Spotify's New Direction Won't Change the Music

DON EMMERT/AFP/Getty Images
Daniel Ek, CEO of Spotify, speaks to reporters at a news conference on May 20, 2015 in New York. Streaming leader Spotify on Wednesday announced an entry into video and original content, hoping to expand its reach beyond music. Spotify, by far the largest company in the booming streaming industry, said it was updating its platform to support videos and would offer news and other non-music content provided by major media companies.

The addition of news, radio and podcasts won't get rid of the streaming service's royalty situation.

Spotify is a music service. It is still a music service after adding non-music video clips to its catalog. And it will continue to be nagged by the same criticisms.
 
Spotify is now a music service that also offers videos. This evolution is a step toward greater growth and better financial health. But video isn't going to change the criticisms surrounding its royalties and licensing deals with labels.

A music-only service will get Spotify only so far. Some competitors have already realized this. Following its purchase of podcast app Stitcher in November, on Tuesday Deezer added 20,000 podcasts in the United Kingdom, France and Sweden (it says an international rollout will happen "in the coming months"). Apple acquired Swell, another podcast app, last year for a reported $30 million.
 
Video could bolster Spotify's oft-criticized freemium model. A Spotify spokesperson tells Billboard the video clips will be made available to both free users and subscribers. What's more, both groups will be able to view the clips on mobile devices, according to the spokesperson. Free users never had it so good.
 
Spotify's freemium model functions by attracting a large number of users and converting some of them to the paid service. Its bet is video will attract incremental free users that will result in incremental subscribers and incremental revenue.

Video could have strategic value. More users would give Spotify larger market share and greater leverage when dealing with rights holders. Video might also steal some of YouTube's viewing time. There could more practical value, too. Video could help Spotify continue its rapid growth, appeasing investors and improving its long-term financial position.
 
As for music rights holders and creators, Spotify believes the addition of video presents no downside. A spokesperson tells Billboard the video clips will not have advertisements, but won't reduce the pool of money shared with labels and publishers. Spotify believes video presents only an upside -- more users means larger payouts.
 
But video can't get rid of some nagging problems. Spotify's critics -- both artists and labels -- have complained about its conversion rate. At last count, Spotify had 15 million subscribers and 45 million free users, which works out to a 25-percent conversion rate if you don't count the (unknown) number of inactive free users. Video might attract more users, and thus more subscribers, but it won't necessarily improve Spotify's conversion rate.

More importantly, the addition of video doesn't change how rights holders are paid. Many artists and labels are unhappy with the per-stream royalty rates paid by Spotify. (A typical royalty is 0.5 to 0.6 cents per stream.) These rates won't necessarily change if video grows the pool of money -- the licensing terms will remain unchanged. Additional users will mean additional streams, and additional streams could mean a larger pool of money... which pays out the same per-stream rate.
 
There is also anger about perceived inequities in licensing deals with digital services. Aside from the contentious royalty rates received from free streaming services, there are concerns that labels extract ample revenue that's not shared with creators. A leaked licensing contract between Sony Music and Spotify published at The Verge (and has since been removed) confirms that Sony receives revenue in a variety of ways. What is not clear is whether the artists and songwriters share in any of that revenue.
 
The contract shows three forms of payment beyond royalties. One is the advance. Spotify paid Sony $42.5 million in advances over three years ($9 million in the first year, $16 million in the second and $17.5 million in the third). Another such payment is called an "adjusted contract period advance." This amount, paid annually, is the difference between Sony's and other labels' advances relative to each label's market share. If Sony's adjusted advance falls short of its competitors, Spotify pays the difference (less any amount of over-recoupment of Sony's advance).

There's also a non-royalty payment is called a "top-up fee," a payment owed if after 12 months Spotify's freemium model didn't get Spotify to certain subscriber goals (see more in miscellaneous observations below). Paid monthly, top-up fees were paid monthly and were paid on top of royalties, minimum revenue guarantees and advance payments.
 
The details of the leaked contract speak like no trade magazine article ever could. The contract's major points have already been known in ambiguous form. The revelation is actually seeing the actual size of the advances and other guarantees that are hidden behind strict confidentiality rules.
 
Spotify needs growth. Billboard estimates Spotify could eke out a positive operating income by 2017 if revenue grows at a compound annual rate of 50 percent while the CAGR of non-royalty operating expenses is only 20 percent. These numbers imply massive growth in subscribers, a slowdown in growth of R&D and hiring and no expansion into markets such as Japan that may produce few early returns.
 
Rights holders and creators need Spotify to grow, too. Subscription services are accounting for much of the digital growth that keeps revenues from plummeting. Spotify is a major source of that growth. As noted by Will Page, Spotify's director of economics, the service accounted for 90 percent of growth in U.S. subscription revenue last year and represented 10 percent of record label revenue in the first quarter.
 
Spotify is more a partner with labels, publishers and creators than the antagonist often described in media reports. They need one another. But partners fight, and video won't change that.


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