Spotify vs. The Integrators

Spotify intrigues me in many ways. It’s easy to be bearish on Spotify. That is at least the most common narrative I see from Wall. St and pundits. Spotify makes a great product, but they are also up against dynamics that are hard to overcome.

The Apple and Google Challenge
The biggest challenge for Spotify is they are up against Apple and Google, who are both what I like to call super integrators. Microsoft was a super integrator back in the day. That dominant position they held with Windows and their ability to create new apps and services that were essential defaults in Windows, like Internet Explorer in the browser wars, is what lead to regulation that attempted to limit Microsft’s ability to stifle competition. Spotify, behind the scenes in investor conversations, has suggested a similar concern. Specifically, that Apple and Google can bundle and more tightly integrate their respective streaming music services into the core experience of iOS and Android. This is no doubt a valid concern, and the reason why super integrators like Apple and Google will always have an advantage when it comes to specific services.

Apple pre-loads the Music app on all iPhones sold, and in many Android partner cases, they also pre-load Google Play Music onto the device. With Android OEMs, they largely can pre-load other apps so technically some of them can bundle Spotify as well if they so choose. It’s worth discussing whether or not Apple or Android is in similar monopoly power to Microsoft during the browser wars. Music is a top 5 use case with smartphones, so it’s arguably a core experience, and thus the integrators like Apple and Google can continue to push their services harder, thanks to their control of the operating system than Spotify will ever be able to. While I think it is hard to make this case in today’s age, it is an interesting discussion point, and one Spotify has mentioned as a major concern.

Google does some interesting and aggressive pushing of their services, YouTube Red in particular. I open the YouTube app many times during the day and constantly see a YouTube Red advertisement as the first main screen regularly. Apple, has similarly, pushed a notification from time to time to promote Apple Music. These are things the platform owners can do that Spotify will never be able to do competitively and it gives Apple and Google a significant advantage.

The Business and Scale Challenge
Spotify will be heavily pressured to grow, and grow fast, or Wall St. will turn on them very quickly. To do this, they will inevitably have to focus on the free part of their service. Today at an event in New York, they did just that.

Spotify will continue to add more value to their free tier, and the concern will be that it comes at the expense of their paid service. Which, would then put them squarely in a primarily advertising-focused business model. Which, we all know, creates another set of challenges. Spotify’s best bet is to invest deeper in the paid service, where margins will be better, but that business won’t get them the scale they need.

To that end, Spotify likely takes customers from Pandora. Which is reflected in this chart I shared a few weeks back when I looked at Spotify more in the context of Pandora than Netflix as a comparison.

The question in this scenario is whether the overall business is better for Spotify than it is turning out to be for Pandora. They are different services after all, but the underlying economics are still hard especially when ads are the primary revenue driver.

If in the coming month’s Spotify continues to add new customers to the free tier, and doesn’t seem to convert those customers to the paid tier, then I expect some stronger negativity in their Wall St. story. That being said, I do think Spotify’s biggest upside growth potential is on Android and not on iOS.

A Bold Prediction
Ok, maybe this prediction is not so bold. I think Sonos and Spotify will become much tighter partners. And possibly all three may get much close to Amazon. Post Spotify IPO, if it continues to go well, I can see them making a bid for Sonos. We know Sonos wants to IPO, but I don’t expect that one to go very well should it happen. An acquisition, or merger, may make the most sense since Sonos needs a music service that is proprietary for additional revenue and Spotify can use a hardware play. Even if this happens, it is not a guarantee of success, but I do think it would help each company greatly toward their overall ambitions.

The narrative both companies need to navigate around is that they are one trick ponies from a business standpoint. The proven businesses that Wall St. likes are ones with a diverse set of revenue streams. This is a primary reason both GoPro and Fitbit have struggled. This same dynamic will make it hard for Sonos in particular as a stand-alone company. And for Sonos, if they can’t become more like Netflix by driving more paid subscribers, it will be hard for them as well in the long run. I’m looking for who either company deepens a partnership with to see the big upside from a scale perspective. But now that Spotify is public we will see much more clarity around their business when they release earnings over the next year.

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Ben Bajarin

Ben Bajarin is a Principal Analyst and the head of primary research at Creative Strategies, Inc - An industry analysis, market intelligence and research firm located in Silicon Valley. His primary focus is consumer technology and market trend research and he is responsible for studying over 30 countries. Full Bio

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