Pando

Is Spotify doomed because of Apple Music? No -- Spotify's been doomed from the start

By David Holmes , written on June 12, 2015

From The News Desk

On Monday, Apple finally unveiled its long-anticipated subscription music service, Apple Music. And all week many commentators have been saying the same thing we've been writing for months: That the streaming music space is Apple's to lose.

With roots already firmly planted in the music industry, a design sensibility and cultural cachet that appeals to artists, and most importantly a massive cash store that enables the company to out-promote and outbid competitors for copyrighted content, Apple is astoundingly well-positioned to once again become the biggest digital music provider in the world -- just like it did with iTunes over a decade ago.

What about Spotify? Daniel Ek's startup is the biggest on-demand streaming music service in the world and the most formidable threat to Apple's domination of this space. But if Apple Music becomes as popular as many expect, is Spotify doomed? Or is there room in streaming music for multiple winners?

Thanks to a huge global market that's barely been tapped, the streaming spoils could certainly be spread across multiple companies. But that may be a moot point, because there's a good chance Spotify's living on borrowed time, anyway -- and for reasons other than the 800-pound gorilla who just entered in the space. In fact it's possible that Spotify was always doomed.

Taking out the competition

The case for Apple Music's success was only bolstered when the full details of the service were revealed this week. With the introduction of its music-focused mini-social network Apple Connect, for example, the company went gunning for YouTube and SoundCloud, giving artists a way to release clips, songs, or entire albums either for free or behind the service's subscription paywall. This sense of artist and label control over how and if a song is monetized is precisely what YouTube tried to take away, alienating many of the service's most prolific and popular creators.

Meanwhile, Connect's social component and its emphasis on artist/label control bear a strong resemblance to SoundCloud, which automatically puts the service on watch -- no startup is safe once a monster like Apple stumbles into their sandbox. To be sure, Apple will have some catching up to do if it plans to foster a community as vibrant as SoundCloud's, particularly in the EDM genre. But SoundCloud has recently turned off many of its creators -- including EDM folks -- by taking a more rigid approach toward copyright enforcement than it had it in the past. To make matters worse, by failing to produce meaningful revenue for rightsholders the company has also annoyed major labels which have begun to pull their content from the platform; there's nothing worse than being hostile to both creators and corporations, something I didn't think was possible. Now, SoundCloud is reportedly considering its own subscription streaming service -- an act of desperation, considering how crowded with giant, powerful tech firms the streaming space has become.

And so thanks to a series of tactical and public relations missteps taken by its competitors, Apple appears to have the inside track against YouTube and SoundCloud, not to mention smaller competitors like Rdio, Deezer, and Rhapsody, all of which lack the resources to take on a behemoth like Apple. (I'm not even going to dignify Tidal by explaining why it stands zero chance of survival). There's Pandora, but that's solely a radio app, and one with a unique value proposition -- the Music Genome Project -- that therefore may survive alongside Apple as opposed to in direct competition with it. Furthermore, Pandora's destiny is largely in the hands of legislators and bureaucrats, which is a whole separate mess.

Spotify is really the only legitimate competitor left. But its fate, like that of every streaming music service, is also subject to forces outside of its control -- forces that are guided by the three-headed hydra of Warner, Universal, and Sony.

How Spotify can survive -- at least for a while

Spotify has a huge headstart on Apple, which the company reemphasized by publishing updated user numbers two days after the Apple Music announcement. Daniel Ek's Swedish startup now has 75 million active users, 20 million of whom are paid subscribers. (Unlike Spotify, Apple Music will not offer a free ad-supported version. This is crucial, but we'll get to that in a moment).

Keep in mind that despite Spotify's sizable lead, Apple has 800 million credit cards on file and only needs to convince 10 percent of these customers to pay $9.99 a month in order to overtake Spotify. But that may be more difficult for Apple to accomplish than it sounds. Although Apple Music and Spotify's paid tier offer perks that free subscriptions do not -- namely, full mobile access and no ads between songs -- the majority of users will not pay for something they can basically get for free, even if they miss out on a handful of features. The percentage of Spotify users who pay for the service bears this out, having held steady for years at only 25 percent. And this trend shows no sign of abating -- according to the most recent figures, paid users as a percentage of the whole crept up a hair but still sits at only 26.7 percent.

Furthermore, users possess different attitudes toward paying for music than they do toward paying for video. From cable subscriptions to VHS rentals, video consumers have been accustomed to paying for access versus ownership for decades -- hence the success of paid services like Netflix. The same can't be said for music consumers.

And finally, while $9.99 a month may be an enormously good bargain for access to 20 million songs -- especially considering the average price for a single compact disk in 2000 was $14.04 -- that amounts to an annual rate of $120, which is far more than consumers have ever spent on music. At the height of the industry, Americans only spent $28 a year on recorded music. Granted, there's evidence to suggest that the better the value, the more listeners will spend; the average user of iTunes, which standardized album and song prices to only $9.99 and $0.99 respectively, spends $48 a year on music. Nevertheless, all of these factors weigh against Apple convincing massive numbers of current or potential users of Spotify's free tier to pay $120 annually for what's already essentially available for free. That's particularly true for young people with limited disposable income that they would rather spend on concert tickets and weed.

That doesn't mean Apple Music won't be a success. It simply means that most of Apple's subscribers may be older, upper-class consumers -- many of whom are first-time streaming users -- along with Apple fanatics and music snobs who reject free services on philosophical grounds. In turn, Spotify will appeal more to everyday consumers versus the more educated and elitist Apple customers -- not unlike the demographic breakdown between users of Android and iOS devices.

This analysis could very well bear out. It ignores, however, an enormous wild card factor in the music industry -- a group of stakeholders that are far greedier and more powerful than perhaps any other old world gatekeeper: Major record labels. And while naive, idealistic proponents of capitalism prefer to think of the fight between Apple and Spotify as some pure, consumer-driven dispute that will bestow victory upon the best product, that simpky isn't true. That's because record labels hold far more sway over the future solvency of these streaming services than consumers or even the services themselves do.

This is the way Spotify ends: Not with a bang, but a whimper

It may come as a surprise that despite having more cash on-hand than any US company, in tech or elsewhere, Apple still cannot dictate the terms of its licensing agreements with record companies. Major labels, which are often owned by the same conglomerates as the music publishers, possess the rights to all these songs, which is a far more valuable bargaining chip than any amount of cash. That's why they were able to reject Apple's attempts to price its service at only $4.99 a month, thus undercutting its competitors and launching a price war that neither Spotify, which isn't even profitable, nor anyone else in the space could afford, other than maybe Google-owned YouTube. More importantly for consumers, $4.99 a month -- or $60 a year -- is much closer to the market price listeners are willing to spend on music each year. But the labels, short-sighted as always, were reluctant to set a new lower benchmark for monthly subscription fees, even if it meant attracting more paying customers in the long run.

Moreover, Apple is alleged to have "pressured" labels to withhold their catalogs from Spotify if the service didn't eliminate its free streaming tier -- a gambit the labels also rejected, before painting this to the press as a cold and ruthless attempt by Apple to destroy its biggest competitor.

“All the way up to Tim Cook, these guys are cutthroat,” an industry source told the Verge.

I don't doubt Apple's capacity for cruelty. But like the company's attempt to establish a lower monthly subscription fee, this move would have done more than neutralized an opponent -- it would have brought the entire music industry closer to sustainability. Because whether they're paying $4.99 or $9.99 a month, it can't be emphasized enough how much more valuable paid subscribers are than freeloaders to both streaming services and the industry at large. According to the most recent numbers from the International Federation of the Phonographic Industry (IFPI), the annual revenue created last year by the estimated 400 million people who listen to music for free on Spotify or YouTube was only $610 million -- all of which came from ad dollars. In turn, the $41 million people who pay to use services like Spotify was $1.6 billion. That means each paying customer created 26 times more revenue a year than each free customer.

So that's twice the labels could have effectively destroyed Spotify's precarious and unprofitable business, but opted against it -- and it's not because they have a soft spot for bald Swedish guys. No, labels benefit from having two major streaming platforms to play against one another in negotiations, just like they did when campaigning in the eleventh hour for a higher percentage of Apple's subscription revenue. In theory, these negotiations are a symptom of a healthy market where multiple competing distribution platforms exist. But Spotify is not a real business in the traditional capitalistic sense. It isn't profitable, and is likely nowhere near profitability either as it continues to burn through a war chest of venture capital to meet the ever-increasing demands of labels -- labels who turn around and demand even more from Apple, which thanks to its hardware business can afford it. In short, Spotify is subsidizing streaming music through venture capital, Apple is subsidizing it through iPhone sales, and record labels are making out like bandits while the interests of artists are lost in the shuffle.

Assuming this trend continues, labels will bleed Spotify dry until the company runs out of money or is absorbed by a larger firm, at which point the labels will have a much more attractive deal with Apple than they would had they killed Spotify straight away like Apple wanted. And so to the original question of whether Spotify is doomed? Yeah, there's a good chance that it is. But it's not because of Apple Music, or at least not directly anyway. It's because of record labels, who have the leverage and the patience -- "They're still making that Nat King Cole money," one industry source told me -- to drain Spotify until all that's left is another failed Valley entrepreneur and some slightly-less-rich VCs.

[illustration by Brad Jonas]