Ten years after its inception, Spotify has much to show for its success. The streaming service has become the largest music platform in the world with over 140 million users, half of them subscribing to its premium offering. The company is present in over 60 countries.
Spotify can be categorized as a three-sided platform, with record labels as the suppliers of most of the content, users who opt for different tiers of subscription, and advertisers. It operates as a freemium model, and although advertisement is a small source of revenues (approx. 10% ), it is a key component of its customer acquisition strategy. Network effects are low, although social features such as Collaborative Playlists and Friend Activity are purposefully increasing them.
The Swedish firm creates huge amounts of value for the two main sides of the platform. Users get immediate access to 30+ million songs for free (plus ads), or for a small fee of $9.99/month. Interestingly, the value for the user grows proportionally with time for two reasons. First, as long as the user streams music, she is not buying albums, and thus, the value of her alternative to the service (e.g. her private collection) decreases. Second, Spotify is fiercely leveraging data from users to bridge its transition from a pure search-and-play platform to a discovery platform. As the user spends more time on the platform, the algorithm recommends music more attuned to the user via features such as Discover Weekly, Release Radar, or Your Daily Mix.
For labels, streaming services have substituted its traditional distribution arm and now account for their largest source of revenues (over 45% for Universal Music Group ), far outstripping physical purchases and digital downloads. Although the music industry complaint for years about the disruption created by both iTunes (2001) and Spotify (2008), experts credit these technologies with saving the industry from the piracy threat and with enabling healthy levels of growth in past years .
Record labels, which are both platforms and Spotify’s main suppliers, have avoided the fate of other traditional media industries, such as publishing . Music, as opposed to news, doesn’t necessarily lose value with time. That enables labels to sit on top of huge back catalogs (with copyright of 70+ years) that provide them with a regular source of revenues, which in turn helps them sign on new artists. This explains why the industry has consolidated into the “Big Three” labels (Universal Music Group, Warner Music Group, and Sony Music Entertainment), accounting for over 80% of the industry.
For both sets of platforms, music is a commodity . Both the Big Three’s and Spotify’s economic incentives are aligned to maximize average revenue per user and increase access to the service, i.e. getting as many people as possible to pay for streaming. Multi-homing makes economic sense for labels for that reason, which in turn prevents users from subscribing to more than one service since the offer is not differentiated enough (as opposed to film and TV platforms).
However close their fates align –and even if the Big Three own a sizable stake on Spotify and want to avoid going back to the old days of Apple’s monopsony–, labels are partially responsible for Spotify’s current unprofitability. Their agreements are pegged to consumption (i.e. revenue sharing) , and although new deals include “margin relief” clauses, scale alone won’t help Spotify grow margins at the pace investors might expect them to. On the competition side, pressures on pricing and offering keep heating up, with diversified players such as Apple and Amazon looking at music streaming as a loss-leader segment to enhance their broader product ecosystems .
As the Swedish platform gets ready to IPO, several growth strategies are on the table. Spotify can focus on expanding its geographic reach both organically (Apple Music is available in 50+ countries that Spotify is not ) or through partnerships (for example, the recent minority stake swap with Tencent ). They can also increase rates of conversion to premium via market segmentation and attractive bundles with other services, such as their Hulu bundle for students .
But ultimately, Spotify’s sustainability depends on them finding novel models to reduce their reliance on labels, either by entering new verticals (e.g. video, podcasts, news) or by signing their own artists and developing exclusive content to drive differentiation, which might prompt a reaction from the Big Three. So far Spotify has thrived by building a better user experience compared to Apple or Amazon, but their future (and independence) might depend on them evolving into a full entertainment platform or a record label itself.