Legalandprofitable

aaVolume 13
Issue 3 September 2015

Legal and Profitable? Spotify: The Challenges of an Online Music Service Case1, 2 prepared
by Joëlle BISSONNETTE3 and Professor Eric BRUNELLE4
Foreword
Founded in Sweden in 2006, against the backdrop of a music industry plagued by illegal
music downloads and plummeting record sales, Spotify is an on-demand music streaming
service. It offers online music consumers legal access to a repertoire of over 30 million pieces
of music, which varies by country. Its mission is to let people listen to the music they want,
when they want and where they want. To accomplish this, the company offers a legal
alternative that is superior to piracy, via a simple, clear and rapid platform, making listening
to and sharing music easier than ever. But the company still faces major challenges. It has to
respect intellectual property law, which requires adequately compensating the rights holders
to the music it disseminates, while trying to become profitable and differentiate itself from
the competition. How will Spotify position itself to meet the needs of online music
consumers better than other online music services, while respecting the law and turning a
profit?
1. Background: A Music Industry Between Crisis and Opportunity
1.1 Music and technology: a longstanding relationship
Since its beginnings, the music industry has undergone many technological transformations
that forced it to rethink how it does business. The introduction of cassettes in the 1960s made
it possible to create copies for private use and led to a crisis with fine-groove records. When
compact discs (CDs) hit the market, dethroning the cassette, almost 20 years of growth in
sales of recorded music followed; it was a golden age for the music industry, reaching a peak
toward the end of the 1990s.
1 Translation from the French by Rhonda Mullins of case #9 40 2015 015, “Légal et
rentable? Spotify : les défis d’un service de musique en ligne.”
2 This case was prepared on the basis of public documents, i.e., articles, records and
interviews in the media and sectoral studies of the digital music market. It is also a direct
observation of Spotify’s Internet activities up until September 2015.
3 Joëlle Bissonnette is a doctoral student and research professional at HEC Montréal. 4 Eric
Brunelle is an associate professor in the Department of Management, and Director and
Editor-in-Chief of Gestion, at
HEC Montréal.
© HEC Montréal 2015 All rights reserved for all countries. Any translation or alteration in
any form whatsoever is prohibited. The International Journal of Case Studies in Management
is published on-line (http://www.hec.ca/en/case_centre/ijcsm/), ISSN 1911-2599. This case is
intended to be used as the framework for an educational discussion and does not imply any
judgement on the administrative situation presented. Deposited under number 9 40 2015
015T with the HEC Montréal Case Centre, 3000, chemin de la Côte-Sainte-Catherine,
Montréal (Québec) Canada H3T 2A7.
HEC110
For the exclusive use of M. BACAK, 2018.
This document is authorized for use only by M. ZEKI BACAK in Strategic Management
(online) Su18 taught by MICHAEL SHERIDAN, SUNY - New Paltz from May 2018 to Nov
2018.
http://www.hec.ca/en/case_centre/ijcsm/
Legal and Profitable? Spotify: The Challenges of an Online Music Service
During the same era, the emergence of high-speed Internet connections and the mp3 file
format – which has become the official file format for digital music – led to transformations
that still have the industry trying to find its way, upsetting the foundations on which its
performance is based. The mp3 file format can compress files to almost 12 times the size of
the original, with no real audible loss of quality. With households adopting Internet
technology, particularly high-speed Internet connections, these files could circulate
efficiently. Digitized, compressed and stored by individuals, music started to be exchanged
for free and with no restrictions on the Internet, without the authorization of the rights holders
in these musical works and without providing them the compensation that is theirs by right.
1.2 Illegal downloading: from Napster to peer-to-peer
In 1998, the first free sites for downloading mp3 audio files appeared, including Napster in
1999, which made it possible to easily share file directories between Internet users. In under
three years, 60 million users illegally exchanged over 1.5 billion titles (SODEC, 2002, p. 22).
However, Napster’s limitation lay in its centralization. Since the data it contained was not
replicated anywhere, the operation of the network depended on the central server. If it failed,
community members had no way of establishing a connection with other members. So in
2001, when the courts found for the music industry majors,1 who saw the sharing system as a
threat to their control over music distribution, Napster was forced to get rid of its central
server, provoking the collapse of its Internet community. In the meantime, Internet users
came up with alternative solutions. To avoid repeating the Napster experience, Internet users
created sharing systems using multiple servers, ensuring that they remained independent of
one another. In the event of an attack on one server, the community could remain connected
via the remaining servers. The idea was refined and developed, from the principle that having
more servers ensures a robust network, leading to the complete decentralization of sharing
systems: peer-to-peer.2 With this decentralized method of sharing, illegal downloading took
off, was refined and diversified, to the point that it became completely uncontrollable.
1.3 Plummeting CD sales
At the same time as illegal sharing networks were being developed, CD sales in all markets
went into freefall. For example, in the U.S., the largest music market in the world, CD sales
dropped from 730 million units in 2000 to 206.4 million in 2013, a decline of almost 72%,
according to
1 “Majors” refers to international record companies that assume, in whole or in part, the
technical and financial responsibility for producing, manufacturing, promoting and
distributing recorded music (Ménard, 1998, p. 36). Until very recently, there were four
majors, who together accounted for three quarters of music industry sales worldwide, even
over 80% in Europe and the U.S.: Universal Music Group, Warner Music Group, Sony-BMG
and EMI Group (Curien and Moreau, 2006, p. 23). In November 2011, Universal Music
Group and EMI Group merged, further increasing the level of concentration. However, this
oligopoly now has a major competitive fringe made up of thousands of small independent
producers.
2 In peer-to-peer networks, members play the role of both client and server. As files are
downloaded by a user, they become available for download to other users. The particularity
of files that circulate on peer-to-peer platforms, .torrent files, is that they are broken down
into small pieces. Once users receive a piece of a file they are downloading, they immediately
and automatically start sharing this piece with other users. Each new download of a file
increases its availability so that other members of the community download it, thereby
creating a vicious circle of downloading. Sharing is done directly between users, who have
access to all files downloaded by each of the other members of the peer-to-peer community.
Controlling the files available on these systems is therefore impossible, given the
fragmentation of servers that make them available. The only limits to sharing are the size of
the community and the number of files all members have.
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Nielsen SoundScan data (Statistic Brain, 2014). According to the same data, in Quebec,
where the decline in CD sales hit later and was less pronounced, from 2004 to 2013, sales
dropped by half, going from 13 million units sold in 2004 to 6.1 million in 2013. Across
Canada, CD sales went from 36.6 million to 11.7 million during the same period, or a drop of
68% in nine years (Fortier, 2014). While the drop in CD sales cannot be directly linked to
illegal downloads because too many variables were at play,1 the fact remains that one of the
foundations of music industry revenue was challenged, at the very time the Internet and
digitization came on the scene. As a result, the music industry needed to look at the fit
between how they meet consumer needs ‒ in other words, creating value for them with
recorded music ‒ and how they generate revenue for themselves.
1.4 The digital music market
In response, new ways of creating value for consumers are emerging, such as the sale of
digital tracks and albums and continuous or on-demand streaming of music. They are inspired
by new music consumption habits that are developing online and the opportunities of
digitization. These initiatives led to a 1000% increase in the market value of digital music
between 2004 and 2010 worldwide (IFPI, 2011), and this market continues to grow year after
year (figure 1).
Figure 1: Increase in global revenues in digital music from 2008 to 2013 (IFPI, 2014)
In 2013, revenue from digital music accounted for 39% of all global music revenue (5% more
than in 2012 and 10% more than in 2010) and even represented the majority of this revenue
in three out of the ten largest music markets. In comparison, in 2013, revenues from CD sales
accounted for 51.4% of music revenue, almost 5% less than in 2012 (IFPI, 2014). This
growth trend in digital music revenue is still far from compensating for the drop in revenue
from CD sales of the past 10 to 15 years (figure 2).
1 On the question of variables at play in the drop in CD sales, readers can refer to Curien and
Moreau (2006, pp. 63-67).
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Figure 2: Drop in revenue from CD sales compared with revenue growth from digital music,
worldwide from 1997 to 2012 from 2013 IFPI data (King, 2013)
1.4.1 Music file sales platforms and music streaming services
Among the legal initiatives behind the rise in sales of digital music, there are platforms for
the sale of digital albums and tracks, such as iTunes and Amazon MP3, as well as music
streaming services, which include Spotify, Deezer, Rdio and Apple Music, to name just a
few. According to IFPI data, in 2013, 67% of worldwide revenue from digital music was
generated by downloading music files, from platforms that sell albums and tracks, compared
with 27% for music streaming services. Music downloads therefore remain the main source
of global revenue for digital music. However, streaming services are gaining in popularity on
all markets. Their revenue rose 51% between 2012 and 2013 (figure 3), growth that shows no
signs of slowing. These services offer online music consumers access to a vast online music
library, anywhere, any time and on any platform. Because of the growing popularity these
services are enjoying and the approach to consuming music they offer, they are seriously
undermining the illegal offer, which some observers see as hope for the music industry.
Figure 3: Online music streaming services (IFPI, 2014)
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In some markets, music streaming services even outperform the downloading of tracks and
albums, such as in Sweden, France and Italy. The clearest example of this is Sweden, where
94% of digital music revenue comes from these services, mainly from Spotify (IFPI, 2014).
Of these services, Spotify is garnering attention for its positioning with online music
consumers, differentiating itself in a number of markets from other streaming services and
even from music downloading services, and for the way it has worked with music rights
holders to make its music library legally available. The magnitude of the challenges the
service has to tackle in terms of profitability and compensation for rights holders make it
even more interesting.
2. Spotify’s Origins
The men behind Spotify are Daniel Ek and Martin Lorentzon, two Swedish entrepreneurs and
music lovers who have had successful careers in the Internet and information and
communication technologies. In 2006, at turning points in their respective careers, Ek and
Lorentzon decided to team up to find a technological solution for the music industry. They
were concerned that the industry was in crisis, at a time when people were listening to more
music than they ever had and when there was a greater diversity of artists than ever before. In
fact, at the time, the Swedish music industry, like the industry everywhere else, was in the
midst of a decade of constantly plummeting revenues. At the same time, the country had long
been a hotbed of pirating. It is in Sweden that Kazaa was developed, a peer-to-peer
downloading software, and, more importantly, The Pirate Bay, one of the largest platforms
for illegally sharing music files. In the European elections of 2009, the Swedish pirate party
(Piratpartiet) even won 7.1% of the vote, earning it a place in the European Parliament. Ek
and Lorentzon wanted to offer something better than pirating: “Our idea was to create
something that would generate revenue for the music industry and that would work on any
terminal, that would be like water” (quoted in Beuth, 2011). Rather than dismissing piracy,
they drew inspiration from it. Daniel Ek describes his brief flirtation with the illegal
downloading site Napster at the end of the 1990s as being the experience that most changed
him as a music consumer. That was where he discovered his two favourite bands, The Beatles
and Led Zeppelin. Because of this experience, he also became part of the generation of 18 to
30 year olds who don’t believe in paying for music, and who think that it should circulate
freely on the Internet. In fact, in a November 2011 article about Spotify that appeared in
Wired, Steven Levy explains the influence Napster had on this generation. He says:
“Unleashed in a dorm room in 1999 and killed in a courtroom in 2001, it taught a generation
that music should be obtained with mouseclicks, not money.” Having experienced it, Ek
understands how Napster, The Pirate Bay and the other illegal downloading platforms shaped
the expectations of this generation when it comes to access to music, its uses and how it is
consumed. So rather than offering online music consumers the chance to buy and own the
music they listen to, he came up with the idea of offering them access to a vast library of
music, that would have all the characteristics of illegal downloading sites. He took as a given
that the best way to listen to music was to give the public unlimited access to an exhaustive
catalogue of songs, stored on servers and available online. This was similar to what Napster
had been offering, except the now-defunct service had used downloading rather than
streaming, was
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slow and often experienced glitches, and users could be traced and prosecuted. So there was
room for improvement.
2.1 Drawing inspiration from pirating
Before improving on the pirating experience, Ek tried to keep what worked best on the top
illegal downloading platforms. So he built his service using the same technology as The
Pirate Bay – peer- to-peer architecture – which enables a very fast rate of transfer of music
files. Spotify functions as an application downloaded to the user’s hard drive rather than as an
online service, and it draws on the hard drives of all users. This increases the speed of the
service and relieves the pressure on the central servers by spreading demand over different
connections.1
2.2 Improving on pirating
But Spotify does more than just draw inspiration from the best aspects of pirating platforms.
Ek wanted his service to do better than the most popular of these platforms, to be more
efficient, convenient and accessible. Illegal downloading platform interfaces are often not
clear or inviting, and users cannot always create their own accounts, adapt the platform to
their preferences or use it on any device. Plus the music offer is not always as diverse or
complete as users would like. So opening an account, downloading a program and being able
to listen to any of the 30 million tracks on Spotify is what differentiates the company from
illegal alternatives. This is in addition to Daniel Ek’s obsession to create an endlessly faster
and higher performance platform, striving to keep diminishing the time between click and
sound. He combines a number of technologies to accomplish this: a local cache memory,
peer-to-peer sharing, as noted above, and traditional streaming. When consumers click on a
song, it plays immediately, as if it were already on their hard drive. In order for listeners not
to notice a delay between the click and the sound, songs have to be streamed within 200
milliseconds, or the time it takes for the human brain to perceive the slightest delay. When
building Spotify, Daniel Ek told himself that if he could manage to deliver this speed to
consumers, it would be as if they owned all the music in the world on their computer hard
drive. With this superior technology infrastructure and its presence on multiple platforms,
including mobile platforms, Spotify encourages consumers to abandon pirating and may
eventually lead them to want to pay for the service. In fact, Ek believes that “An entire
generation had rejected the idea of ownership […] If not files, maybe they would pay for
convenience” (Greeley, 2011). But what distinguishes Spotify from pirating platforms is also,
and most importantly, the ability for Internet users to get unrestricted access to music online,
without breaking the law.
3. Legal Constraints
Daniel Ek couldn’t have launched Spotify without entering into agreements with the rights
holders to the works his service would provide access to. He wanted to demonstrate that it
was possible to
1 This approach has allowed Spotify to build and grow, and, in April 2014, the company
announced that its even higher performance servers could gradually replace peer-to-peer
technology.
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work with the companies that represent rights holders. But after his company was launched,
he met with resistance from record companies, which were not taking him seriously or
buying into his model. But Daniel Ek was 23 years old at the time and was confident no
challenge was too great. So while he thought it would take him less than three months to
negotiate an agreement that would authorize him to use all European music, it was only in
October 2008, more than two years after Spotify was founded, that it was finally launched in
Norway, Sweden, France, the U.K. and Spain. Its launch in Finland, Denmark and the
Netherlands followed soon after. It took almost three more years to finalize agreements with
rights holders in the U.S., which was accomplished in July 2011, two years later than
anticipated. And legal issues again meant that it took until November of the same year for the
service to be offered in Austria, Belgium and Switzerland, and until March 2012 for it to be
available in Germany. In Canada, Spotify only managed to reach an agreement with
copyright lobby groups to launch its service in September 2014. These groups believed that
the service devalued music and asked for a higher rate each time music was streamed. The
rate negotiated is not as high as the lobby groups would have hoped, but is comparable to
what was negotiated in other countries – for every 1000 streams, rights holders receive 10.2
cents – and Spotify committed to promoting Canadian talent on the Canadian version of its
platform. A channel specializing in Canadian content was created to do just that.
4. Spotify’s Strategies
Spotify is not the first or the only legal music platform on the Internet, nor is it the only
service that offers access to an online repertoire of music. It faces competition in every
market. The French company Deezer, its main competitor in France, and the American
platform Pandora, which still beats out Spotify in the U.S., along with Rdio, KKBOx, WiMP
and Tidal, to name just a few, all offer online music services that, while markedly different,
are interchangeable for consumers (exhibit 1: Comparison of the Main Online Music
Streaming Services). What’s more, in recent years, the Internet and electronics giants,
particularly Amazon, Google and Samsung, have launched music streaming services of their
own, the most recent addition being Apple with Apple Music, which was released in June
2015. Apple Music presents a real threat to Spotify. Both services, which are available for the
same price, have a comparable offering: their musical repertoires are similar in size, the two
companies offer a radio service as well as features for sharing and discovery. However, while
Spotify has an established reputation in the world of music streaming, Apple Music has a
considerable advantage in its dealings with record companies, its availability in 110 countries
(compared to 58 for Spotify), its 800 million users already acquired via iTunes and greater
risk tolerance afforded by its position in the Apple family. As the service is still in its free
trial period, it is not possible to comment on its performance, but it is clear that Apple Music
will be a force to be reckoned with in the online music services sector. And this is in addition
to the omnipresence of iTunes, which is substantially different from Spotify in terms of how
its users listen to and buy music, but whose offer clearly competes with Spotify’s. To stand
out in a highly competitive market, Spotify needs to be in line with current practices, while
demonstrating originality.
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4.1 The “freemium” model
Spotify’s service falls under the “freemium” model. Users can access music in the catalogue
for free and listen to it on a phone, tablet or computer, in return for being exposed to sound
and visual ads for a few minutes every hour. Users previously had a ten-hour monthly
listening limit and could only listen to a track five times, but Spotify recently lifted the
restrictions on this free option to get an edge over its serious online music competitors. Users
can also access the Premium service for $9.99 per month, with no further commitment. They
enjoy unlimited access to the Spotify catalogue, without ads or interruptions. The music is
available with superior sound quality for listening on computers, phones, tablets, and, since
2013, televisions. In addition to being available on all platforms, Spotify is also optimized for
the most popular electronic environments. Since 2011, Spotify users have also had access to
Spotify radio, which encourages discovery by playing music based on the user’s preferences.
Recommendations systems (like the “Discover” page, which offers users new titles based on
the music they listen to and favourite artists) and thematic playlists are also available on
Spotify to personalize the use of the service and promote exploring the repertoire.
4.2 Social media integration
In September 2011, Facebook integrated to Spotify and vice versa. The goal of this
integration is to allow Spotify users to share the music they listen to with their contacts via
Facebook and to encourage those who do not yet use Spotify to subscribe to it. Spotify users
have the option of automatically publishing what they are listening to in Spotify on their
Facebook page, and this information then appears on their friends’ news feeds. Their friends
who use Spotify can then listen to the songs, and those who don’t have an incentive to
subscribe to the service. This partnership also benefits Facebook, because exchanges increase
when music is shared, as Daniel Ek points out: “Facebook is the largest distribution platform
in the world today. What Facebook enables is content sharing. Mark Zuckerberg realized that
Facebook’s value lies in interactions between people. And music is one of the most social
things there is” (Beuth, 2011). Music is also closely tied to identity. People can express who
they are by letting others know what they are listening to, whether by wearing a T-shirt or a
hat with the name of a band or artist or by sharing music on Facebook. To get the greatest
benefit from integrating music to its site, Facebook did not offer Spotify exclusive access to
the some 900 million users it had at the time; the popular social network has many other
music partners that are Spotify’s competitors. But Spotify seems to have made its presence
felt. According to Facebook vice-president Dan Rose, it has two advantages over other
services. The first is that the platform has taken the social network aspect the furthest, starting
from its initial design. Sharing music between users is encouraged in any form. The second is
that the company has a business model that fits perfectly with the sort of discovery that
Facebook was designed to enable. If Facebook users see through their news feed that a friend
is listening to a song, an album or an artist and they want to listen, they can easily do so by
going straight to Spotify. The site, with its free access to a catalogue of over 30 million titles,
is designed to enable exploration, showcasing the repertoire and the discoveries users can
make. At the same time, its free offer is a catalyst for these discoveries, because unlike
platforms such as iTunes, where you
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have to pay to listen to a whole song, there are no barriers of cost or access to the music
experience of Spotify’s free offer. In November 2011, two months into the partnership
between the two companies, some sources suggested that Spotify had gained some four
million users in countries where both services are available. In 2012, Spotify announced that
users who link their Spotify account to their Facebook account are three times more likely to
become paying subscribers.
4.3 Creating value jointly with consumers
The social networks of Spotify, Facebook and Twitter are places for sharing many playlists
created by the company’s employees or users, based on a theme, genre or emotion. For
example, when spring arrived in 2014, Spotify asked its some 829,000 subscribers via Twitter
what they were listening to and encouraged them to share their current playlist, offering the
incentive that this list could then be promoted by the company. Spotify does the same thing
on Mother’s Day, Valentine’s Day, Halloween, on a sunny or rainy day – any occasion that
presents itself. Spotify users share playlists every day on Twitter. The company even opened
a Twitter account with the name @SpotifyPlaylists, where it shares its playlists and where
users can share theirs. A group of those users, which adopted this company-initiated practice,
even created the hashtag #thursplay to encourage other users to publish playlists every
Thursday. These compilations give users the chance to discover new songs and share their
tastes. They also ensure that less explored parts of the repertoire are promoted, because with a
repertoire of over 30 million songs to choose from, users can have a hard time figuring out
what to listen to. It lets them discover other people’s recommendations, based on criteria that
appeal to the user, and to make their own recommendations, making them feel as though they
are playing a role with other Spotify users, while asserting their tastes, and, in turn, their
identity. For Spotify, this has reduced some of its operating costs, because the company does
not have to promote its repertoire on its own, and it also builds customer loyalty and
commitment. Spotify goes even farther in getting customers involved. In 2011, the company
launched a development platform that allows professional and amateur developers to create
applications for Spotify. Spotify already has a team of developers for such applications, but
they thought it was a good idea to get outside developers involved to generate new ideas and
respond to needs that users have identified, which the company never could have. Developers
have access to a platform for designing applications without worrying about getting the
licences to access music repertoires. With this obstacle out of the way, they can let their
imagination run wild, to everyone’s benefit. TuneWiki and MusixMatch, for example,
provide users with lyrics to the songs available on Spotify. Songkick creates a calendar of
concerts likely to be of interest to users based on the music they listen to on Spotify.
MoodAgent offers instant access to playlists that match the user’s mood. The Complete
Collection displays album covers for music played on Spotify. Classify allows users to
explore classical music. These applications add to the value the company creates, because
they are made available to other users, once the company has approved them. They promote
even more widespread use of the music available on Spotify and a more thorough exploration
of repertoires. A sure sign that they add to
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the value created by Spotify, in their first four months of existence, Spotify applications were
used for 13 million hours. For example, the playlist generator MoodAgent generated on
average some 3.5 million playlists per week. On social networks, specifically Facebook and
Twitter, users share opinions about these applications. Spotify encourages these discussions
about applications, occasionally asking users for their favourite application. In being asked to
share their opinion, users help build the popularity of applications and even create value for
the company. Spotify therefore plays the role of facilitator for these activities and instigator
for its customers, who are immediately inclined to help create value for the company. It
creates the mechanism, such as the platform for developers or the use of social media,
harnessing customer willingness to get involved in activities that create value. These
activities help Spotify improve, extend its reach, increase its popularity and promote its music
repertoire.
4.4 Brand partnerships
To increase revenue, Spotify also partners with companies that will pay for access to its
consumers and their attention. First, advertisers can disseminate messages via the service, in a
number of audio and visual formats.1 In addition to offering an environment that is
advertising friendly, Spotify offers advertisers the ability to target their potential consumers
from data the company has collected (demographic and geographical data, and data on their
musical tastes). The company also provides advertisers tracking functionality and detailed
reports on how their ad was used. Second, sometimes Spotify has closer and more intimate
relationships with brands, as is the case with Lucozade, Coca- Cola, Reebok, Volvo and Ford
(see exhibit 2: Spotify’s Commercial Partnerships). In such cases, both the partner brand and
Spotify benefit from the other’s audience. Spotify has gained many customers through these
partnerships that it wouldn’t have reached otherwise.
5. A Meteoric Rise
Spotify has had a meteoric rise since it was founded thanks to its functionality and
partnerships. From the end of 2012 to the middle of 2015, the company expanded its network
from 13 to 58 markets, including Germany, France, the U.K. and the U.S. – four of the largest
music markets – along with the Scandinavian countries, Turkey, Taiwan and Australia. In
2015, it had 75 million active users, including 20 million paying subscribers. The company,
with headquarters in the U.K. and Sweden, and offices in 18 countries, had 300 employees in
2012 and now has over 1200.
5.1 A strong influence: from ownership to access
This meteoric rise is proof that the company has effectively responded to the needs of online
music consumers. Spotify’s rapid adoption by millions of Internet users has had an impact on
the entire
1 Here is how the Spotify website sells the benefits of buying ad time or space on its service:
“Everyone listens to music. You can be sure your customers do too. But unlike commercial
radio, Spotify makes it possible to listen to music instantaneously. At any time of the day,
anyone can listen to the music that makes them happy. Our audience knows that ads are what
fund our legal, free online music service and that allow us to compensate the artists they love.
Without advertisers, there is no free music. Does this sound like an environment for your
brand?”
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music industry. In fact, Spotify offers a different approach to consuming music that is
gradually taking over. With services like iTunes, people acquire ownership of a piece of
music, while with Spotify, people acquire access to a song, a bit like renting it. In the U.S., in
2010, before Spotify came on the scene, almost 80% of music industry revenue from the
digital market came from the sale of songs and albums, mainly from iTunes. In comparison,
in Sweden, two years after Spotify was launched, the sale of songs and albums represented
only 20% of digital music revenues, while 60% came from on-demand music streaming,
mainly from Spotify. In 2013, 94% of digital music revenue came from music streaming
services in Sweden. With the popularity of this approach to consumption, digital music now
accounts for 70% of music industry revenue, and Spotify has become the leading source of
music revenue in this country (physical and digital media combined). Clearly this approach to
consuming music is a better fit for the expectations and needs of online music consumers. In
Sweden, apparently no one brings a computer or hard drive to a party anymore. They just
connect to Spotify from any terminal with Internet access. The Scandinavian countries
(Denmark, Norway and Sweden) have demonstrated the streaming model’s potential to
revitalize the music industry. In 2013, the Swedish music market saw growth of 5.7%
attributable to streaming revenue, Denmark’s grew 4.7% and Norway’s grew 2.4% (IFPI,
2014).
6. The Problem of Monetizing Music
While Spotify has grown since it was founded, particularly since entering the U.S. and
striking up its partnership with Facebook, and while it plays a decisive role in the entire
music industry, the company is not yet profitable. It does create value for over 75 million
online music consumers in 58 countries, but its costs still exceed revenues.
6.1 Spotify’s net revenue
Spotify reported earnings of 747 million euros in 2013, an increase of 73.6% compared with
the 430 million euros earned in 2012. However, its losses also increased by 16.4%, rising
from 80 million euros in 2012 to 93 million euros in 2013, according to Spotify’s most recent
consolidated financial statements. Its net losses can be represented in the following graph
(figure 4) as declining from 87 million euros in 2012 to 58 million euros in 2013, but this is
largely attributable to its 39 million euros in stock options. According to experts, operating
losses, which were 93 million euros in 2013, are a better indicator of Spotify’s performance
(Dredge, 2014). In other words, Spotify had a deficit of 93 million euros in 2013.
© HEC Montréal 11
2018.
Figure 4: Spotify’s revenue and net income from 2008 to 2013 (Statista, 2015)
6.2 Capital investments and cumulative losses
Since its beginnings, Spotify has accepted close to $300 million in outside capital from
investors such as Horizon Ventures, Li Ka-Shing, Northzone, Creandum, Wellington
Partners, Sean Parker, Founders Fund, Goldman Sachs and Coca-Cola. However, it has
accumulated losses of over $200 million, according to the firm PrivCo, which studies the
performance of private companies. Its losses are indeed growing and accumulating, but there
is also growth in revenue, and investors continue to believe and invest in the project. In an
industry as early in its development as music streaming, some experts are even talking about
progress (Brustein, 2014).
6.3 Spotify’s revenue and cost structure
To understand Spotify’s inability to reach profitability and the losses that are piling up year
after year, one needs to understand its revenue and cost structure. Of the 747 million euros in
revenue in 2013, 91%, or 679 million euros, came from subscriptions to the Premium service.
The remaining 68 million euros are from advertising revenue attributable to users of Spotify’s
free service. Given that the company ended 2013 with 36 million active users, 8 million of
whom subscribed to the Premium service and 28 million of whom subscribed to the free
offer, 91% of the company’s revenue comes from 22% of users who pay for the service. On
the cost side, to legally offer such a vast repertoire of music to Internet users, Spotify must
pay rights holders of this music: lyricists, composers and other intermediaries involved in
creating, producing and promoting musical works. According to Spotify, 70% of its gross
revenue goes directly to rights holders. This has amounted to $3 billion since the service was
launched (including $500 million in 2013 alone). Spotify’s other most significant costs are
technology related, i.e., the cost of hosting and storing data and the cost of the bandwidth
required to stream such a large volume of music on demand. These costs vary depending on
the number of users, and fortunately they increase in line with revenue growth. This is in
addition to the fixed costs of developing the
© HEC Montréal 12
2018.
on-demand music streaming service and the underlying infrastructure. These are expenses
related to programming and maintaining the streaming platform, the database of over 30
million songs and the company’s websites, as well as costs related to its offices in 18
countries and salaries for 1200 employees.
6.4 Streaming versus downloading: the rights holders’ cut
Despite the fact that Spotify hands over a seemingly generous 70% of gross income to music
rights holders, what ends up in their pockets each time a song is heard is a micro payment. It
is hard to accurately establish the amount distributed to rights holders when their songs are
used by Spotify. In December 2013, the company announced that it had paid music rights
holders between $0.006 and $0.0084 every time a song was heard, or between $6 and $8
when a title was heard 1000 times, depending on the country where the Internet user listened
to the music, the type of subscription (free or paying) as well as Spotify’s sales figures. How
this amount is distributed among the rights holders of the title in question (the producer,
lyricist, composer and performer) and other intermediaries varies according to commercial
practices in each country and the contracts signed between the lyricist, composer, producer
and/or record company. The amounts paid by Spotify are similar to, and even higher than, the
royalties paid by comparable music streaming services, such as Rdio, Pandora and Deezer
(see exhibit 1: Comparison Table of the Main Music Streaming Services). In 2013, Pandora
paid 48% of its $600 million in net income to rights holders, with an estimated rate of
$0.0011 each time a song was streamed. Like Spotify, Pandora is not profitable. While
competitive, the royalties paid by Spotify are very low compared with those paid by certain
local services, as shown in figure 5, which was prepared by an independent record company
to show what it earns from music streaming, and lower still than revenue from digital music
downloading platforms, such as iTunes:
Figure 5: Music streaming service payouts, according to an independent record company
(Resnikoff, 2014)
© HEC Montréal 13
2018.
In comparison, iTunes, for example, where the price is a standard $0.99 per track, pays $0.69
for each title sold, which is split among intermediaries and rights holders (digital distributors,
record companies, producers, performers and songwriters). The figure below (figure 6) shows
the number of titles that have to be streamed on the different music streaming services to
equal the sale of a single title on iTunes, in terms of revenue for the same record company.
According to this data, a track would have to be heard around 135 times on Spotify to equal it
being downloaded once from iTunes. Figure 6: Number of times a track needs to be streamed
to equal the sale of a title on iTunes
(Resnikoff, 2014)
Some claim that the situation is even worse for emerging musicians. In 2013, folk rock
musician Damon Krukowski calculated that one of his songs would have to be played 47,680
times on Spotify or 312,000 times on Pandora to bring in an amount equal to the sale of a
single album (with 10 to 12 tracks), or between $10 and $15 (Brustein, 2014). Many music
rights holders have criticized Spotify’s compensation, and a number of leading artists, such as
Adele, Radiohead, Black Keys and, more recently, Taylor Swift, have refused to have their
music on Spotify or on other music streaming services, because what they earn each time one
of their songs is played is much too low compared with what they would earn if they sold the
song. Taylor Swift, however, accepted that her 1989 album be made available on Apple
Music, after managing to make the company go back on its decision to not pay music rights
holders during its free three-month trial period. Indeed, in an open letter to Apple, in which
she called out the injustice of a service that exists thanks to the work of music rights holders
but that refuses to compensate those same rights holders, Swift convinced Apple to pay
creators, producers and performers for the use of their music during the trial period. In
response to Apple’s decision, Taylor Swift agreed to make her most recent album accessible
on Apple Music, but this is an exception to the rule, in response to Apple’s reaction, as the
artist continues, like many others, to deny Spotify and other music services access to her
music. Like Swift, in November 2011, the British distributor
© HEC Montréal 14
2018.
STHoldings, which represents over 238 independent record companies, decided to remove its
entire catalogue from Spotify, alleging that while on-demand music streaming services
promote music to millions of people, they bring in very little money, devalue music and are
likely to cannibalize traditional digital sales revenues, although no study has shown this yet.1
Without being able to establish a direct causal link with the rise of streaming, one can
observe that downloading music tracks and albums has, for the first time since its beginnings,
declined slightly since 2013 and the decline continued in 2014. In 2013, revenue from
downloading tracks and albums dropped 2.1% worldwide, although it still accounts for 67%
of digital music revenue (IFPI, 2014). To give just a few examples, in Quebec, sales of tracks
and albums declined 12.8% and 3.7% respectively between 2013 and 2014. Across Canada,
the drop was in the order of 12.4% for digital tracks and 4.4% for digital albums. In the U.S.,
it was 12.5% for digital tracks and 9.4% for digital albums (Observatoire de la culture et des
communications du Québec, 2015). Not escaping the trend, for the first time Apple reported a
drop in sales of digital music on iTunes of 13% to 14% (Karp, 2014).
The iTunes model, leader in legal music downloading In spite of this drop, iTunes is
undeniably a world leader in legal downloads of music. In 2003, the release of the
iPod/iTunes duo allowed Apple to quickly dominate the still emerging market of legal music
downloading and become part of the music consumption habits of millions of people around
the world. Paying $9.99 for albums and $0.99 for tracks became the standard for most online
sales platforms, a drop in price compared with albums sold in physical format in the store, but
an increase considering the competition iTunes created for illegal downloading platforms,
where all music was being exchanged for free. Since its launch, iTunes, which is available in
147 countries and offers a catalogue of 37 million titles, has 800 million users registered with
a credit card and has sold over 35 billion titles, the equivalent of 4.9 songs per person on the
planet. It pockets 30% of the revenue from each title sold, paying out $0.69, which is split
among all other players in the supply chain, from the digital distributor to the songwriter.
So in the world of digital music, making works available on Spotify, Rdio, Deezer, Pandora
and other platforms is not profitable for rights holders, not even for international stars, when
compared with selling tracks and albums on legal downloading platforms. But in a context
where consumers are migrating toward music streaming platforms because they feel they
better meet their needs than legal downloading platforms like iTunes – when they do not
simply move on to illegal platforms – many rights holders agree that having their work on
Spotify is still better than being pirated. And it has been proven that legal music streaming
services, because they are similar to what illegal music download platforms offer in terms of
accessibility, put a substantial dent in pirating. Sweden’s GfK Research showed in 2013 that
90% of Spotify’s paying users and 70% of users of its free service download music illegally
“less often” since joining Spotify (IFPI, 2014).
1 On the contrary, a March 2012 study conducted by Nielsen on the evolution of on-demand
music streaming since 2005 showed that the increase in this method of consuming music did
not affect legal downloads of albums and tracks. In other words, no correlation can be drawn
between these two uses of music (Pham, 2012).
© HEC Montréal 15
2018.
6.5 Increasing revenues to offer better compensation for music, but how?
In spite of these benefits, music rights holders would like to be better compensated for the use
of their music on these platforms. If Spotify wanted to pay higher royalties, it would need to
raise the price charged to consumers. Yet by charging consumers more, competition from
free illegal offers would become stronger, and the company would lose market share. Striking
this balance is a constant challenge, one that the company has not yet managed to tackle.
Spotify could also rely on more paying subscribers, given that the Premium service is a much
more substantial source of revenue than ad revenue associated with the free service. Spotify’s
share of paying subscribers ranges between 20% and 27%, the peak of 27% being reached in
the middle of 2015, when 20 million of the 75 million users paid to access the service. That
means that the 55 million other users are satisfied with the free offer. And rightly so. Users of
Spotify’s free offer are among the most spoiled of all music streaming service users. There
are no limits on how much time they can spend listening to music, they can access it from
any platform, and advertising is well integrated and targeted. In comparison, Deezer, which
makes its free offer available only via computer, has 38% paying users, whereas WiMP
simply doesn’t have a free offer, and does relatively well in its market. The 75% to 80% of
users who do not pay to access the 20 million songs available on Spotify generated, through
ad revenue, less than 10% of its annual income in 2013. In comparison, in the entire music
industry, the share of revenue related to users of the free offer of music streaming services
tended to be higher and handily exceeded 10% of revenue (figure 7). The proportion of
paying Spotify subscribers is therefore much lower when compared with that of other music
streaming services. Figure 7: Revenue share related to the types of use (paying and free) of
streaming services
throughout the music industry (Brustein, 2014)
The company remains optimistic about its ability to generate more revenue and better
compensate music rights holders. According to Daniel Ek, Spotify has already proven its
ability to create value
© HEC Montréal 16
2018.
for users, and it knows that the more time people spend using its service, the more inclined
they are to become paying subscribers. As the company reaches more users, the proportion of
them who will pay to access the service will grow, revenue will climb and the amounts paid
to music rights holders will increase proportionally (Dredge, 2014). To increase the share of
paying subscribers, for a few years Spotify has been trying to bundle subscriptions to its
service with other complementary services. The company has signed some 30 bundling
agreements, the most important of which was in the U.S. with phone service provider Sprint.
Sprint will offer family plan subscribers a reduced-rate subscription to Spotify and actively
promote it, which should lead to a significant increase in the number of paid subscribers to
Spotify in the U.S. and in turn increase revenue.
6.6 Solving the profitability impasse
While increasing the number of Spotify users could lead to an increase in royalties paid to
rights holders, achieving profitability will not be quite so simple. Spotify pays rights holders
a fixed percentage of its gross income, or 70%, rather than a fixed rate, as similar services do.
As a result, an increase in the number of its subscribers, which results in a rise in gross
income, increases its costs at the same rate (figure 8).
Figure 8: Growth in Spotify’s revenue and costs from 2009 to 2012 (Brustein, 2014)
For a company running a deficit, with losses accumulating year after year, the increase in
gross income needs to be significant for it to be able to cover its costs and eliminate its
accumulated deficit with its 30% margin. Spotify therefore faces quite a paradox: on the one
hand, its service is causing a sensation among consumers, and it has seen a meteoric rise
since it was founded. It easily outpaces the other legal online music services, such as Deezer,
Pandora and Rdio, on many markets. And in spite of some reticence, rights holders are
making their music available on the platform, figuring that it is better to have titles on Spotify
than on illegal downloading platforms, but hoping that this use of their music will end up
paying more one day. This allows Spotify to offer one of the most complete music catalogues
on the market. So Spotify has achieved a certain success. On the other hand, the company has
not yet turned a profit, and despite the fact that it accepts running an annual deficit to pay
rights holders, what they earn is not enough. Even sharing 70% of
© HEC Montréal 17
2018.
its revenue with them and racking up losses, Spotify is not contributing to the viability of
those who create, produce and promote music. It is drawing consumers away from illegal
downloading platforms, of course, but the revenue it manages to generate is practically
symbolic once in the hands of music creators, producers and promoters. Paying rights holders
more would mean increasing the contribution for consumers, at the risk of losing them to
free, illegal platforms. So like the entire music industry, Spotify is struggling with the issue of
the very value placed on music and the difficulty of monetizing it. How will this impasse be
broken? How can they keep giving consumers what they consider value – free music,
instantaneity, accessibility, diversity and flexibility – while monetizing that value to better
compensate rights holders and achieve what any company aims for: profitability? The
outcome of this struggle to create value, which music consumers and rights holders play a
part in along with Spotify’s legal and illegal competitors, is far from simple. To reconcile the
interests of consumers with those of rights holders, to reconcile the values of a generation of
Internet users with the value of music, while aiming for profitability and differentiating itself
from the competition, Spotify will need a great deal of creativity and strategy. 2015-09-11
© HEC Montréal 18
2018.
Exhibit 1 Comparison of the Main Music Streaming Services
Service Launch Reach in
2015 Number of
subscribers in 2015
Number of paying
subscribers to Premium
service in 2015 and as a
percentage
Cost/month for Premium service
Free offer Percentage of revenue
allocated to music rights
holders
Titles in the catalogue
(in millions)
Profitable
2006
(Sweden)
58 countries 75 million 20 million
27%
$9.99 Yes, on computer,
without limitation, with
ads
70% of revenue
30 No
June 2015 110 countries
11 million trial subscribers
Unavailable $9.99 Yes, with limitations, without ads
Unavailable 35 Unavailable
2010
(U.S.)
85 countries Unavailable Unavailable $9.99 Yes, but only for radio
streaming
Unavailable 32 Unavailable
2007
(France)
180 countries
16 million 6 million
38%
$9.99 Yes, on computer only,
with ads
Unavailable 35 Yes, in France
2000
(U.S.)
3 countries
(U.S., Australia and New Zealand)
1.2%
$4.99 Yes, on computer and
mobile devices, with
ads
48% of revenue
1 No
2014
(U.S.)
1 country
(U.S.)
110,000 to 200,000
110,000 to 200,000
100%
$9.99 No 65% of revenue
20 Unavailable
2004
(Taiwan)
7 countries in Asia
20%
$9.90 Yes, online only with
limitations, with ads
10 Unavailable
2010
(Norway)
5 countries in Northern
Europe
580,000 580,000
100%
- Including 17,000 Hi-Fi
3%
$4.99 (Basic) $9.99 (Premium)
$19.99 (Hi-Fi)
No Unavailable 25 Unavailable
November 2014
35 countries
(Europe and North
America)
Unavailable Unavailable $19.99
(high-quality streaming)
No Unavailable 25
+ 75,000 videos
Unavailable
© HEC Montréal 19
2018.
Exhibit 2 Spotify’s Commercial Partnerships
In addition to partnering with advertisers, who place their ads on the music service in a
number of audio and visual formats, Spotify sometimes enters into closer, more developed
relationships with brands. In these cases, both the partner brand and the service benefit from
each other’s audiences. Most significantly, by being associated with music, which is an
important expression of identity, the brand takes on some of that identity. It increases its
value, takes on a new personality, one users are more likely to identify with.
1. Lucozade For example, in March 2011, Spotify partnered with Lucozade, the leading
energy drink in the U.K. A promotional campaign ran online on social networks, primarily
targeting 16 to 24 year olds, who account for a significant share of Spotify users. The public
was informed that when they bought a bottle of Lucozade from March 1 to May 31, they
could win one of a thousand Premium subscriptions to Spotify as well as other prizes related
to music or Lucozade. Every bottle sold during that period contained a promotional code,
giving consumers access to exclusive content from Spotify on the Lucozade website, such as
playlists created by popular artists who took part in the campaign. For example, artist Tinchy
Stryder shared songs that inspired him, and consumers were encouraged to vote for their
favourite song. They could also play online DJ and remix songs. When consumers took part
in these activities, they became eligible to win one of the prizes. This partnership provided
Spotify with new users and allowed Lucozade to boost its image with existing consumers and
attract new ones, no doubt won over by the music they could access by taking part in the
contest. Both companies have reported being satisfied with this partnership. Adam Williams,
Spotify U.K.’s director of sales, said that there was a great deal of synergy between the
brands. Andy Mahoney, Lucozade brand manager, said that the partnership came at the right
time for both brands.
2. Reebok, Volvo and Ford In April 2012, Spotify announced that it would take partnerships
further with brands that wanted to leverage Spotify technology to offer their customers music
services. Since then, it has signed an agreement with Reebok, which offers playlists for
runners. It also entered into partnerships with Volvo and Ford to integrate Spotify services in
both brands’ vehicles, with touch and voice controls to choose music, change tracks and
create playlists, while remaining focused on driving. These latest agreements will add value
to the two brands’ vehicles and significantly grow the number of Spotify users, particularly
thanks to Volvo, which would like to offer the service to customers for free.
3. Coca-Cola A partnership was also created between Spotify and Coca-Cola, resulting in the
Coca-Cola Placelists application. The application, which also works with Facebook Places,
encourages teens to associate songs from the vast Spotify repertoire with places and events: a
neighbourhood café or park, a tourist destination on the other side of the planet or a World
Cup soccer game. The application’s other users agree or disagree with a song being on the list
for the place or event. New
© HEC Montréal 20
2018.
playlists are thus created collaboratively via Spotify, lending the sites and events a tone or
ambiance and offering songs context. For Coca-Cola, Spotify is becoming a way to keep up a
conversation with young people, tapping into their universal passion for music, and a way to
associate Coca-Cola with the music experience, as Joe Belliotti, director of entertainment
marketing at Coca-Cola, explains: “We want to combine the physical experience of drinking
a Coke with the virtual experience of listening to, discovering and sharing music. Our
ambition is to have a Placelist associated with everywhere Coca-Cola is enjoyed.” Spotify
technology was the perfect way to achieve this goal, because it uses music as a connector and
offers a platform for discovering and sharing new music. For Spotify, this is another way to
attract new customers, leveraging collective value creation with users and remaining in line
with its desire to democratize music. These strategic partnerships with Lucozade, Reebok,
Volvo, Ford and Coca-Cola, to name only those, help extend Spotify’s reach beyond the
markets the company normally targets and introduce the service to ever-increasing numbers
of people.
© HEC Montréal 21
2018.
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streaming_giant_spotify_arrives_in_canada.html
http://www.theglobeandmail.com/technology/tech-news/rock-on-music-streaming-service-
spotify-launches-in-canada/article20853317/
http://www.stat.gouv.qc.ca/statistiques/culture/enregistrement-sonore/vente/
nombre_annuelle.html
http://latimesblogs.latimes.com/entertainmentnewsbuzz/2012/03/nielsen-on-demand-streams-
download-sales.html
http://www.privco.com/spotify-infographic-2013
http://www.digitalmusicnews.com/permalink/2014/02/21/favoritepays
http://expandedramblings.com/index.php/pandora-statistics/
http://www.sodec.gouv.qc.ca/libraries/uploads/sodec/pdf/publications/cahier_mus_num.pdf
http://www.statista.com/statistics/244990/spotifys-revenue-and-net-income/
http://www.statisticbrain.com/music-albums-sales-statistics/
http://www.digitaltrends.com/music/pandora-spotify-beats-rdio-itunes-radio-algorithm-
comparison/
http://www.digitaltrends.com/music/pandora-spotify-beats-rdio-itunes-radio-algorithm-
comparison/
http://www.apple.com/music/
http://www.deezer.com/
https://www.facebook.com/Spotify
http://www.kkbox.com/
http://www.pandora.com/
http://www.rdio.com/
http://www.spotify.com/
http://www.tidalhifi.com/
https://twitter.com/%23!/spotify
http://www.wimpmusic.com/
 Foreword
 1. Background: A Music Industry Between Crisis and Opportunity
o 1.1 Music and technology: a longstanding relationship
o 1.2 Illegal downloading: from Napster to peer-to-peer
o 1.3 Plummeting CD sales
o 1.4 The digital music market
o 1.4.1 Music file sales platforms and music streaming services
 2. Spotify’s Origins
o 2.1 Drawing inspiration from pirating
o 2.2 Improving on pirating
 3. Legal Constraints
 4. Spotify’s Strategies
o 4.1 The “freemium” model
o 4.2 Social media integration
o 4.3 Creating value jointly with consumers
o 4.4 Brand partnerships
 5. A Meteoric Rise
o 5.1 A strong influence: from ownership to access
 6. The Problem of Monetizing Music
o 6.1 Spotify’s net revenue
o 6.2 Capital investments and cumulative losses
o 6.3 Spotify’s revenue and cost structure
o 6.4 Streaming versus downloading: the rights holders’ cut
o 6.5 Increasing revenues to offer better compensation for music, but how?
o 6.6 Solving the profitability impasse
 Exhibit 1 Comparison of the Main Music Streaming Services
 Exhibit 2 Spotify’s Commercial Partnerships
 References
o Monographs and periodical articles
o Other

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aaVolume 13

Issue 3 September 2015

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