Spotify: The sound of the next disruption?
Photo by Sergi Kabrera on Unsplash
Over the past few weeks, we’ve explored how the interplay of traditional business models and crypto often works to create interesting, innovative possibilities (and how, sometimes, they equally do not). As we’ve written many times, our view is that applied correctly, token economics can be deployed to create incentives that were not possible under a traditional equities framework.
From bootstrapping a network of wireless base stations with Helium to creating a global network of play-to-earn gaming with Axie Infinity, crypto seems to be finding its way into creating real-world implications for people around the globe. While we are always excited by the prospect of some application of token economics with the aim of disrupting traditional business models, we are also conscious that there are varying degrees of difficulty in disruption.
One company that gave us pause for thought, and some internal dissonance in opinion, was Spotify. For those who remember, just over a year ago now, Spotify staged an impressive breakout as it announced a full-scale incursion into the world of podcasts and audio content that wasn’t simply music. From the Joe Rogan podcast to partnerships with DC comics, Spotify seemed to have cracked open a new niche for themselves – after all, we are very much fans of podcasts ourselves, partly because of the ease of consuming them, partly because of the in-depth content that can be found on some of these podcasts, especially when running at 2x replay speed.
In many ways, Spotify was a disruptor of the music industry, stepping into the breach that Napster famously blew up in the defences of the hitherto fortified world of record labels and distribution deals. Much has been written about the topic, and as we did our research, we found these two notes here and here on Packy M’s NotBoring blog particularly useful for getting a detailed look into how the music industry functioned before and after Spotify.
But one niggling thought persisted: as much as Spotify was disruptive in terms of channel, and it is arguably a behemoth (almost a monopoly) on audio content distribution, it did not have pricing power over its content.
In that light, we can not only contextualise the strategic decisions they have made in their business. We can also attempt to imagine how the future may look like for them and the industry, toying with the hypothetical question of: what happens when token economics gets into the mix?
Friends, Romans, Countrymen (and women) - lend us your ears.
The dual nature of audio entertainment
As of the end of last quarter, Spotify had a total of 365m Monthly Active Users, distributed as follows:
Put into numbers, the breakdown looks something like this:
- North America: 87.6m
- Europe: 124.1m
- Latin America: 80.3m
- Rest of World: 73m
A quick back-of-envelope calculation of MAUs as a % of total population in these regions (roughly) puts the number for North America and Europe at somewhere between 15-16% of the population, with Latam being at around 12%. Quick math suggests that this “penetration” proxy for the “Rest of World”, based on a global population of about 7.7bn total, spits out a figure of 1.28% - a tenth of Latam.
Great runway ahead, lots of potential for Spotify MAUs to grow, right? If there’s an ideal time to pull a MAU growth trick out of the bag, now’s the time given the trend in YoY MAU growth:
Source: https://investors.spotify.com/financials/default.aspx
If Spotify were to be looked at as a distribution network, then MAU must be its most important metric. The disappointment on the street was understandable, therefore, when they reported numbers that showed MAU growth that missed their guidance numbers. To be fair, +22% YoY growth was a respectable number, but the market is all about reality vs expectations. More interesting were the reasons for the miss: engagement was reportedly lower thanks to lower marketing activity (understandable) and higher COVID prevalence in some of the new markets they are pushing into e.g. India.
That got us thinking: shouldn’t a lockdown and movement restrictions increase, rather than decrease, engagement? After all, shouldn’t lockdowns do for Spotify what they did for Netflix?
Clearly, based on the numbers and commentary, that hasn’t been the case. This led to an interesting hypothesis: that audio content can itself be split into two subcategories – actively vs passively consumed audio.
It is often said (and we concur, based on personal experience), that audio content is much easier to consume than video, simply because the attention demanded of the consumer is much lower. Listening to a podcast while having a walk is entirely possible – watching a film on Netflix while having a walk is a recipe for disaster. However, anyone who’s tried to listen to a podcast while working out at the gym would likely agree that the podcast content very quickly faded into background noise, and that it would’ve been much more enjoyable pulling up one of Spotify’s top Gym tracks playlists.
Therein lies the split when it comes to audio content: there is content that one consumes as “background noise”, while commuting, travelling or working, somewhat passively (like music); and there is content consumed actively which requires attention, like a podcast. Of course, this is a generalisation – a music student would pay maximum attention to a recording of a classical piece, for example, but in general we think it’s safe to make this assumption for the majority of Spotify users.
Not all audio content is created equal – Spotify’s results have made that pretty clear. The lack of mobility (no commutes, no sitting around waiting for trains and buses to and from work etc) has shown its impact on Spotify’s user growth numbers, and it also has implications for their margins.
Balance of power
For all of Spotify’s successes, the one thing that has stood in its way has been the obstacle of raising its gross margins. This somewhat reflects the equilibrium that exists between Spotify and the record labels: on one hand, Spotify needs access to the back catalogues of major record labels in order to have anything to distribute; on the other, the record labels need to give out enough of a cut to incentivise Spotify since it is now arguably the single largest streaming channel worldwide.
It’s a stalemate, and it shows in Spotify’s margins, until recently:
Source: Refinitiv Eikon
Only in the last quarter have we seen GP Margins tick up and break out of their multi-year range, ostensibly thanks to the success they have been having with ad revenue growth, inserting ads into podcasts and, to a different degree, shifting the mix of music served away from artists that are tied to record labels (i.e. lower royalties). This is an encouraging development, with podcast revenues +627% YoY, outperforming expectations, driven by +30% podcast listening YoY and total hours consumed +95%.
Can this continue? The obvious solution to Spotify’s GP margin issue is to say, “Let’s further push the non-music content side of things HARD.” That’s exactly what Spotify are trying to do – every tactic that can be employed (and invented) to shift the mix of content away from record labels is on the table, a testament to the innovation that characterises Spotify as a business, especially their management team.
But pushing non-music content (i.e. “active” audio content) is probably going to be tricky, because that is a completely different market. Spotify listeners enjoy music, that’s the main reason they’re on Spotify at all. Spotify’s motto of “Soundtrack Your Life” unfortunately doesn’t read “Podcast Your Life” – people will still predominantly want to listen to the hottest new hits of the day, and that’s where Spotify needs to deliver.
Podcasts and Independent music are good to have and will continue to grow and improve the mix, but it will be incremental. It’s a long way before they can form the backbone of Spotify’s content offering. Why? Going back to those “penetration” estimates in terms of MAUs – if Spotify’s primary source of future growth from here on is shifting towards the “Rest of World” segment, delivering an ad-driven listening experience in lower-income markets like India, then the content that is most likely to be delivered is music. With a lower possibility that premium subscriptions can be sold (given the price vs average income levels in these markets), it is likely that Spotify’s revenue mix is going to continue to swing towards advertising income, with those ads served while users are listening to popular, mainstream music (Hurray, record labels!) rather than podcasts and independent artistes.
After all, Spotify’s founder and CEO Daniel Ek himself has pointed to the end of the era of their ad business contributing less than 10% of total revenue, expanding to become a substantial part of their revenue mix.
Furthermore, one must wonder whether the drive for high-density audio content (e.g. story podcasts) is putting Spotify in direct competition for time with other forms of entertainment (e.g. Netflix and Video games). After all, one does not simply “hear” a podcast – one has to pay attention and listen properly. Being the source of “incidental” entertainment has kept Spotify out of competition with Netflix et al for now – if it moves into the realm of a more “intentional” form of content engagement, then it has to be ready for a fight.
Can token economics help here?
To be honest, we’re not sure. In a way, Napster in its original incarnation would have made for a fantastic, tokenised music distribution economy, albeit in gross defiance of copyright laws. We came across a decentralised music streaming application called Audius, which seeks to bootstrap, by the use of token economics, a network of nodes that play the role of indexing, storing and serving music to listeners, with incentives paid out in the form of their native token.
This is a great idea and may prove to be a success, especially given how predecessors like Soundcloud have birthed some of the greatest independent artists in the contemporary age. Importantly, the potential is there for Audius to pick up that 25-30% gross margin from music streaming from the “Spotify centralisation”, and distribute that across its tokenholders and musicians, in a censorship resistant manner.
It is still early days, and we look on with keen interest to see if the team at Audius can pull this off, but at the end of the day, a market exists only when there is a coincidence of wants. And the challenge is that what listeners want, at least in this day and age, remains largely music, which remains controlled by the incumbent record label owners. Would record labels elect to release their music on Audius to have a shot at negotiating on a blank slate, at the risk of losing control once distribution goes decentralised? Perhaps, and if so, what would the impact be on Spotify? The permutations are numerous.
Lest we forget, there is also the likes of Tidal, famously made popular by Jay-Z’s acquisition of the platform and subsequent positioning of Tidal as artist-owned to the tune of c. 48% (3% for each of 16 initial artist shareholders). The USP: delivering a premium, high-quality and high-fidelity streaming experience for its listeners, in addition to curated content exclusive to Tidal. Tidal as a platform remains partly owned by artists (not ALL artists, but certainly an impressive roster), although claims that it pays out 4x more per stream than competitors like Spotify have come under some scrutiny. Critically, these artist shareholders were, as one observer put it, the “1% of pop music in the world right now, these are artists who do not answer to record labels, do not answer to corporations.”
The result: a 100% subscription-only streaming platform which charges listeners more. And therein lies the ongoing challenge to find the balance between the interests of artists and listeners. At $9.99 and $19.99 per month for its premium and HiFi subscriptions respectively, that’s quite a huge ask, notwithstanding some discounts for students etc, even for a super-high bit rate, high fidelity stream. Special interaction opportunities to get closer to artists are nice to have, though at what monthly price tag after the initial free trial? Put differently, whose interests does Tidal serve first and foremost? Tidal was an attempt by the artists themselves to go after the distribution margins (I.e. go after Spotify) and ultimately own that margin, but who pays as a result?
Ultimately, with Jack Dorsey’s Square recently buying out an 80% majority stake in Tidal in March this year, one can only wonder how successful the “artist-owned” spiel truly was, other than the punchy return on investment for Jay-Z himself. No public information is available about how “artist-owned” Tidal remains either post deal, but it’ll certainly be no greater than 20%.
This takes us back to the intrinsic imbalance in play: the tug of war between the interests of the artists that work hard to create and perform their music, the labels that have hitherto facilitated production and distribution and (arguably most importantly) the fans and listeners of this music. The holy grail is a balance of alignment of these three-way interests.
Perhaps if we have a new generation of musicians who aren’t tied to record labels AND are willing to go directly to their fan base via independent, decentralised platforms like Audius, accepting a fair, equitable distribution of margins all around the ecosystem, the future could be bright. And with Audius just recently getting to 5m monthly active users, the direction of travel is indeed very encouraging. We’ve always looked at token economics as a means of balancing the field and getting everyone onto the same page in terms of alignment - why should that be any different here?
The move away from dependence on labels is the road most recently taken by none other than Taylor Swift, who deftly exercised her songwriter’s rights to re-record her back catalogue as “Taylor’s Version”, effectively rendering the “original” recordings obsolete. Her entire sequence of moves was succinctly summarised by @ThatsMauvelous on this twitter thread. Does this necessarily benefit distribution intermediaries like Spotify and potentially Audius? Maybe, but again it’s a matter of bargaining power between the creators and owners of music that people want to hear and the listeners that the music wants to reach.
For a start: Songwriters and artists – hold on to those rights, and don’t ever let them go.
Taylor Swift’s move is, in our view, outright genius, and sets a precedent for others to follow, although it’s an option only for artists that are still alive (or still together as a group). For music made by performers who are no longer with us, including some of the greatest of all time, the options are unfortunately much more limited. It is also an option only available to a minority of superstars who have bargaining power. As it stands, she is not the pioneer of re-recording entire back catalogues. It was, in fact undertaken before by the likes of ELO and Def Leppard, to varying degrees of success.
One other possible game changer is government policy which may be shifting in favour of artists, songwriters and composers and away from record labels. MPs in the UK, for example, are calling for a “complete reset” of music streaming to fairly reward performers and creators. Should this come to fruition, it’s all up for grabs as some of the chunk usually reserved for record labels (up to 60% of streaming income) could shift back to artists and songwriters. This would likely prove to be the ultimate bull case for a platform like Audius where there could be more margin to spread around its token holder community.
In this case, decentralisation would possibly be the winner.
Shifting sands (albeit slowly)
With Napster, music was perhaps the first domain in which a decentralised system came into existence. It is unfortunately also the domain in which the incumbents have had the most amount of time to come up with defence mechanisms, through aggressive enforcement of copyrights.
Spotify came along and created a happy common ground in the post-Napster era, but in the words (again) of Spotify’s Daniel Ek, what Spotify is creating is a renaissance, not a restoration. Music streaming isn’t going back to the days when the recording labels control everything, but at the same time, a lot of the power still remains in the hands of those who own the rights to content. And as long as replacement content cannot be re-made (like Taylor Swift did), they continue to maintain that control.
Incrementally, the sands are gradually shifting as a result of technological developments that enable artists to reach listeners directly, as well as bring much of the functions that record labels used to perform “in-house” (i.e. DIY). Platforms like Spotify and Audius can make that happen, especially with non-label audio content, but while the sands are shifting, they’re going to need a lot more movement to get to the right kind of alignment to happen.
Meanwhile, the three-way tug of war continues.