Updated: May 19, 2017
This narrative was the subject of the Weekly Narrative Video the week of May 15-19, 2017. You can see the video on YouTube here, and it’s also embedded at the bottom of this essay.
The music industry has had its ups and downs in the last 20 years – from the CD-fueled boom to the era of Napster and file sharing to the entry of iTunes and other legitimate digital music services and now to the era of streaming. For most of the last 20 years, those trends have driven revenues downwards, but over the last couple of years there has been something of a turnaround, driven by streaming music. However, though it’s tempting to lump streaming into one big bucket, the true picture is one of two very different flavors of streaming.
Streaming is really a technological term – music is streamed rather than downloaded for playback – but actually tells us nothing about the business model behind it. In fact, there are two very different business models behind streaming, often both offered by the same companies, with radically different outcomes for labels and artists.
By far the most popular form of streaming by listener numbers is ad-based streaming. YouTube has over a billion people streaming music through the service, while Spotify likely has around a hundred million and Pandora has a similar number. These services make massive catalogs of music available for free to the user, garnering some revenue from advertising in the process, and paying out a portion of the total to labels. And it’s easy to get the impression that it’s this form of streaming that’s saving the music industry.
But in fact it’s the other flavor of streaming – paid subscription music services – that’s actually driving growth in the music industry, and the user numbers here are much smaller. In fact, the total number of paid streamers at the end of 2016 was around 100 million in total, between Spotify (the market leader), Apple Music, and a variety of smaller providers including Deezer, Rhapsody, Tidal, and others. But these services between them, even with their far smaller overall user numbers, contributed massively more to the industry than all the free, ad-based streamers combined.
Spotify’s annual financials are a good starting point for understanding the stark differences between paid and ad-based streaming. In 2015 (the last year for which we have the numbers), 31% of Spotify’s members were paid subscribers, but 90% of its revenue came from paid streaming. Put another way, it derived around $4 per year from each ad-based subscriber, but $80-90 per year from each paid subscriber. Another way to look at this is that YouTube, with its billion users, paid out around a billion dollars to music labels in 2016, while Apple Music, with its average of around 15 million subscribers in 2016, paid out roughly the same amount.
When the music industry complains about the economics of streaming, it’s increasingly a narrow argument about ad-based streaming, with YouTube the main target. The reality is, though, the the industry needs ad-based streaming, not least because it’s the only way many younger listeners engage with music, but also because it’s the best possible funnel for paid music services, especially where a single company provides both ad-based and paid options and therefore has a natural up-sell mechanism in place.
The big question is whether streaming music can be sustainable for the streaming providers. Apple doesn’t need to make money from streaming alone, because it helps add value to what’s already a highly profitable ecosystem which mostly derives revenue from hardware purchases, and the same can be said for YouTube with its broader ad model. But for standalone companies like Spotify, it’s critical that music streaming itself provide a profitable revenue stream, and that hasn’t been the case so far. Spotify loses money each year, with royalty, streaming distribution, and content expenses eating up 85% of its revenue in 2015, leaving very little room for staff, marketing, and other costs and putting it into the red overall.
There are various theories about what it would take for Spotify to become more profitable – a more favorable split between paid and ad-based streamers, greater scale overall, renegotiated rates with labels, and so on. But it’s possible that it’s just not possible for this model to be successful for a standalone company. Spotify is supposed to be working towards an IPO, and will need to prove that argument wrong if it’s to get investors on board, but it’s far from clear that it will be able to do that just yet.