royalties vs. sales

Spotify’s plan for rescuing the music industry: let it fall apart first

November 15, 2012
Obsession
Mobile Web
November 15, 2012

Spotify, the music-streaming service, just scored a $100 million round of financing. That values the company at $3 billion—but Daniel Ek, its founder, probably isn’t all that hung up on the fact that he’s now the head of one of the few European startups to have exceeded a billion-dollar valuation. (Spotify was started in Sweden, Ek’s home.) “I don’t spend a lot of time talking about our finances at all,” says Ek, sitting in a conference room in Spotify’s Manhattan offices back in September.

“We want to build this for the long run,” says Ek, who compares Spotify to Amazon, another company in a low-margin business that is willing, in the words of its founder, Jeff Bezos, to be “misunderstood for long periods of time”. Ek says, “We want to get the 500 million people on the Internet listening to music, which I think will be a billion and a half in the next few years, to listen to music [through a paid service like Spotify].”

Try telling that to the music industry. Most of it seems to be up in arms about the tiny payments the company makes to artists each time their songs are played. One musician and industry scholar compared Spotify and competitor Pandora’s models to financial speculation: “Pandora and Spotify are not selling goods; they are selling access, a piece of the action.”

Ek is well aware of these criticisms, but he also believes that the music industry will stop pressing CDs within 18 months, leaving it at the mercy of Apple’s iTunes. The industry, he argues, has already been ravaged by piracy and changes in consumer behavior. All he wants to do is rebuild it.

To understand Ek’s plan, it helps to understand how music was sold before companies like his turned streaming music into a mass phenomenon. Artists were paid when their record was purchased on physical media, or, more recently, via iTunes. That led to a spike in sales when a recording was released, and a rapid drop-off in revenue after. But according to internal Spotify data, after an initial burst of interest that resembles the pattern for sales of music, a funny thing happens. Songs in the company’s catalog are played again and again, with no diminution in popularity. The reason is simple: people are building playlists. It’s as if an artist were paid every time one of their fans dropped a needle on their record.

“They’re saying, oh, they’re just paying a fraction of a cent every time someone plays a song,” says Ek. “And then you compare it versus the download revenue. Well, I can tell you it will take you 200 song listens before you make the same amount of money [as a download]. But because the consumption behavior is entirely different, and the revenue then increases in perpetuity, it’s not even a question of if this model is better, it’s just when in the lifecycle it’s better.”

What’s more, according to Ek, Netflix CEO Reed Hastings has told him in private conversations that the same is true for the movie-streaming service, whose cheap all-you-can-watch monthly rates have worried many in the film industry. “It’s equally true for anything that’s an access model,” says Ek. In other words, as the world moves from owning content to getting access to it on demand, Ek’s experience is likely to generalize across all kinds of content. It’s a fundamental transformation of how artists and their industries will make money.

When describing how this will change the way that music labels develop artists, Ek resorts to the language of finance. In the old days, he says, record companies bet on a bunch of different acts, and just a few became big. But that was enough to pay for all the acts that never made it. (Movie studios do the same, relying on a few blockbusters to cover their smaller films and flops.) Likewise, venture capitalists bet on a portfolio of companies, knowing most will fail. “If you start looking at this from a longer term perspective, I actually believe that what we’re going to see is, we’re going to move from a venture capital model to more of a private equity model.” In other words, instead of bankrolling artists at the beginning of their careers, record labels will wait until they have achieved some success on their own, then invest in them for a stake of the proceeds.

Spotify now has a library of 20 million songs, and has negotiated contracts with more than 4,000 record labels and artists, says Ek. The service is now available in 17 countries, but it has plenty of competition on its home turf, including well-entrenched internet radio service Pandora and startup Rdio, and even more overseas, including France-based Deezer and India’s Saavn.

One way Spotify set itself apart from its competitors is its obsessive focus on helping users discover new music. That comes straight from Ek, who says his inspiration was his youth in Sweden, one of the first countries to get high speed broadband internet. At 17, when most of the world was on dial-up internet, Ek already had a 10 megabit-per-second connection direct to his house—the typical speed of a standard internet plan in the US today. By 2001, it was 100 megabits, and today, it’s a full gigabit. Like many Swedish youth, he used his super fast connection to trade music with friends—one reason why Sweden, home to file-sharing site The Pirate Bay and an active Pirate political party, is one of the world capitals of media piracy.

Spotify outsources the job of music discovery to hundreds of other developers. Their apps, built on top of Spotify’s library, are available through the service much like apps in iTunes or on Facebook. They include music blog aggregators that fuse algorithms with human judgment, like Hype Machine, and sites that are mainstays of online music journalism, like Pitchfork. If the key to getting people to consume more music is finding new ways to delight them with it, its app store gives Spotify many more ways to introduce fans to new acts and old favorites.

“We distinctly don’t think we’ll figure out every single use case around music,” says Ek. “We realize that someone who reads Pitchfork is someone who is very different from someone reading Rolling Stone. But we do want to be the platform for music… I just fundamentally believe that music is an integral part of people’s lives. If there’s music somewhere, we should power that.”

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