performance and data. But if Spotify overcomes all these hurdles, it will get its IPO out.

And regardless the stock price, a successful IPO will make many of its employees and early investors a lot of money. Expect to see a backlash from artists after this event, with more and more holding back new music on the service to give retail channels first shot at making money.

Pandora Will Become Musicians’ Most Hated Digital Service

Of all the companies in digital music today, none shows the most contempt for musicians and songwriters as Pandora. While the company has had some outreach, it also has tried to bend itself into a broadcast service to get a lower rate, decided to not pay a single dime for any song released before 1972 (as did XM Sirius), and then had the balls to countersue the ‘60s era group Turtles for violating its first amendment rights.

Pandora is already facing a firestorm for its exceptionally low payments to songwriters, but continues to aggressively lower royalty costs, regardless of how it affects its relationship with artists. While much of the money Pandora is trying to save goes to big corporate conglomerates, it’s the independent artists that always come to the forefront in these stories. Expect the hate to expand in 2015.

Amazon Will Continue To Play Its Game

Seattle’s commerce behemoth will focus on what it always does: keeping its customers buying more stuff. Many expected Amazon to offer a premium service in 2014, but instead the company created a back-catalog offering that kept customers in its Prime service longer.

The company had a rough 2014 with its failed Fire phone launch. While its nose is bloody from that setback, don’t expect that Jeff Bezos’ company will change its game plan. Focus on the customer buying: regardless if it’s a digital download, diapers or dishrags.

2014 In Review: Some of the best stories from the past year.

The Elephant In The Room: Another Cultural Landslide’s very complex and very loooong analysis of streaming music, discovery and the listener.

Streaming Report Card: Music industry analyst Mark Mulligan gives us a rundown on how streaming did in 2014.

Stop Blaming The Internet: Gang of Four’s Dave Allen gives a deep dive into the issues surrounding streaming and artists.

The Streaming Price Bible: David Lowrey’s in depth look at who’s paying what. While I might quibble with Lowrey about why those numbers are so low, the streaming rates on this post is illuminating and depressing.

The Album Cycle: Consequence Of Sound News Editor Chris Coplan looks at the nature of music promotion as the industry is changing.

Five Reasons The Music Industry Hates Pandora The Most: Music lawyer and blogger Jake London lays it out.

Spotify Has Six Years Of My Music Data, But Does It Understand My Tastes: Stuart Dredge digs into the taste profile.

Taylor Swift Announces A World Tour And Pulls Her Music From Spotify: Ben Sisario on everyone’s favorite spatting couple.