The Swedish music streaming business garnered widespread attention for its novel stock market listing, but to achieve long-term success, it will need to overcome an over-reliance on royalties.

Spotify’s listing was anything but conventional – a behaviour in keeping with its philosophy. There were no investor roadshows, no relentless television appearances, and little in the way of the pomp and ceremony that generally revolves around stock market initial public offerings, the typical route for tech companies.

Instead, Spotify was true to the internet’s ethos of open participation. It sold its 178,112,840 shares directly to the public. That is extraordinary in itself, but the company also offered shares for the first time without having a bank underwriting the process. Direct listings are usually reserved for spin-off companies, those coming out of bankruptcy or companies moving from another exchange. Pundits described the event as ‘orderly’ – and the shares settled at around $145 after an initial few days of trading, giving it a valuation of $26bn.

That’s not bad for a business that is unprofitable and whose longer-term business model is under threat from competitors such as Apple Music and Amazon Prime Music.

Daniel Ek and Martin Lorentzon set up Spotify back in 2006, launching their first music app in 2008. In 2009, the app began gaining traction in the United Kingdom as mobile phones made listening on the go easy. Spotify’s music offering has always included a free service, available with advertising, and an ad-free premium offering. Today, Spotify has about 160 million users, with 70 million of those paying for the subscription service.

When Spotify launched, the music industry looked as though it was in terminal decline. Illegal music downloading had become ubiquitous, with net services, such as Napster, enabling fans to share digital files of their favourite music for free. While Napster closed in 2002, following a crackdown on copyright infringement, it set a cultural trend among music lovers to download content from illegal sites for free.

 

 

When Ek told CBS that Spotify had been credited with helping to revive a shrinking music business, he was not far wrong. ‘It’s easy to forget that just three years ago, even in the United States, streaming wasn’t really a thing.’ In 2017, the global music industry grew for the third consecutive year, from $15.7bn to $17.3bn, with streaming subscription sales rocketing by 45 per cent – making it the biggest source of revenue for the industry. Prior to 2015, it had seen 15 years of consecutive contraction. Leading analysts have observed that the music industry is on track to become a streaming industry in all but name. And Spotify has been leading the way.

As big as Apple?

On one hand, that looks like great news for the company. But Apple Music, which launched in June 2015, has been leveraging its dominance in the mobile phone market to play catch up. This year, it may become the world’s largest streaming service, according to a study by Verto Analytics. It all depends how you cut the figures, but Apple Music and Spotify are vying for poll position.

While that is not disastrous, Spotify’s business model makes it look more vulnerable to Apple Music’s challenge. For one thing, Spotify only offers music streaming and is dependent on the revenues that subscribers pay. Its competitors all have parent companies that are cash rich: Apple Music is owned by Apple, Amazon Prime Music by Amazon, YouTube by Google and so on.

That makes Spotify more dependent on the music companies from which it licences content than, for example, Netflix is from the film industry. Spotify’s market value is bigger than both the world’s largest record label, Universal Music Group, and the world’s biggest online radio service, Pandora, combined. But if Universal were to pull the plug on Spotify, it would cease to be viable overnight. In the film industry, by comparison, rights are more fragmented between different companies. Netflix could suffer a business such as Disney pulling its content because there are so many alternative providers.

It is a risk that featured in Spotify’s filing to the Securities Exchange Commission ahead of its listing. Even if every company licenced to the business, as Spotify’s revenues increase, so do its royalty costs – estimated at about 79 cents for every dollar it makes.

Righting songwriters’ wrongs

In January this year, songwriters won a major court victory that will see the income they earn from their craft increase 44 per cent over the next five years. The case was brought in the US by the National Music Publishers Association (NMPA) and the Nashville Songwriters Association, which argued successfully that songwriters should enjoy a reasonable cut of the music streaming bonanza.

‘Crucially, the decision allows songwriters to benefit from deals done by record labels in the free market,’ NMPA President and Chief Executive Officer David Israelite said following the ruling. ‘The ratio of what labels are paid by the services versus what publishers are paid has significantly improved, resulting in the most favourable balance in the history of the industry.’ While an effective ratio of 3.82:1 is still not a fair split, he argued, it was the best songwriters had had under the compulsory license.

In the event, the ruling did not seem to dampen enthusiasm for Spotify’s market listing, even if it will continue to weigh on its quest for profitability. Spotify has options for the future. It could sign musicians at more favourable royalty rates than they receive from their own labels, but at a healthy discount to what it pays the large record companies. It could diversify more into video content. But while it remains a streaming-only business, it will be constrained by the laws surrounding music rights.

Arthur Piper is a freelance journalist. He can be contacted at arthur@sdw.co.uk