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.

Sonic Boom: How Spotify Acquiring The Echo Nest Remakes Digital Music’s Landscape

The Echo Nest: now part of Spotify
The Echo Nest: now part of Spotify

Whoa! Did you hear that? If you’re in the digital music business, that ear piercing sound you just heard is the cracking of the industry’s landscape. Maybe not right away, and maybe it won’t cripple many companies, but the fact that Spotify purchased The Echo Nest today puts a spotlight on the challenges all the companies that partnered with the music discovery company now face. And even beyond that, it could give Spotify a huge advantage.

The Echo Nest powers music discovery for quite a few of the music services, from Rdio to Rhapsody to iHeartRadio to Vevo. The companies use it primarily to run their radio services. But the service can take any piece of content–tracks, albums, playlists, radio, similar artists, or genres–and create recommendations. And The Echo Nest makes the recommendations personal for each of their client’s customers. The service provides the company with all the plays that a customer logged and The Echo Nest creates a ‘taste profile’ for every user. That, in turn, guides the recommendations algorithm.

Within an hour of the announcement, an exec from one of Echo Nest’s customers told me that The Echo Nest said they will fulfill their contract, which he understood to mean that after the contract is up, his firm will need to build a recommendation algorithm. “It’s tractable work. It just requires time and money,” he said.

And talent, too. Let’s not forget that part of the equation. What has made The Echo Nest so attractive to music startups is the peerless quality of their algorithm. To create a great algorithm, you need to understand music, you need to understand technology and you need to understand cultural significance. These are three different skillsets that don’t naturally go together and getting them to work as successfully as The Echo Nest has, for a massive number of customers, is extremely challenging.

So unless startups are willing to create highly skilled teams of musicologists, machine learning Ph.Ds. and engineers that know how to tap big data, a company isn’t going to get close to what The Echo Nest can do. Conservatively it’s at least a million bucks to get into the game, and probably more than that just to get to parity with them. And instead of development times taking a minimum of a year, The Echo Nest can get you up and running in about a month.

But here’s the thing: to do a deal with The Echo Nest, a company most likely chooses to not build its own algorithm, which is what all these companies are staring down the barrel of today. Everyone who is a customer considered The Echo Nest to be a neutral partner that didn’t play favorites to any of their competitors.

But not everyone thought about it this way.

When Spotify launched their radio product in 2011 it was with The Echo Nest’s algorithm, but it quickly developed its own. Why? The company knew owning its algorithm was strategically important. Beyond that, it might not have wanted to hand over customer play data to personalize the system. And that’s where this deal gets very scary.

Think about play data for a digital music company like you’d think about a country’s natural resources. It contains amazing insights of what customers like, what songs relate to each other and a great deal of intelligence about customer behavior. But just like getting natural resources out of the ground, it requires a big data infrastructure to mine it and make it actionable. Some companies have invested in heavily in this infrastructure, but most have this data—perhaps a service’s most important asset—buried deep in within their usage logs.

It just so happens that The Echo Nest has all this data—from all of its customers—to power its algorithms. Services are very protective of this data and are therefore extremely concerned about exposing their streams to competitors, and of the ability for The Echo Nest to potentially centralize the data and create products that show a total view of online listening.

But here’s my question: did Spotify just get access to all the listening data for all of The Echo Nest customers? Even if it does not commercialize it, just seeing that data could lead to enormous advantage for the company.

Look, all these services have different customer bases. An iHeart customer is very different from an Rdio one. Rhapsody customers listen differently than an Xbox one. Insights on how these music fans are different (and are alike) would give Spotify a total view of the listening universe, which could help in everything from tuning their algorithm to targeting customers for acquisition.

And if Spotify wants to continue to sell The Echo Nest’s algorithm, wouldn’t that give the company an enormous, NSA level of music playback? The company confirmed today that they’re pulling out of the algorithm business for other platforms once all the terms are up. But if you want to build an app on the Spotify ecosystem, you can have access to The Echo Nest’s goodness.

Daniel Ek has built Spotify into a company with the best technology in the industry. He’s now bought the shiniest tech toy on the market and he’s taking it home to play with it. Alone.

Algorithmic-Free Linkage

TechCrunchTogether, Spotify And Echo Nest Want To Build The Facebook Connect Of Music

GeekwireSpotify acquires music discovery service The Echo Nest to the dismay of Rhapsody, Xbox Music

HypebotSpotify and Beats Music Acquisitions Illustrate Differing Strategies

Gigaom: Spotify Acquires The Echo Nest and Its Musical Smarts

The VergeSpotify Could Be Making Trouble for Rdio

How Streaming Music Continues to Fail Artists

Streaming services could get fans as close to their favorite artists as they get at SXSW.
Streaming services could get fans as close to their favorite artists as they get at SXSW. That’s Alabama Shakes in 2012.

Perhaps it’s the news cycle, the launch of the next-big-thing or just simply boredom with the topic, but it sure seems like we’ve forgotten the meme of artists getting ripped off by music startups.

Nearly all last year this was a huge topic with artist like Thom Yorke and David Lowery menacing pitchforks at Spotify and Pandora. One of the major problems with the streaming services is they can’t have a frank and honest conversation about how much they pay for their content.  Because of their confidentiality agreements, they are bound to not discuss the financials of their deals with major labels. I’m sure it’s frustrating for Daniel Ek to pay out a billion dollars for the rights to music only to hear David Byrne call Spotify evil.

In December Spotify posted an extensive site that breaks down everything from the formula used to determine payments to specifically how artists are compensated. While the site lays it all out nicely, it kinda buries the real message to artists. The unsaid message goes something like, ‘We paid out a crapload of money for the music. But we don’t pay you directly. We pay the label, so go talk to them.’ Also it shows how future growth will make those moderate sized payments grow to gargantuan numbers, which you need to squint really hard to see.

Fair enough. At least when you consider music playback. But I don’t consider that enough and neither should artists. You see, streaming services really should be vibrant active communities of fans who love their favorite artists. But today, they most definitely are not. They are primarily flat, with stale boilerplate content and the charm of a filing cabinet. Even the recently launched Beats Music had nearly the same execution of artist pages as all the other services, (although I have seen some screenshots of a nice implementation of Topspin’s artist commerce in the app, so I’m assuming that the features will roll out soon).

What streaming services must do is find a way to authentically connect fans to the artists they love. And they should provide ways for the artist to directly speak to fans on their platforms. It’s one of the trickier problems for artists today. Fans are listening everywhere from Pandora to Spotify to Soundcloud to iTunes. But unless the fan reaches out directly through social channels or the artist’s website, they won’t know what the artist is up to. And if they’re not paying attention, a fan can miss it on those channels too.

Let’s take a “use case” as we say in product development. Let’s say I happen to be walking through Billy Reid on Bond Street and I ask the well-coiffed dude behind the counter what was that beguiling song emanating from the speakers. “Oh, that’s Lord Huron. Great band.” I pull out my smart phone, download it using my favorite streaming service and dig into it for the next week. But when I finally get around to checking out the band’s Facebook page for concert dates, sure enough they played in Seattle two nights before. Fail!

My service knows I like the band, since I’ve played it incessantly for the past few days. And since I have the app downloaded it also knows where the hell I am. So why can’t it suck in all the concert dates and let me know that I’m about to miss the band in a super small venue (The Crocodile in this case)? And maybe I couldn’t get to the Crocodile, but I should be able to buy a poster or a tee shirt, right? Maybe I want to connect directly to their @lordhuron and read all their updates while I listen. And why can’t it look at all the other verified @artist tags that Lord Huron is following to give me a list of bands that I might like?

Let’s keep in mind, my use case is of an, um, older demographic. There’s a whole generation of fans who crave direct connections with artists and their needs have yet to be defined. There is so much discovery work that needs to be done to figure out what those products and offerings should be. We’re just getting started on what the best product will look like and what people will need.

Services need to shift the way they are thinking about artist engagement. It’s not just a place where fans listen to music. It should be a place that unites the information and offers from artists to create a unified solution for the fan and also be a platform for artists to market directly to the fans that care most about them.

The bad PR streaming receives right now is because they haven’t scaled enough to make up the revenue difference in flagging physical and digital sales, and these services are hot so they become the punching bag. But the services do have the superfan, the ones that live and die for the artist. They might still buy all the band’s CDs. They make it a priority to see the band when they roll through town. They might even buy a $1500 ticket to take a cruise or travel long distances to see a festival.

Solving this problem should be one of the top priorities for every service out there. Until the day that happens, we’ll be talking about the micropayments for plays and waiting for scale. I’m sure this is discussed at every service, as we used to talk about it all the time. There have been a few early initiatives, like Spotify’s integration of Topspin commerce into their desktop applications or Rhapsody linking Bandpage’s Experiences within their apps, it hasn’t been focused on mobile and personal, which are the two key ingredients for the fan to take action. Addressing those valuable modes will power increased engagement and, hopefully, revenue.

Trust me, I know all too well the jammed up product roadmaps that services must juggle. There multiple competing projects all the most urgent priority. But completing this work will go a long ways toward changing the conversation and building new value for both artists and streaming services.

Links for the Obsessive

The GuardianWhy David Byrne Is Wrong About Spotify

MediumWhat Streaming Music Can Be

WSJ (Requires $$$): An Ode To Joyous Streaming

Hypebot: The Barriers of Music of Music Listening: Past And Present

Viacom BlogMTV’s Music to the M Power

Post-cociousDavid Byrne Tells Streaming Services To Get Off His Lawn