Spotify Wants to Be 'The R&D Department for the Entire Music Industry' -- What Does That Actually Mean?

Courtesy of Spotify
Spotify's chief research & development officer Gustav Söderström speaks at a press conference at the Gramercy Theater in New York City on April 24, 2018.

While execs might not use the words "vertical integration," that goal is arguably alive and well within the company.

Ahead of Spotify unveiling its new mobile free tier at a press conference at New York's Gramercy Theater last Tuesday, the signage outside the venue was refurbished with an intriguing phrase: “Make Spotify Yours.”

These three words have taken on vastly different meanings over Spotify’s decade-long history -- and have significant implications for how the service plans to dig itself out of the red and dominate the music industry in 2018 and beyond.

CEO Daniel Ek first uttered the phrase back in 2011, upon launching Spotify's now-defunct app platform that allowed third-party developers to build new social and discovery features atop the service's standard interface. The idea behind the launch was to foster a vibrant, customizable ecosystem around Spotify’s growth, similar to what Apple accomplished with its App Store: “We’re opening up our platform in a way that lets you curate the apps you want, and really make Spotify yours,” said Ek (emphasis added).

This week, “Make Spotify Yours” was addressing quite a different situation. For one thing, Spotify shut down all native third-party app support in 2014, signaling that the company demanded full control over both its user experience and its industry relationships.

Therefore, rather than referring to a wider, more flexible ecosystem of apps and developers, "Make Spotify Yours" is now all about Spotify funneling more of its user base into its own brand of personalization -- as defined by algorithmic channels like Daily Mixes, Discover Weekly and Release Radar, as well as flagship playlists like RapCaviar and New Music Friday -- which is now available on-demand in much greater scope to free mobile users thanks to new licenses with labels.

Yet, one of the most compelling takeaways from the press conference was business-facing, rather than consumer-facing: Spotify is trying to position itself as an advocate and growth driver not just for itself, but also for the entire music business.

Citing sweeping statistics around social-media and smartphone use -- out of a global population of 7 billion people, 2 billion people use social media regularly, while 1.3 billion use smartphones -- the Spotify execs onstage discussed how no single music streaming service to date has surpassed even 100 million paying subscribers and how Spotify was poised to be the leader in closing this market gap for mobile music listening, while delivering actionable insights to the wider music landscape in the process.

“We want to be the R&D department for the entire music industry,” Gustav Söderström, Spotify’s chief R&D officer, told the audience on Tuesday. “We don’t think the industry has ever had an R&D department before -- and we’re it. That’s our mission.”

Understandably, this statement, which sounds handcrafted for controversy, startled many music professionals who had dedicated years of their lives to R&D in various forms -- including but not limited to scouting and developing talent, researching audience and fan behavior and building innovative tech from scratch.

But in the grander scope of entertainment, Söderström’s claim is not untenable or unrealistic. In fact, one formidable peer in the digital streaming ecosystem is already bringing this vision to life: Netflix.

Unlike Spotify, Netflix has established itself as a direct competitor, rather than a partner, to traditional film and TV studios, setting aside a whopping $7 billion for original content in 2018. This means that Netflix can vertically integrate the entire pipeline for any of its original shows and movies, from casting actors pre-production to localizing content for international markets post-production (the company has reportedly even considered buying up brick-and-mortar movie theaters in New York and L.A., to gain yet more control over distribution).

As a result of this vertical integration, Netflix has been hiring data scientists for an entirely new internal R&D division that it created this year, called Studio Production Science and Analytics. An extensive writeup on the Netflix Technology Blog explains the motivation behind these new roles, diving into the multiple points in the film production pipeline where data science can help streamline processes and reduce costs without sacrificing creativity -- including but not limited to planning budgets, finding locations and building sets, using studio space efficiently and even scheduling guest actors.

“Each production is a mountain of operational and logistical challenges that consumes and produces tremendous amounts of data,” reads the blog post. “At Netflix’s scale, this is further amplified to levels seldom encountered before in the history of entertainment. This has created opportunities to organize, analyze and model this data that are equally singular in history.”

In other words, through the lens of “studio production science,” Netflix thinks it can grow into a comprehensive "R&D department" for the entire film and TV industry.

While it is wholly unrealistic for Spotify to become the “Netflix of music” overnight, both Spotify and the wider music industry face many similar challenges to the ones depicted above, when it comes to financial and logistical issues around artist development and constantly-shifting content release strategies.

In fact, Spotify has consumed and produced even more data than Netflix -- 200 petabytes, to be exact, versus roughly 60 petabytes at Netflix as of Nov. 2016, according to the former’s SEC filing. Artists and labels also continually struggle with analyzing dozens of data sources on a daily basis (across streaming, social media, ticketing, etc.) in a way that streamlines and elevates, rather than overwhelms, the creative process.

A&R in particular remains terribly expensive. In its 2016 report “Investing in Music,” the IFPI found that music companies invested nearly 17 percent of their revenue back into A&R, a total aggregate spending of $2.8 billion annually (versus $1.7 billion for marketing and promotional campaigns). That percentage ranked higher than the equivalent R&D spend in any other sector: pharmaceutical & biotech companies spent 14.4 percent of their revenue on R&D, software & computer services invested 10.1 percent and tech hardware & equipment companies spent 8 percent.

According to its SEC filing, Spotify’s R&D expenses in 2017 accounted for 10 percent of total revenue -- amounting to just €396 million (US$475.2 million), but increasing by more than 91 percent year-over-year.

This keeps Spotify more akin to software & computer services than to labels -- and arguably highlights that, at least from Spotify’s perspective, “A&R” and “R&D” are not quite the same thing. In fact, A&R is just one step in a much longer, more complex pipeline for music production, marketing and distribution that Spotify’s own R&D aims to study and streamline in-house.

For proof, look no further than Spotify’s recent acquisition and hiring history. In Jul. 2017, the service poached François Pachet (former head of Sony’s Computer Science Laboratories in Paris) to lead its new Creator Technology Research Lab, which focuses on “making tools to help artists in their creative process” -- including but not limited to researching music composed by artificial intelligence.

Later in Nov. 2017, Spotify acquired cloud-based recording and production studio Soundtrap, one of many moves the company has taken to cultivate deeper relationships with the artist community. While not directly linked in a commercial sense to the streaming business, Soundtrap said in a statement it was “highly aligned with Spotify's vision of democratizing the music ecosystem.” Most recently, Spotify bought licensing startup Loudr to help streamline royalty tracking and payments to music publishers.

Beyond these acquisitions, Spotify is also making aggressive moves into the live entertainment space, organizing multi-city tours around its RapCaviar and Who We Be playlists in partnership with Live Nation, as well as intimate, highly-targeted concerts with the likes of Kylie Minogue and Keith Urban through its Fans First initiative.

In addition, during Tuesday's press conference, Spotify made it clear as day that it was qualified to compete with, and perhaps even replace, terrestrial radio. “Historically, free, ad-funded radio drove music discovery, and sent listeners to the record store to buy the songs they really liked,” said Söderström. “Buying the CD also allowed you to listen to the specific songs you wanted offline without ads. Today, Spotify is both the radio station and the record store. We both create demand for music and monetize it.”

In other words, while no Spotify exec might have uttered the words "vertical integration," that goal is arguably alive and well within the company. The only way Spotify can truly become "the R&D department for the entire music industry" is if it has a legitimate stake in every sector of music -- contributing significantly to production, marketing and data collection processes, rather than being merely a distribution channel (and relinquishing nearly 80 percent of its revenues to rights holders in the process).

What would make this vertical-integration approach even more potent is if Ek can pull off his vision of “building a two-sided marketplace for users and artists," as the CEO articulated during Spotify's inaugural investor day in Mar. 2018.

Looking beyond music, one reason why big-tech conglomerates like Google and Amazon have profited so well in the modern economy is because they have adopted what some call a “supply chain as a service” (SCaaS) business model, in which third-party clients rent and “stack” different components of their digital supply chain from said big-tech companies. (In this vein, Spotify is actually a SCaaS client of Google, as the former stores and processes all of its user data on Google Cloud Platform.)

Out of all the streaming services in the market today, Spotify might be the best-positioned to become the definitive SCaaS provider for the music industry, in terms of expanding beyond distribution into creative, marketing and rights management offerings.

Even though Google, Amazon and Apple are gaining ground with their own music streaming apps, they arguably see music as a marketing loss-leader to support sales in other verticals like devices or IT services, and are less interested in going deeper vertically into music than in venturing horizontally into multiple other industries, such as fashion and healthcare.

Spotify sees this contrasting approach as a competitive advantage, rather than a weakness. “At Spotify, music is not just a feature, nor is it merely a marketing strategy for something else,” Söderström said at the press conference, taking a precise jab at big-tech rivals. “It’s what we do. We’re very passionate about it, and we know we’re going to be successful as a company only if the music industry is successful.”

Interestingly, perhaps sensing this vertical integration, labels are ramping up their own R&D and analytics investments in order to stay competitive. Warner Music Group recently acquired data-driven A&R startup Sodatone, while Sony/ATV is doubling the size of its internal research & analytics team. Label contracts more broadly are increasingly moving to a customizable services model, to reflect the flexibility that artists demand.

But Spotify still sees itself as an indispensable part of this growth picture: Söderström went so far as to declare that “the ‘glorious '90s’ will just look like a practice run for this industry” if his company can deliver on its long-term goals.

The revamped mobile free tier is just one tiny gear in the gargantuan machine driving this vision -- and Spotify's aggressive acquisition and R&D strategy reveals that the catchphrase “Make Spotify Yours” is as much a command for the music business as it is for fans.