Spotify and Coca Cola, another sip of music streaming?

What do they have in common? What can we learn from the soda industry about the music industry?

Branding? sure, pretty complimentary

The soda industry has a long history of sponsorship in the music industry: artists such as Michael Jackson or Beyoncé, events like South by Southwest (SxSW) or local music initiatives have been heavily sponsored by Pepsi or Coke.

You may remember this $10 million partnership signed in 2012 which featured Spotify logo on 100 million Coke bottles in several countries (mostly in the UK and Germany) with a Web address for their interactive "PlaceLists" app. The app consists of a Coke-red map of the globe with clickable tags to songs that folks are listening to worldwide.

This summer 2016, in Canada, Coke buyers were able to access specially-curated playlists for moments such as “First Kiss”, “Road Trip” and “True North, Strong”, by downloading the "Play a Coke" app, pointing their smartphone at their Coca-Cola bottle or fountain cup.

This complementarity is pretty obvious from a marketing perspective (partners share the same pool of customers) or from a financial perspective (a low margin industry - music - funded by a high margin industry - soda). Looking at the economics of both companies is also informative to understand the ambivalent relationship between record labels and music streaming platforms.

Value Chain? absolutely, right!

It is well known that Coke and Pepsi appropriates most of their returns from their suppliers and distributors. Why that? The main reason relies on the structure of the soda industry, its division into two sub-activities, which are:

1. producing the concentrate (the secrete recipe) and,
2. putting this concentrate in bottles, cans, vending machines or fountains by adding sparkling water and other flavours.

The first activity is extremely profitable, the second one is not. The first activity is a duopoly (Coke and Pepsi), the second one is fragmented (many independent bottlers). The first activity is marketing-driven, the second one is pure distribution costs. Sounds familiar?

• Coca Cola Company = Music Majors
• Bottlers = Spotify

Like the record labels in the music industry, Coca Cola Company possesses a patent-protected asset (the famous secret recipe). Based on this unique resource, they charge an arbitrary price to their bottlers (independent or franchised). The bottlers set the final price and need to take care of the distribution of cans and bottles to vending machines, supermarkets or local stores. The chart below illustrates this problem of margin distribution:

• while the overall prices in the US economy increased by 2.9% in twenty years (the Consumer Price Index or CPI)...
• ...retail prices of Coke charged to the consumer decreased by -1,4%...
• ...and the concentrate price charged to the bottlers increased by 3.6.

This price evolution means more profits for Coca Cola Company (upstream) and less profits for bottlers (downstream). A look at the financials of both companies is enlightening (see my chart below). While Coca Cola spends most of its revenue on marketing (36%) and bottling activities (29%), Spotify loses most of its revenue by paying for royalty (55%) to record labels and distribution fees (28%) to telco and app stores. Raw materials represent only 5% of the cost of revenue for Coca Cola while it represents 55% for Spotify. Not surprisingly, the net margin is negative for Spotify by 9% while the net margin for Coca Cola is pretty high (18%). Streaming is not even a low margin activity, it is a negative-margin activity...a "gross margin blues" would say one of my Berklee grad student.

In summary, we have a good example of ambivalence here:

• music majors can transfer or not transfer more profits to their buyers (music streaming platforms) by charging more or less the catalogue of songs
• music majors can't reach the digital consumer as efficiently as Spotify who, in returns, desperately needs the catalogue of songs to attract listeners.

Who cares?

I do. And I am worried when I read Vivendi CEO Arnaud de Puyfontaine (owner of Universal Music Group - the most important record label in the world)' statements in an earnings call with investors earlier this month:

The quality of our products is something that has a value and we are not of a mindset to decrease price to increase volume… if you pay peanuts, you get monkeys, so [we want Spotify to] give the right value to what we offer, which is a second-to-none experience to the customer.

 We want to do the very best to be able to accelerate the growth of all the incumbents in the streaming platform and the leadership currently is the Spotify one. So we want to create the condition to be a partner that is going to help Spotify to reach its ambition.

“ [We are] not expecting to be part of a decrease of the yield of the subscription, if I can use that image. But, I mean, discussion not yet ended.”

The message is clear: our assets (songs) have a price and we are not going to inject profits into Spotify by reducing our margin. I get that. Problem: Spotify is structurally unprofitable (see my upper chart and the chart below). And the trend is not changing: more revenues = more net loss...

As written by Tim Ingham in Music Business Worldwide:

Spotify can’t continue as an unprofitable company indefinitely – yet it does not expect Universal to agree to taking a smaller percentage of total revenue (ie. that 55% share) to help it enter profitability.

Killing Me Softly

History of relationships between bottlers and Coca Cola Company tells us what happened next: by reducing the margin of their suppliers and distributors, Coca Cola Company and Pepsi started to acquire them and formed bottling branches (called Coca Cola Bottling Group), an entity separated from the concentrate production activity (named Coca Cola Company).

Transposed to the music industry, it means that major labels would acquire music streaming platforms for a cheap price by deliberately makes them unprofitable. It is not surprising that Warner Music (owned by Access Industries) became the major shareholder of Deezer last year (see my previous post). That strategy reminds me "Killing Me Softly With His Song" (The Fugees).

Conclusion

Coke and Pepsi are both "smart" competitors: they kill the bystanders, control their suppliers and/or distributors but they don't kill themselves. Let's hope that the music industry is smart enough to do the same without killing Spotify...

...if not, we can still enjoy a Coke while listening to The Fugees.