This is reposted from the original 3/16/19 post with some updated thoughts cross posted from SITALWeek #201 at the end.

A few thoughts on the music streaming industry as a loss leader and related competitive issues:

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People like music, but for whatever reason it’s been treated more as a public good than something people are willing to pay a lot of money for. What people are willing to pay per hour listened is shockingly low. Maybe millions of years of free and communal music around the campfire as the species evolved has wired us to expect it for free. When music programming is combined with some added element of distribution convenience, you see counter-intuitive examples of folks willing to pay (for example, the 35M Sirius XM subscribers paying ~$150+/year for programming in their cars despite the endless hours of content available for free or very cheap through phones or car radio). And, of course, the overall music streaming business is generating decent subscribers, revenues, and payments to record labels and artists. However, those fees paid by the distribution platforms (which are higher for streaming than radio due to historic industry dynamics that have been a legal saga for decades now) and other delivery costs are exceeding the money people are willing to pay for music. This creates a situation where the future of music streaming appears unviable. Unless, however, music is forever treated as a loss leader – a bundled service as part of a broader entertainment and services package offered by one of the big platforms – Apple, Amazon, Alphabet, Tencent, etc.

As the industry stands today, without a legal outcome to pay artists less, a standalone music streaming business like Spotify is dead long term – it won’t make it sustainable profits because people won’t pay twice what they are paying now to support its $25B valuation (currently analysts estimate Spotify would need to double their revenues to drive a meager single digit operating profit margin, which wouldn’t even support half of Spotify’s current market cap). Part of the problem is the distribution fees paid to platforms like Apple, which are well over-earning their keep at the 30% take rate for year 1 and 15% tariff on further years of subscriptions. This was the heart of the Spotify lawsuit against Apple this week in Europe and the hilarious and disingenuous response where Tim Cook plays the victim – as he weeps and accuses from his $900B Cupertino fortress that hasn’t produced any meaningful innovation or progress since the iPhone was introduced 11 years ago. This legal battle is unlikely to be resolved before Spotify faces existential evaporation.

One of the big differences between a music platform like Spotify and a video platform like Netflix is the ability to diversity with owned content. Netflix has pivoted to producing and owning much of their own content instead of exclusively paying high fees for content generated by others. In the music business, however, most of what we listen to is catalog and most of that is controlled by a small number of owners such as Vivendi and Sony. Spotify could go sign up the next 100 hit artists and try to own that content, but the majority of subscribers will still want the Beatles. This is one of the reasons Spotify has made a couple of large acquisitions in the podcast space and will try to shift their subscribers listening from music to podcast originals.

So, the reality is everyone wants music, but no one wants to pay for it, so it likely needs to be considered an essential platform element and it should be bundled and subsidized by big platforms in order to keep the entire system going so that labels and artists make their cut. Unless there is a major restructuring legally to pay artists less (artists already have to make the majority of their money touring as it is) or somehow buyout the record labels and eliminate all the catalog fees, streaming music will be a tough business. We like to look at power law and network effect economics, and the reality is there aren’t great network effects in music beyond a certain number of subscribers and the data they generate around listening habits – the first couple million listeners in each country give you enough to create playlists, but having 10M vs. 2M doesn’t add significant value in terms of data collection, and barriers for consumers to switch platforms are quite low.

This is a case where the highest NZS (non-zero sum or win-win) outcome is to bundle and subsidize music. This gives greater benefit to the artists, labels, consumers, and the platforms themselves which can create stickier and higher value product offerings, and compete with each other for consumers with the best set of bundled services. But, this of course leaves a really tricky situation for independent distributors like SiriusXM (which now also controls Pandora) and Spotify. Short of Spotify being acquired by a large Internet platform to become part of a loss leader bundle for music, the regulatory bodies will need to enforce lower app store fees and/or lower fees to musicians to keep independent streaming platforms viable.

It’s also possible we see more creative bundles to keep independent services viable outside the big platforms – the Spotify/Hulu bundle is a great and very successful example. But, let’s go further – why not bundle Spotify with transportation as a service and get a certain number of Lyft rides a month for a combined fee with a music streaming service? Or, how about Lyft rides, food delivery, music streaming, video streaming, etc.? Creating bundling to drive direct consumer relationships outside of the app store monopolies, lower churn, and higher NZS may create hybrid platforms to compete with the Internet giants for consumer wallets.

Update on 7/14/19, cross posted from SITALWeek #201

I had a terrific back and forth on Twitter this weekend regarding the piece I wrote on Spotify earlier this year about music as a loss leader and the challenges Spotify faces. I think the debate boils down to a fascinating open question regarding supply-side vs. demand-side network effects. There is a very good argument that Spotify is growing large enough to extract better economics from the labels. My counter argument is that people tend to anchor on certain artists from certain periods in their lives (like high school or college) well into old age. So, even though more and more people are discovering and listening to new artists, streaming services can’t get away with dropping the catalog. And, it’s a question of frequency – I might easily be able to live without my favorite movie on a video streaming platform, but a music streaming platform without Bob Dylan would be unusable to me. So, I think the power is a little more balanced with suppliers even as Spotify continues to grow. And, I think people may very well have multiple music streaming services, some of which may be part of a wide variety of bundles. We think a lot about non-zero-sum (NZS), or win-win outcomes, and I worry that every point of increased Spotify margin takes dollars away from the artists powering their business, i.e., win-lose instead of win-win. But, I wouldn't lose sight of the forest for the trees either, potentially billions of folks globally might be streaming music subscribers (or monetized through ads) creating more win-win. Another challenge to Spotify’s margins could come from more recent popular artists creating new, powerful labels through consolidation that have just as much bargaining power as the incumbent labels. I think Spotify would still be a home-run acquisition for Amazon, Alphabet, Apple, or Facebook, but that regulatory ship probably sailed already. Like many stocks I look at, Spotify really comes down to “I don’t know” for me – I can justify points on both sides of the argument, so I will keep absorbing data points as objectively as I can to sway my opinion one way or the other.

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