Rights and the Evolution of Music Streaming

This past week has seen headlines about three different companies each seeking new rights agreements with major music labels. Spotify is reportedly trying to lock in longer-term deals with the major labels ahead of its IPO, Amazon is apparently trying to secure rights to offer a cheaper subscription service that will only work on its Echo devices, and Pandora is trying to sign US and international rights in order to launch an on-demand streaming service. Each of these stories tells us something about the state of the music streaming market and, taken together, they highlight some interesting trends.

On-demand streaming has won

One thing has become obvious over the last couple of years — on-demand streaming has won. Pandora did well for a number of years with its personalized radio experience but after a certain point, it arguably just created demand for a truly personalized service where users could control exactly what they wanted to listen to. Apparently, having an algorithm guess at what you might like to hear next is not quite as good as allowing the user to make more granular decisions. In addition, Pandora benefited from the unique royalty model in the US but that also made it hard to export its business model elsewhere. Meanwhile, Spotify has eclipsed Pandora’s user numbers and, adding in Apple Music, Deezer, Rhapsody and others, makes clear which way the wind is blowing – Pandora’s model has stalled, while on-demand streaming is the future. Hence, Pandora’s acquisition of Rdio and the pursuit of rights for on-demand streaming.

Differentiation in on-demand streaming is tough

The problem is differentiation in on-demand streaming is tough because the basic concept is so simple. Once you get into the tens of millions of available tracks and you make your service available on every major platform, you’ve checked most of the boxes people care about at a basic level. Differentiation then shifts to the edges, into things like curation, recommendations, and the user interface. Spotify has done well here with its algorithm-driven Discover Weekly feature and others, while Apple has taken a more human-centric approach, but it was Pandora that pioneered algorithm-driven taste-matching and they could have an interesting advantage here.

Amazon is clearly trying something new. Apple was reportedly looking for a better deal from labels in order to offer a slightly cheaper service, but failed and ended up at the same classic $10-per-month price point. Amazon, on the other hand, is taking a different tack – offering an Echo-only service for half the price of most on-demand services. That’s a hook to hang its plea for lower rates on but it’s questionable whether it will provide enough value for users. Perhaps, like Amazon’s recently introduced monthly and video-only Prime options, it’s mostly intended as a funnel for full annual Prime subscriptions and its lack of utility outside the home is actually a deliberate ploy to up-sell users. I wonder whether the labels will be willing to supply their content at lower rates to support such an experiment.

Ad-based streaming dominates and the labels don’t like it

Whether the labels support Amazon’s bid for differentiation depends, to a great extent, on how they view its proposed service. One thing the labels have made very clear is they don’t like ad-supported streaming and they want to push the industry towards paid streaming. Amazon’s service could be viewed in the same light as ad-supported streaming because it offers less than the usual $10 per month or it could be viewed as just another flavor of on-demand streaming and therefore a good thing.

All of which brings us to Spotify, whose 100-odd million subscribers are dominated by the free, ad-supported variety. That in turn is making its negotiations with the labels challenging, because the labels want it to up its contribution. Spotify, for its part, needs to reduce the cut rights owners take because over 80% of its revenues pay those bills today, leaving very little wiggle room for its other operating costs, let alone profit. That’s starting to feel like an increasingly intractable tension that’s going to be hard to resolve. On the one hand, Spotify needs to lock down long-term rights to get the valuation it wants at IPO and, on the other hand, it needs its rights costs to come down for exactly the same reason. Something has to give.

Advantage Apple?

One interesting thing about this market is there are two major sets of players – those who make their money solely from these music services and those who make the vast majority of their money elsewhere. Spotify and Pandora can’t afford to keep losing money in this business because it’s the only business they have. Amazon, Apple, Google, and others, however, can afford to subsidize these offerings or run them at low margins because they feed the other parts of their businesses and generate additional revenues indirectly. Apple may be in the strongest position of all here because it has a user base willing to pay for content and they can afford to run the music business at a relatively low margin, while Amazon’s customer base is highly driven by saving money and Google’s true customer base is its advertisers, not its users. Much has been made of Spotify’s lead over Apple in on-demand streaming, but Apple offers the flavor of streaming the labels like and has already signed up half as many paid subs as Spotify. That’s the key number to watch – the labels have a stake in Spotify but would arguably benefit much more in the long-term from an industry that takes a dramatic turn toward paid streaming, a goal which Apple seems a lot more likely to help them achieve.