One day, possibly before Hell freezes over, Spotify will be floated on the stock market, some think it may be next year, which, hopefully will be a long time before the ice age reaches Hell. But Spotify has a dilemma, and one that is faced by other companies operating in very different industries.
Free! According to economic theory, digital products should be free. Here goes the explanation: if you have ever had the misfortune to pick up an economic text book, or worse than, studied it at school or university, you will know that according to economic theory price is determined by demand and supply, which means that price is set at that point where marginal cost equals marginal revenue. But in the digital environment, marginal cost is zero, ergo price should be zero too.
This is what Chris Anderson, ex editor in chief at Wired, was referring to in his book entitled Free.
And that is why advertising has become the key source of revenue for many of the world’s biggest companies – or at least two of them: Google/Alphabet and Facebook. Actually, in a way, Amazon makes a lot of its money via advertising, because when a third party sells products over Amazon, Amazon makes a margin. But from the point of view of the seller, this Amazon margin amounts to much the same thing as the price they would pay to Google for an ad. Indeed, for that matter Amazon has now entered the ad business anyway.
But there is something odd about the music business. It does not obey the rules of economics.
It was not always like that. In the Napster days, it looked as if piracy was going to kill music sales, such that the only way you could make money from music was through performing it live, and digital music was in effect an ad for your live performance. Apple changed that with iTunes, and now the music streamers, such as Google, Deezer, Apple, Amazon, Tidal, Spotify, Vevo and Pandora have changed it again.
At first, the music streamers made most of their money from advertising. Economic theory, was alive and well.
But, thanks to the magic of advertising, there is money in it for music labels and publishers again.
There is resistance to the idea. Taylor Swift once commented on the idea of her music being available on Spotify that she was “not willing to contribute my life’s work to an experiment.”
But now, things have changed again. Music streaming is going premium and in a big way.
And now Spotify has agreed a deal with Universal, the world’s biggest record company, with whom Spotify has not had a contract for two years. The deal does mean that Universal music will become available on Spotify, but new albums will be exclusive to the premium service, at first.
But look at the hard numbers. Spotify now has 50 million paying customers, with 20 million of them coming in the last year.
It’s a trend seen in other industries. Take the newspaper and magazine business, premium content is making a return – to the extent that the pool of quality newspapers that provide free content is diminishing fast.
Not all of the music industry is happy. Typically, 60 per cent of the revenue from music streaming goes to the owners of the recording. 30 per cent goes to the platform, and ten per cent to the publishers and song writers.
It’s the publishers and song writers who are most unhappy. They will struggle to make a living, while Spotify is supposedly heading for an IPO.
But such a critique misses the point.
Before there was digital music there were record shops. They made a margin, which the industry was happy to accept. The streamers have simply replaced the music stores.
And yet, despite all this, Spotify’s business model looks questionable. In 2015, it made a net loss of 173 million euros, from 1.95 billion in revenue. The reason is plain to see. Royalty and distribution ate up 1.63 billion euros.
Publishers and song writers may be unhappy about the way the music streamers are taking more money than they are, but then when you factor in that despite having such a huge user base, Spotify is losing money, you have to question if the problem lies elsewhere.
But let’s leave you with one idea. Why do the music publishers and song writers need music labels?
In the age of streaming services, what stops the artist from going direct?
Maybe that is the next big disruption.