When Spotify lists on the New York Stock Exchange in the coming weeks the loss-making music streaming service is likely to be valued at more than $20bn (£15bn): such is the faith of investors in its charismatic Swedish founder,Daniel Ek.
Ek, they believe, can build Europe’s answer to Netflix – a global cultural behemoth that can take on industry incumbents and the big four technology companies at the same time, and come out on top. If Netflix can overturn Hollywood, thenSpotify can transform the music industry. At least that is the hope among US fund managers.
Only 10 years after it was founded, Spotify is a force to be reckoned with. It has 159 million active users, with 71 million paying monthly subscriptions. The rest are part of Spotify’s “freemium” service and have to listen to ads to get their music free. Annual revenue last year was nearly $5bn. Apple Music, by contrast, has 36 million subscribers.
In a letter posted alongside Spotify’s pre-float filings on Wednesday, Ek said the company hoped to “democratise” the music industry. Spotify, he wrote, could “connect all of us, across the world, in a shared culture that expands our horizons”.
Lofty aims, couched in the aspirational terms that those in Silicon Valley like to espouse. But there are reasons to doubt Spotify can pull off the same level of success as Netflix. Music is a very different industry to film and television, and the competitive landscape it finds itself in brings challenges that Netflix has never had to face. The industry has never regained the profitability it enjoyed before the likes ofNapster ripped up its business model.
Spotify lost $1.5bn last year, up from losses of $650m the year before. Its relationship with the music industry incumbents– that is, the companies that produce the records – is one major obstacle. The company has to license its library through the same bottleneck of major labels as any other player in the streaming world, and for the time being the labels still hold all the cards. Its losses are down to it paying more in licensing than it can afford – even as the amount that trickles down to many artists is less than they can survive on .
The company has paid out some $10bn in royalties to artists, music labels, and publishers so far, according to the financial services company Hargreaves Lansdown, and it is obliged to pay at least $2bn in further royalty payments over the next three years.
“Just four music companies control the rights to 87% of the music streamed on Spotify,” says the Hargreaves analyst Laith Khalaf, “which gives them a healthy bargaining position when it comes to getting their pound of flesh from Spotify’s revenues.”
But Pär-Jörgen Pärson, an early investor in Spotify, reckons the power dynamic is shifting, and there is reason to believe the terms of contracts will become less onerous. Pärson, a partner at the Swedish venture capital company Northzone, argues that the licensing agreements signed to date “were very much slanted to the owners, and the cost of growth fell to Spotify to finance”.
Now, he says, “it’s the streaming services that hold the key to making or breaking artists, and also to the kind of underlying support an artist needs in order to build their careers and their creative work. That was historically the role of the labels but they have increasingly failed at delivering.”
Even if Spotify can negotiate down its royalties, however, it will still face a hard time divorcing itself from the major labels – in sharp contrast to Netflix, which has reduced its reliance on Hollywood content by producing its own hits.
Netflix has been focusing more and more effort onin-house productions, promising more than 800 new shows over the coming year as part of an $8bn spending spree. But music fans value a complete library that spans every label and genre.
Then there is the competition. Three of the big four technology companies, Apple, Google and Amazon, have their own direct competitors to Spotify. Of those, Apple Music is by far the most successful, offering an equivalent service for an equivalent price – but one built directly into its bestselling smartphones, tablets and smartwatches.
Apple Music still has fewer subscribers but it has one other major advantage: Apple does not need to turn a profit from its streaming music service, while Spotify does. Apple can leverage an operating loss on Apple Music indefinitely, to sell more iPhones and make an overall profit; Google can extend its domination of the overall market with Google Play Music All Access; and Amazon can use Amazon Music to sell more of, well, everything.
“Apple are a formidable threat,” agrees Pärson, but goes on: “I think that they have a product that is inferior – shown time and again whether you look at customer reviews – and their key value is that they are embedded into the phones. But we shouldn’t forget that they only have a 20% market share, and Spotify is everywhere.”