Spotify’s business model
In my eyes Spotify is one of the most interesting startups of the past few years due to its unique business model, strong product offering and the fact that it is striving to disrupt the music industry (and reduce piracy). As a member for over three years I thought it would be interesting to put together a brief strategic analysis on Spotify and throw out some thoughts on where I think the business and industry are heading. Just to quantify some basic figures, in its most recent filings Spotify clocked a $42m loss, up from $26m in 2009, even though the number of users quintupled (now boasting above 3m premium subscribers). Is this loss making history an omnipresent indicator of a product offering constrained by content owners that don’t readily adopt to new technology?
Spotify User Interface
History and growth
Spotify was founded during 2006 in Stockholm by Daniel Ek and Martin Lorentzon (featured above) after an autumn long brainstorm. The application was released to the public in 2008 under an “invitation only” registration so that Spotify could control user growth. The removal of the “invitation only” umbrella was in February 2009 – reflected by the sharper uptick in user growth in the graph below.
Estimated Spotify User Growth (Sources: Spotify, Quora, Mashable)
What makes Spotify appealing?
Spotify has experienced pretty solid user growth, but why? How have they convinced their 14 million users to stream songs rather than own them outright? First and foremost it is due to the streaming music being free, supported by ads, and also due to the fact that you have the ability to listen to the songs that you want too. In addition to this Spotify currently has a huge catalogue of over 15 millions songs (which is updated three times per week) – meaning even the most obscure of your requests will most likely be fulfilled, probably best to toggle private listening for that one! There is also the social aspect that they have been pushing hard ever since inception, which was only solidified by their Facebook pairing – it allows users to see what their friends are listening too as well as share songs easily. Intuitive interface and leading technology also contribute to its appeal – Spotify uses some particularly cleaver streaming technology to deliver instant high quality music. It uses a non web-based client that is essentially a form of peer-to-peer (P2P) network (similar to that of torrents) that can scale up to meet the demands of millions of users.
How did the Spotify name come about? (Via Daniel Ek on Quora)
This again takes us back to my flat that I had out in the suburbs of Stockholm. Martin and I were sitting in different rooms shouting ideas back and forth of company names. We were even using jargon generators and stuff. Out of the blue Martin shouted a name that I misheard as Spotify.
I immediately googled the name and realized there were no Google hits for the word at all. A few minutes later we registered the domain names and off we went.
We were a bit embarrassed to admit that’s how the name came up so our afterconstruction was to say that Spotify stems from SPOT and IDENTIFY.
Revenue generation (Quoted from the 2011 Annual Report filed with Companies House)
Sale of advertisements – The company sells advertisements on its service. Advertising revenues are deferred and recognised over the period in which the advertisement is displayed in the Spotify player provided that no significant obligations remain at the end of the period and collection of the resulting debt is probable. Sale of subscriptions – Subscription revenue is based on the actual number of activated Premium subscriptions and recognised on a straight line basis over the life of the subscription. Revenue from the partner sales premiums certificates is recognised from activation of the account on a straight line basis over the life of the subscription. If a certificate expires without activation revenue is recognised. The expiration time is 12 months from the day of the sale. Sale of Partner Subscriptions – Revenue from the partner sales premiums certificates is recognised from the date when the account is activated on a straight line basis over the life of the subscription. If a certificate expires without the account being activated revenue is recognised at the date of expiration. The certificate expires within 12 months from the date of sale. Interest Income – Interest income is recognised using the effective interest method. Dividend Income – Dividend income is recognised when the right to receive payment is established.
Founder Daniel Ek talking about how Spotify generates revenue:
We have different layers of rights that Spotify has deals with. Those are record labels, publishers and collecting societies. Artists/Composers in their turn have deals with the above mentioned parties. The deals artists have with labels/publishers tend to differ quite a bit and therefore it’s impossible for me to say what an artist actually gets in the end.
Spotify has three buckets of revenue. We get revenue from advertising, subscriptions and paid downloads. All of them are very different as a subscription is €10, a song is roughly €1 and advertising is a pool of revenue based on ads per month. We share the vast majority of all revenue we get in to all the right-holders.
Our part in the end is not that different from how the Apple app store works, where Apple sells apps and get a small percentage. What makes it slightly complex is that we have many more layers of rights in many different countries.
It’s important also to mention that what Spotify is trying to do is to increase the amount of people who are consuming legal music. Our view is that there’s so many people enjoying music out there, every single day, but the massive portion of them are currently not paying anything. We are trying to bring them back to paying for music again.
Spotify has seen its fair share of controversy as some smaller independent labels jumped ship complaining that they weren’t receiving enough royalties. This has been visualised below, the graphic illustrates how many albums or songs an artist would need to sell through conventional channels (self pressed CD, retail album and a track download) to earn the US minimum wage ($1,160 per month). At the minute, this doesn’t seem to be a large threat to Spotify – however if Merlin (a non-profit network of over 12,000 indie music labels) rethought its contract Spotify could see quite a sizeable chunk of their library disappear. Warner Music CEO Edgar Bronfman Jr. was also quoted saying that music streaming services were “not net positive for the industry.”
Source: Information is Beautiful
Competition
US digital music service Rhapsody is setting in motion plans to relaunch Napster in the UK and EU as a competitor to Spotify. I don’t think Spotify will be worrying too much about Napster’s offering simply because there is very little to compete on – once you get beyond the music catalogue and the user interface the only thing left is pricing. As we have seen margins are already very thin, evidenced by Spotify operating at a loss for the previous 2 years – beyond that the only thing that could tempt users is a prolonged trial period.
Grooveshark is probably the closest web based rival of Spotify, having had quite a few friends that used to use Grooveshark religiously that have now switched to Spotify illustrates its ailing position. In the future, as with Napster, I could potentially see Grooveshark adopting the desktop client model and partnering or being acquired by a larger entity.
Apple must be kicking themselves that they did not think of the core business model – one of the few times when they have been caught napping (it can happen too easily when you are at the top). I expect a competitor from Apple in the next few months, easily attaching to the iTunes model further strengthened by their established links with the labels. We could perhaps see some modifying of the Spotify model to facilitate video content which could be distributed through the soon-to-be-launched Apple TV.
What’s next?
I think Ek and Lorentzon were extremely smart partnering with Facebook as it instantly provides them with a competitive edge over new entrants to the market such as Napster. As annoying as the live feed is, it will constantly strengthen the brand of Spotify and push it ahead of the competitors. With regard to where the industry is heading – I think the music labels are slowly starting to understand that streaming is going to become the norm and that it does have positives such as reducing the amount of piracy.
(header image credit)
