Spotify's IPO -- Now What?

AT LONG LAST, today is the day -- Spotify's long-anticipated, awaited and unconventional IPO.  Yes, Spotify will raise its goal of $1 billion today at a valuation in the tens of billions. Those are absolute certainties. But, now what? How does Spotify -- which has never approached profitability despite its global omnipresence -- now take those billions and convince the world that it is not only here to stay, but also a smart long-term "buy" (especially after losing a whopping $1.5 billion in 2017 alone)?

Well, it certainly won't be easy. Spotify (a "pure-play" service as I explain below), Pandora, Apple Music, Amazon Music Unlimited, YouTube – these are the main cast of characters in the global music streaming wars that now dominate the music industry.  This is what the music streaming giant faces as it plots its next major strategic moves amidst far bigger behemoths (like Apple, Amazon, Google) that are intent on crushing it. 

I.          SPOTIFY & PANDORA – THE LEADING PURE-PLAYS

Spotify is the closest thing to holding Netflix-ian dominance amongst music streaming services. You and I both probably use it. As of January 1 2018, Spotify counts 70 million paying subscribers for its $9.99 monthly on-demand streaming service across 60+ countries. That’s up from 50 million paying subs from about one year earlier. Spotify also offers ad-supported radio-like free streaming.

We also likely listen to Pandora. Prior to 2017, Pandora offered only less-controlled radio-like streaming in two flavors -- free ad-supported, or ad-free at $4.99 monthly.  But, in a major strategic shift to significantly improve its overall challenged economics, Pandora launched its own “Spotify-Killer” on-demand service in 2017 at a now-familiar $9.99 monthly price point. Pandora announced big plans when it did, forecasting 6-9 million paying subscribers by end of 2017.

But, those lofty goals hit cold stark reality soon thereafter when the company reported only 390,000 paying subscribers to its new service as of Q2 2017. Even worse, it reported that its active listener count had actually declined. And, as year-end 2017 approached, while Pandora’s active user base approached 80 million monthly users (an impressive number to be sure), roughly only 5% of were paying customers -- and the vast majority of those pay for Pandora classic at $4.99 monthly rather than the higher-priced Spotify-like service. That’s why interim CEO Naveen Chopra advised the industry in Q3 2017 that Pandora would re-focus its efforts on its free user base, “not relying on the subscription model as much as in the past.”  

Spotify and Pandora (and Tidal, Napster, Deezer, and Slacker) are pure-plays like Netflix and Hulu on the video side, which almost exclusively monetize just the music itself via ads, subscriptions, or both. As a result, all of these continue to bleed cash. As I note above, Spotify alone bled $1.5 billion in 2017 alone, despite gargantuan revenues of about $5 billion.

"How can this be?", you ask? Here's why. Spotify and the other pure-play music services face the same challenge – the same existential crisis -- that Netflix and Hulu confront on the video side against multi-faceted behemoths Apple, Amazon, AT&T and YouTube (what I collectively refer to as the "Behemoths"). The business models of those tech Behemoths differ fundamentally from those of stand-alone pure-play OTT streaming services. For Apple, Amazon and YouTube, content (in this case music) is simply a means to an end. Not the end itself.

That’s why Pandora, like SoundCloud, needed a life-line in 2017. And it got one in June in the form of a $480 million investment from SiriusXM, which acquired a 19% stake in the company in the process. Will SiriusXM ultimately convert its 19% “try” to a full 100% “buy” via M&A?

My Magic 8 Ball says "YES," because neither Pandora nor Spotify (even with its new massive cash hoard) can stand alone long-term as independents unless they achieve some kind of new monetization breakthrough. They will instead end up playing strategic roles in a much bigger machine. In the belly of one of the Behemoths.

II.        THE BEHEMOTHS

Speaking of … now it’s time for the giants that have the luxury of being able to use music as marketing.

APPLE

Let’s first take Apple. Apple Music is one big advertisement for Apple hardware (iPhones, Macs). Content is its Trojan Horse. Apple Music succeeds even if Apple Music doesn't generate $1 of profit. But, that doesn’t mean that Apple Music isn’t strategic for Apple, because it most certainly is. Apple needed an on-demand music streaming service to counter its declining iTunes music download business and continue to drive the faithful into its kingdom of hardware delights. Unable to build it itself, Apple looked into the marketplace and found a kindred spirit in streaming service Beats (a company that shared Apple’s DNA by operating primarily in the hardware business with its headphones).

Apple Music offers two tiers of music streaming – monthly $9.99 or $14.99 for a family plan (note to self – Apple also quietly offers a $99 annual plan that can be unearthed with some digging). Apple Music now boasts about 40 million paying subscribers, more than double its numbers from one year earlier. Impressive – a feat driven by Apple’s unique ability to bundle and headline Apple Music across all of its Apple products.

That’s certainly a luxury that Spotify, nor any other pure-play, has.

AMAZON

Amazon’s multi-pronged business model is like Apple’s, but also very different. Yes, Amazon too sells hardware, including the surprisingly massively successful Kindle and Alexa-driven Echo. But, unlike Apple, Amazon is not and never will be fundamentally a hardware business. Amazon is all about commerce pure and simple. Selling stuff. And lots of it. So, Amazon’s Music Unlimited subscription service, as well as its companion Amazon Prime Video service, function as Apple-like gateways to Amazon’s virtual mega-mall and its increasing focus on mobile shopping. Like Apple, Amazon doesn’t need to profit from the music itself, and that gives it great business and competitive freedom.

Amazon flexed those threatening muscles big time when it launched Amazon Music Unlimited late 2016 with a disruptive new monthly price point $2 lower than the competition ($7.99 for Amazon Prime customers). Amazon’s royalty rates with the major music labels likely aren’t any different than those of the pure-plays, but Amazon simply can “eat” that extra $2 and spread it across its overall financials.

Scary indeed for those that can’t.

GOOGLE/YOUTUBE

Ahh yes, and then there’s the biggest 800 pound Media 2.0 music gorilla of them all, YouTube -- a very different animal altogether. YouTube is, by far, the biggest music service in the world -- the #1 way millennials consume their music. And, YouTube continues to feel virtually uniform industry wrath because of it -- and because of its very different economics that flow from its very different video-first DNA. Yet, YouTube nonetheless succeeded in negotiating new licensing deals with all major labels in 2017, because its strategic position in the overall music industry is now simply too cemented in millennial lives.

Ultimately, YouTube -- and the music content that drives over 40% of its videos -- are all about driving Google’s fundamental underlying and seemingly unlimited advertising-based cash machine – just keeping its overall user base entertained amidst increasingly predatory competition.

That’s quite a differentiator and competitive advantage over Spotify and the other pure-plays.

III.       THE WRATH OF THE TITANS

Apple, Amazon and Google/YouTube also control massive marketing dollars outside the wildest dreams of Spotify (although that may change a bit now with its new IPO cash). Apple continuously bombards us with Apple Music pitches in its own characteristic “sexy” way, with every breath you take and every move you make, across all of its platforms -- both virtual (online) and physical (offline retail stores). There is no escape. And, to be absolutely sure, Apple features Apple Music natively on all Apple devices (iPhone, Macbooks). No app install is needed. That's immediate distribution – and headlining -- that Spotify and the others can't match.

The Behemoths also certainly have the ability to invest significantly more deeply in artist relations and artist exclusives – differentiated content that is increasingly critical for these services in this aural battle royale (just like the strategic role Originals play in the OTT video world). Steve Jobs played to artist sensibilities from day 1, and Apple underscored the strategic nature of its heritage when it retained Jimmy Iovine and Dr. Dre as part of its Beats acquisition. Meanwhile YouTube, faced with mounting music industry pressure, smartly hired long-time music executive Lyor Cohen as its new head of music in order to try to quell the music industry masses about YouTube’s advantageous economics.

Spotify, on the other hand, seemingly bit the hand that feeds over the years and counted a very vocal and very bitter Taylor Swift and Radiohead – in addition to the labels themselves -- as foes at various points not that long ago. Sweden’s Spotify – born a long, long way from the U.S.-based music industry -- proudly celebrated its colder tech-based roots first and foremost in its early days, ignoring the music industry’s more sunny soulful essence until it learned the hard way. The company finally atoned when it hired well-known, highly respected entrepreneur and artist manager Troy Carter (Lady Gaga, John Legend, among others) as its new global head of creator services in 2016. These kinds of gestures matter. And, Carter is a force.

Yet, even with Spotify's new gazillions, Spotify and the other pure-plays will continue to face daunting challenges in the face of giants. Yet, in the immortal words of Yoda (as he fixes his gaze upon Spotify, Pandora and the others, based on his own intergalactic challenges), “Do, or do not. There is no try.” So, “do” they do.

Here’s how. First, Spotify will catch the Tidal wave (clever, huh?) and increasingly feature artist and song exclusives like it did last year when it dropped Jay Z’s latest first. Content is king here in the music world too – the most critical differentiator – and featuring Jay Z is massively more important to boosting paid subscriber numbers than adding yet another service feature. The trick, of course, is for the pure-plays to find a way to continuously incentivize artists and labels to work with them rather than with the deeper-pocketed big guys. Tidal got the job done by making Jay Z and a few other marquee artists part owners. So, that’s one option. Spotify, of course (much like Snapchat versus Instagram), also will continue to try to out-innovate on the feature and user experience side of the house. Its “Discover Weekly” personalized playlists were a big taste-making hit in 2017.

Even more fundamentally – nay, critically -- Spotify and other pure-play music services will try to diversify their one-dimensional business models. Yes, everyone around the world uses Spotify, but that doesn't mean that stand-alone music streaming businesses are long-term sustainable. Conversion rates from free ad-supported music streaming to ad-free paid subscription streaming are simply too low. Even if they weren’t, today’s licensing realities and overall economics just don’t pencil out. That’s why mid-2017, Spotify announced re-positioning its overall advertising opportunity. Now, Spotify plans to build a leading ad sales business targeting small and medium businesses and with the audacious goal of becoming the world’s third biggest digital advertiser next to Google and Facebook. So, look forward to seeing more and more sponsored playlists and new audio ad formats. 

At around the same time, Spotify also announced that it would begin to focus on podcasts, a throwback format that continues to be shockingly popular. Bloomberg reports that about 15% of U.S. individuals over age 12 listen to at least one podcast weekly -- and nearly 25% of us at least one monthly. Even better, podcast ad revenues are forecast to close up 85% in 2017. That’s some massive growth. Importantly, podcasts don’t come with music’s massive licensing price tag. Those royalties accounted for an EBITDA-killing 75% of Spotify’s costs in 2016. And, in another new strategic area of focus, Spotify also now integrates with Google’s Home smart speaker in its quest to enhance its monetization hopes and dreams.

One of Spotify’s previous big bets to change the order of things is our good old friend video Originals, although by year-end 2017 its video ambitions had significantly narrowed to be playlist-focused. But, Spotify still hopes that seeing is believing in a pay-worthy and broader music lifestyle experience kind of way. Tidal succeeded briefly in that regard when it debuted Beyonce’s incredible long-form Lemonade video in 2016 and boosted its paid subscription numbers significantly in the process.

Pandora itself announced major video plans in 2016, but we didn’t see much happen there in 2017. In any event, video game playing by pure-plays Spotify and Pandora won’t be easy. Their DNA is music, and we go to both Spotify and Pandora to listen. It’s not obvious that we will think of those services more broadly. Pattern behavior, after all. And, of course, the OTT premium video market is increasingly downright saturated. Maybe that’s precisely why both Spotify and Pandora, which trumpeted their video scores loudly as 2017 began, decrescendo-ed those notes throughout the year.

So what else can the pure-plays do to surmount their daunting challenges in the face of seemingly impenetrable behemoths?

Why not take their broader revenue-generating quest significantly further by engaging much more directly with their users who are massive and frequently rabid artist fans? Fan engagement means live events, compelling e-commerce (merchandise), and direct artist-fan and community engagement. Hey Spotify and Pandora! Focus on deeply integrating those components into your overall customer experiences and, man, significant monetization (not to mention brand love and loyalty) will follow. No music streaming service does that right -- no, not even the Behemoths. Music is unlike any other form of media in terms of its impact on our lives. Artists are our messiahs. Tap into that transformational human element -- that’s where the magic happens. Fans will pay (a lot!) for that direct connection, as well as for a direct link to others in the community who feel the same way about the artist as they do.

Even so, the pure-play existential crisis is unlikely to resolve itself in the face of behemoth super-powers, which means that Spotify’s and Pandora’s most likely end games are to be swallowed up in true Apple/Beats-ian fashion. Like the big banks, Pandora and Spotify are simply too big to fail, of course. One of the many Behemoths out there will bail them out instead. After all, many have the means necessary, as we saw when AT&T dropped $85 billion to buy Time Warner (or, try to buy ... since the company remains in Justice Department and political limbo land). Yes, pure-play stand-alone economics may not work, but their respective brands, global audience reach and overall engagement in our daily lives do.

How many of us listen to streaming music services for hours each day?  (I know I do, virtually 24/7 – it keeps me sane as I write this article). That’s some kind of reach. And, Behemoth buyers can amortize the singular, fundamentally challenged pure-play business models across all of their many revenue streams. After all, they can simply throw those challenged financials into their marketing expense lines. So, in the immortal lyrics of one of my favorite 80’s bands Tears For Fears, these new streaming music realities inevitably will be “sowing the seeds” of M&A for Spotify, Pandora, and a host of others. 

Yes, you heard it here first -- Spotify ultimately will be acquired by a much bigger fish.

Of course, that means fewer competitors in the music distribution game – certainly not the optimal reality for any supplier (in this case the music labels). The more competition, the better. More demand for the content that fuels that competition. More leverage in negotiations. More lucrative terms. Feels almost like those “big box” days of yore, when Walmart and Target used music as loss-leaders to drive sales of paper towels. Don’t forget, Amazon is kind of doing that now by charging $2 less per month for Amazon Music Unlimited for its Prime customers so that they stay in their virtual store and buy more, well, paper towels (and all kinds of other stuff that most certainly is not music). That race-to-the-bottom pricing pressure and overall mentality ultimately killed the pure-play Tower Records and Virgin Megastores of the past.

Quite a different state of affairs, then, from what’s happening in Media 2.0’s video side of the house. While the number of streaming music players continues to shrink, it’s “go, go, go” time in the world of streaming video, where we see a continuing string of new market entrants joining the long list of OTT players already in the game – all kicking and screaming to create and license as much premium video content as possible (and significantly driving up video content prices in the process).

Music and video. Both premium content. But, very different rules of the game, because of the very different players who wrote them.