SM-1613-E

August 19, 2017 | Author: Kateryna Krasnoshchok | Category: Spotify, I Tunes, Music Industry, You Tube, Royalty Payment
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SM-1613-E December 2014

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After sampling some of the new music releases of early 2014, Daniel Ek closed his Spotify session. Soon, millions of Spotify users would learn he had just listened to Kanye West’s “Atmosphere,” as the profile of Spotify’s CEO was one every new Spotify account followed by default. Some users might be curious enough to click and listen to the album, share it on Facebook, or include one of its songs in a virtual mixed tape that could be posted online. The company was proud of the social features of Spotify’s client software, which had probably played an important role in the tremendous growth the service had enjoyed since its launch back in 2008. But Spotify was making lots of other noise; the company had just secured a $200 million credit facility, and despite the company’s efforts to avoid the issue, the media was full with speculation that the company was about to go public.i And why not? After all, Spotify was one of the leading music streaming services in the world. It had over 24 million users, of which six million paid a monthly fee for Spotify’s premium services.ii It had just entered the difficult U.S. market with great success, and it was already present in 56 markets. Spotify’s catalog contained more than 20 million songs, including the libraries of all major recording labels. Yet Ek knew that not everything was so favorable. Spotify posted a net loss of €58.7 million in 2012,iii the red ink growing alongside its user base. Despite that, some artists protested the low rates that, according to them, Spotify paid to the creators of the music it played. Worryingly, tech behemoths like Google and Apple were entering the market with their own music streaming services. And some analysts pointed at how other companies offering

streaming music, like Rhapsody, had not been successful in the past. If Spotify was going to IPO, Ek needed to convince potential investors that Spotify had a sound long-term business model. Many other music streaming services had failed before, and despite Spotify’s impressive growth, some believed it could go on to become yet another casualty in the troubled history of digital music.

This case was prepared by Professor Govert Vroom, and Isaac Sastre Boquet, case writer, as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. December 2014. Copyright © 2014 IESE. To order copies contact IESE Publishing via www.iesep.com. Alternatively, write to [email protected], send a fax to +34 932 534 343 or call +34 932 536 558. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means – electronic, mechanical, photocopying, recording, or otherwise – without the permission of IESE. Last edited: 12/9/14

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Spotify: Face the Music

SM-1613-E

Spotify: Face the Music

The History of Digital Music

At first glance, one might say the advent of digital music had been bad news for the music industry. From a peak of $38 billion in global revenues as of 1999, it had fallen to $16.5 billion in 2013, when digital was already bringing in the majority of revenue.iv The industry, in general, blamed piracy for these lost sales,v but Daniel Ek had his own opinion of what had happened: “I realized convenience quite often wins... It’s not that people don’t want to pay for music. [...] It was the only point in time when the stolen product has been much, much better than the one you legally acquired... For me it was a pretty big given why we ended up vi where we ended up in the music industry.”

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The United States was the world’s leading market, providing 30% of the income of the global recording industry. U.S. companies dominated most of the worldwide music market and had the world’s most popular bands under contract. Thus, the United States became the place where most of the developments in digital music would take place. One of the most notorious events in this story befell on July 27, 2001, at the Northern California District Court in San Francisco. vii In one corner sat the Recording Industry Association of America (RIAA) – the trade association representing the interests of the record labels and music distributors in the United States. On the other side was Napster, the company that in 1999 had launched a service that allowed users to search and download music files for free. In just two years Napster had amassed 60 million users, who shared songs without paying artists or labels.viii Three developments had made Napster possible:

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MP3 compression technology. In 1993 the Moving Picture Experts Group – the expert group tasked with setting the standards for digital audio and video formats – published the MPEG-1 Layer III standard for digital audio, commonly known as “MP3.” The MP3 standard reduced the size of a music file by an order of 10, while keeping a quality that was nearly undistinguishable from larger, lossless formats on all but high-end playing devices.ix The result was that users could “rip” their audio CDs, store their entire record collection on their computers, and easily share it with friends.



The rise of the Internet. The Internet was opened to commercial operators in the early1990s, and, in 2000, 43% of the U.S. population already had access to it, a percentage that rose throughout the years and reached 81% in 2012. x At first, most Internet connections were slow, and several minutes were needed to download a single music track. However, soon faster connections were developed and offered by Internet service providers. These so-called “broadband” connections would eventually allow instant play of music tracks and videos. In 2013, it was estimated that 390 million of these connections existed in the United States alone, more than the entire population of the country.xi

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The Digital Medium and the Rise of Music Piracy

Spotify: Face the Music

New devices. These new digital formats spurred the development of a wide range of software and devices capable of creating and playing digital music files. These devices had greater capabilities than the older analog or CD player technologies allowed. For example, a typical portable digital music player was eventually able to contain the user’s entire music collection, as opposed to just the 60-90 minutes of a typical CD or tape. Users could easily browse and play any song and could store and display information like song title, band, genre, etc. They could then create playlists with their favorite tracks and easily move music between the player and their computers. All in all, these players possessed features and usability that were unheard of in older technologies. Portable digital players quickly became very popular. Later, the massive adoption of smartphones would further increase the user base and capabilities of devices able to play digital music.

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When Judge Marilyn Hal Patel finally ordered an injunction of Napster, its users were swapping more than 165 million songs per day.xii Despite the music industry’s efforts to stop them, further sharing networks would emerge: Gnutella, Kazaa, Torrent, eMule, and others. These networks removed the need for a centralized database hosted in a physical location, which made it impossible to shut them down. The genie was out of the bottle. The industry would have to figure out what to do with it.

The First Steps of the Industry The first companies that marketed digital music usually lacked the backing of the recording industry. For example, in 2000 eMusic launched a service offering unlimited track downloads from a library of 125,000 to those who paid a monthly subscription.xiii However, only artists from independent labels were available. By way of comparison, in 2014 most leading digital music services had libraries of 20-25 million tracks. Likewise, in 2001 MP3.com was offering unsigned artists the chance to distribute their music through its website, paying them according to the amount of downloads accrued.xiv Both companies would change ownership and business models in the following years; MP3.com eventually shut down and sold some of its assets – including its coveted domain name – to CNET Networks in 2003.xv On the other hand, eMusic was still operating in 2014, allowing customers to download a fixed number of tracks for a set monthly fee. The reaction of the major labels to the new technology was initially litigious. Besides suing makers and users of music sharing networks similar to Napster, they also tried –but failed – to obtain an injunction to prevent the sale of the Rio PMP300, the first commercially successful portable MP3 player.xvi Indeed, the first attempts from major labels to enter the digital market showcased the industry’s wariness of the new technology. In the early 2000s, two joint ventures backed by the major recording labels were launched: MusicNet – supported by EMI, Warner, and BMG – and PressPlay – backed by Sony and Universal. Both services had several limitations that made them unpopular with users. For example, PressPlay only allowed two songs from the same artist to be downloaded each month, it didn’t allow songs to be copied to portable music devices, and every downloaded song “expired” at the end of the month and had to be downloaded again. xvii MusicNet and PressPlay relied on a subscription model and, if

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Spotify: Face the Music

terminated, the tracks became unplayable. Furthermore, MusicNet and PressPlay only had the music of the labels that backed them, so users needed to purchase two separate subscriptions if they wanted to listen to all major artists.

One of the allies of the major labels in these failed efforts was RealNetworks, a company that had thrived in the 90s developing video and audio streaming technologies for the fledging Internet; RealNetworks’ protocols allowed users to see videos and listen to audio without downloading them to their computer. In April 2003, RealNetworks acquired Listen.com as the basis for a new service: Real One Rhapsody (later shortened to Rhapsody).

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Rhapsody offered a subscription model where users paid a monthly $9.95 fee for the ability to stream an unlimited number of songs from a library of 330,000 tracks, including artists signed to all major labels. Users couldn’t download the tracks directly to their computers, but Rhapsody offered the option of paying an extra $0.79 per track to burn them on a CDxxi. Users could then rip that CD to a computer, making downloading a digital copy of a song a two-step process. Rhapsody was better received than MusicNet; it reached 800,000 subscribers in 2009. However, growth slowed down and ultimately declined; in 2010 it had lost 100,000 subscribers, and analysts at the time doubted its ability to compete with other music services that weren’t using a streaming model. Rhapsody was spun off from Real Networks in February 2010, in order to help the parent company achieve profitabilityxxii. In 2013 the now independent Rhapsody acquired Napster, and started using that brand name for most of its business outside North Americaxxiii.

The Success of the iTunes Model The industry, however, didn’t have to wait long for its first massively popular digital music service. In February 2003, Steve Jobs unveiled the iTunes Store during his keynote speech at Apple’s Music Event. At launch, iTunes offered a catalog of 200,000 songs, with backing from major and independent labels, which were sold at $0.99 per track.xxiv Initially, iTunes was only available for Mac computers, but support for Windows was added a few months later, greatly expanding the potential customer base.xxv By the end of the year, it had already sold 25 million tracks.xxvi The service would grow explosively, and by 2013 its customers had already downloaded 25 billion tracks, and the catalog had expanded to 26 million. xxvii Despite these numbers, Apple long claimed that iTunes’ music sales didn’t provide significant profits to the company.xxviii However, they drove sales of iPods, which carried big margins for the company.xxix On the heels of iTunes’ success, several companies replicated its model for selling digital music. For example, Sony launched the Sony Connect Music Store in June 2004, selling tracks and albums at the same price as iTunes. xxx Likewise, longstanding Apple rival Microsoft launched Zune Marketplace in 2006. xxxi These stores were not as successful as

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Soon the labels abandoned these services; MusicNet was sold in 2005xviii and Press Play was sold in 2003, merging with the Napster brand for the latter’s re launch as a legal service.xix Both Music Net and Press play were jointly placed at number nine on PC World’s list of the “Worst tech products of all time.”xx

Spotify: Face the Music

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iTunes; Sony Connect closed in 2008,xxxii while Microsoft discontinued the Zune brand and launched Xbox Music in 2012.xxxiii Major labels fully backed these and other offerings, as they had done with iTunes.

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Nevertheless, iTunes and other similar stores still came with a significant restriction. Digital Rights Management (DRM) technologies were embedded in the tracks purchased. These limited the number and type of devices these tracks could be used on, ensuring that the customer could not freely distribute the files after purchasing them. Moreover, they also allowed stores to control how tracks could be used.

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For example, tracks purchased from iTunes could only be played on up to five devices. Moreover, besides a computer, only Apple devices such as the iPhone, iPod, or iPad could play iTunes tracks. In consequence, iPod sales skyrocketed in parallel to iTunes’ success, reaching 22 million in 2009.xxxiv Likewise, Sony Connect tracks could only be transferred to compatible devices that supported Sony’s ATRAC3 format, like the Walkman or the PSP gaming console. Meanwhile, Zune customers had to procure themselves a Microsoft-certified device, like Microsoft’s own Zune-branded line of players. This, however, changed in late 2007 when a new entrant, online retailing giant Amazon, launched its own digital music store. Unlike its competition, labels allowed Amazon to sell tracks without DRM.xxxv Users could buy from Amazon and play the songs on any number of devices that supported the MP3 format, including iPods, Zunes and Walkmans. Unlike Sony and Microsoft, Amazon was successful and quickly became the second largest digital music store in the United States.xxxvi The competition soon followed its path: iTunes, the market leader, abandoned DRM in 2009.xxxvii Artists too began to experiment with the opportunities that the digital format presented. For example, in 2007, the high-profile British band Radiohead skipped music labels and released their album “In Rainbows” directly to their fans as a digital download on the band’s website, letting customers choose the price they wanted to pay.xxxviii No sales figures were released. Attempts like Radiohead’s to upset the usual release process were, however, piecemeal.

Streaming and the Smartphone Era Though it seemed that stores in which users could buy and own digital music had captured most of the market (as opposed to streaming services like Rhapsody), other streaming services soon appeared. Pandora launched in 2005 and was followed by similar services like Slacker Radio and MOG.xxxix Pandora allowed users to listen to customized “radio stations” for free, getting revenue through advertising. Its “Music Genome Project” analyzed and broke down songs in multiple traits; users could then “like” or “dislike” songs that were being played, and the service would attempt to learn their music tastes and play only music that interested them. During the second half of the 2000s, smartphones became popular. Smartphones fused the functionality of a portable media player with a computer with Internet connection, allowing users to access Internet music services while on the go. In 2010, nearly 300 million smartphones were sold worldwide.xl This greatly benefited streaming services, which couldn’t be used on regular portable music players as they needed an active Internet connection.

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Spotify: Face the Music

According to Pandora, the introduction of a smartphone app in 2008 practically doubled their growth overnight.xli Thus, in 2013 Pandora claimed 70 million monthly users in the United States and Canada, dwarfing other subscription-based streaming services like Rhapsody.xlii

Spotify Daniel Ek and Martin Lorentzon founded Spotify in Sweden in 2006 after having both worked in several Scandinavian-based online start-ups. Sweden was, ironically, infamous for hosting The Pirate Bay, the largest search engine for downloading illegal music and video content on the Internet. Spotify finally launched in October 2008 in Sweden and other Western European markets after announcing deals with all major labels plus several independent companies that allowed Spotify to stream their catalog.xliii

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Initially, Spotify only allowed a limited number of users to join their unpaid service. The company periodically sent out “invites” to their existing users that they could use to invite their friends. Paid subscription users were not subjected to this and could join at any time. Spotify lifted that limitation in 2009 in the United Kingdom and proceeded to do the same in most of their markets in the following months.xliv Spotify launched in the United States in 2011, when it already had 10 million users throughout Europe. This time, Spotify used a different approach. Instead of throttling free users, it offered six months of free premium use to all U.S. customers. Afterwards, they could enroll in a paid subscription or start using the free, ad-supported version of the service. Spotify grew quickly in the United States, and in March 2013 it claimed one million paid U.S. subscribers – and six million worldwide.xlv Spotify kept expanding in the following years: Germany, Australia, and New Zealand were added in 2012, and in 2013 the service became available in Italy, Poland, Portugal, Mexico, Honk Kong, Malaysia, Singapore, Estonia, Latvia, Lithuania and Iceland. In 2014, Spotify was available in 56 countries spanning the Americas, Europe, Asia and Oceania.

The Spotify Service In 2014, Spotify offered two service tiers in the United States: free and premium. Both tiers allowed on-demand unlimited listening of every song in the Spotify catalog, an unlimited number of times, from any computer. Free service users saw their playback interrupted every five songs by a short audio ad – usually promoting music-related merchandise like new records or band tours. Premium users could listen to music without being interrupted by ads, had access to higher quality audio, and enjoyed other features. Figure 1 shows the differences between the two service tiers and compares them with Pandora, the largest streaming service in the United States in terms of number of users.

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One of these streaming services was Spotify, which was rapidly expanding in the U.S. market.

Spotify: Face the Music

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Figure 1 Spotify service tiers in the US compared with Pandora (2014)

Free

Premium

Free

Premium

Mobile

Desktop & Tablet

All devices

All devices

All devices

Full catalog access

Yes

Yes

Yes

Yes

Yes

Playlists

Yes

Yes

Yes

No

No

Play tracks on demand

1

1

Yes

No

14 days

14 days

Unlimited

No

No

Ad-free listening

No

No

Yes

No

Yes

Sound quality (kb/s)

128

128

320

128

192

Offline mode

No

No

Yes

No

No

Yes

N/A

N/A

$9.99

$0

$4.99

2

Spotify Connect Monthly fee

No

No

No $0

No

1

Yes

Roaming

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PANDORA

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SPOTIFY

1 Max 6 track skips per hour. 2 Spotify Connect allowed synchronization between several devices owned by the same user, plus wireless streaming to compatible headphones or speakers. Source: Own elaboration.

Spotify also provided a mobile app that could be installed on Android or iOS devices. Notably, only premium users could play music on demand with the Spotify mobile application. Free users were not able to select a particular song but could create a “station” that would play random music that followed certain user-provided guidelines (e.g., genre, era or artist). Spotify often ran promotions to try to sign more customers to their subscription services. In early 2014, it was offering a free month of premium service to all new users. It had also just signed an agreement with mobile carrier Sprint to offer a six-month free trial to all its cell phone service customers, as well as discounted subscription rates. xlvi Spotify did little advertising. Spotify’s functionality was simple. When the user launched the application, music started to play automatically, resuming the last active playlist. Users could search for any song straight from the home screen, access their list of favorite songs and artists, access their playlists, and browse the most popular tracks and artists of the moment. The radio feature brought several preset thematic radio stations and allowed for the creation of new ones using a variety of guidelines. Spotify also had a “discover” feature that suggested new artists based upon the listening habits of the user. (See Exhibit 1 for several screenshots of the mobile and desktop Spotify clients in 2014.) Spotify had several social features. Inside the app, users could “follow” their friends to see what music they were listening to. They could also follow artists, bands and other personalities in order to get news about them and be alerted if they released new songs on Spotify. Integration with Facebook and Twitter allowed users to see their friends’ activity and favorite music and artists and generated items about their listening habits on these social IESE Business School-University of Navarra

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Spotify: Face the Music

networks. They could also share songs on Facebook, so their friends could listen to them even if they weren’t a Spotify customer.

All users were also able to save and share their playlists through e-mail, messaging applications and social networks. A non-customer could click and listen to the playlist but would be asked to register an account with Spotify. Playlists were a popular feature, and third-party websites, such as playlists.net or shareplaylist.net, had been set up where users could share, discuss and rate them.

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Spotify promoted autonomy within its structure, with the aim of fostering innovation and quick decision-making and implementation of improvements, design changes or features. There were little formal dependencies between working groups (called “squads”), but crosspollination and informal interaction between squads and particular members were strongly encouraged. The company even allocated 10% of its employees’ working hours to “hack time”, where they were asked to come up and test new ideas or features, in an unrestricted environment. This culture enabled Spotify to be agile and react quickly to changes in the environment, while pushing innovations quickly. As Daniel Ek put it; “We aim to make mistakes faster than anyone else.”xlvii

The Music Industry in the United States in 2013 In 2013, total revenue from the music industry in the United States – including both physical and digital sales – reached $7 billion. (See Exhibit 2 and 3 for data on the music industry in 2013.) Figure 2 Recording industry US market share in 2013

Company name

Distribution market share of album sales and track equivalent (10 tracks=1 album)

Universal Music Group

37.7%

Sony Music Entertainment

30.4%

Warner Music Group

20.8%

Others

11.4%

Figures may not add up to 100% due to rounding. Source: Adapted from Nielsen’s Entertainment and Billboard 2013 Mid-Year Music Industry Report.

Three big distributors dominated the market – the so-called “major labels,” as shown in Figure 2. The major labels acted as both producers and publishers, coordinating and handling recording, manufacturing, promotion, marketing and distribution of music. These 1 Sean Parker, founder of Napster and former Facebook president, served on Spotify’s Board.

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Spotify tried to develop even closer integration with Facebook1 and at one point forced users to log onto Spotify using a Facebook account. This was badly received and Spotify soon reversed its plans.

Spotify: Face the Music

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larger companies often also acted as publishers of smaller independent companies, which lacked the capacity to develop effective distribution and marketing arms. This increased the major labels’ market share even further. All the major labels were part of large, horizontallyintegrated media conglomerates. The market leader, Universal Music Group, reported revenues of $6.7 billion worldwide in 2013, and EBITDA of $979.6 million.xlviii Purchased by Kateryna Krasnoshchok for use on the Business Strategy Individual Assignment SS2015, at Universitat Wien. Taught by Dr Steffen Keck, from 1-May-2015 to 3-May-2015. Order ref F249634. Usage permitted only within these parameters otherwise contact [email protected]

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The physical recording industry business model was built around the sale of albums that contained usually around 10 music tracks, with an average selling price of $12.35 in 2013. These records could be purchased at physical stores or bought from online retailers. This part of the business had been declining sharply, and in the 2000s high-profile closures or downsizings of famous record store chains like Tower Records and Virgin Megastore had underscored the crisis of the traditional brick and mortar record store. Meanwhile, digital sources of income had been growing throughout the decade. However, they were still not compensating the loss of revenue in the industry’s traditional business. Figure 3 shows the evolution of music industry revenue expressed as spending per capita in 2011 dollars, broken down by format, from 1973-2009.

Figure 3 US Recorded Music Revenue - 2011 Dollars Per Capita

Source: Business Insider, “These charts explain the real death of the music industry,” February 18, 2011.

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Interestingly, digital and physical customers seemed to display distinct consumer behavior. For example, the vast majority of digital unit sales were single tracks, while physical sales were dominated by albums, singles not even attaining 1% of unit sales.

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Digital operations were mainly divided into two types of business: –

Download operations sold single tracks or albums digitally. Users could select an album or a track, listen to a sample, and then pay an amount (typically around $1 for a song and $10 for an album) to download it to their computer or portable device. The market leader was Apple’s iTunes Store, which reported the sale of 1.26 billion tracks in 2013.xlix Other important players were Amazon.com, Google Play Music, and Xbox Music.



Streaming allowed customers to listen to music without downloading it to their device. Thus, unlike download, users never “owned” the tracks. Streaming services usually obtained revenue via paid subscriptions or advertising. Pandora was the market leader in terms of users, while Spotify earned the most revenue after only two years in the U.S. market.

While downloading was bringing 40% of the total revenue of the recording industry, streaming had been growing rapidly and was now contributing 21% of total revenue. Six years before, in 2007, that figure had been just 3%. Furthermore, in 2013, the iTunes Store had reported its first sales drop since it began operating in 2003, and overall download sales were down from 2012.l Amidst this, in 2011 digital sales had attained a significant milestone in the United States. That year, digital sales surpassed physical media for the first time.li It was, however, a larger slice of a dwindling pie. It was that very same year, 2011, when Spotify finally launched in the U.S. market. Could the Swedish company be the solution to a shrinking industry?lii

Spotify Performance When Spotify launched in 2008, it did so with major music labels taking 18% of its shares, for a contribution of 100,000 Swedish kronor ($13,500).liii Spotify’s rapid expansion required significant investment; however, the company didn’t have trouble raising capital. In 2014 it had successfully completed 6 funding rounds, reportedly raising a total of $537.8 million.liv On the face of it, Spotify’s performance during its short life had been nothing less than impressive. In 2012 it had more than doubled its revenue, and the number of users kept growing at a frantic pace. However, there was an obvious downside; since its launch in 2008, 2 Synchronization rights were the licensing of music to be used as the soundtrack of an audiovisual output, typically films, TV shows, commercials or videogames.

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In 2013 digital sales totaled $4.4 billion, while physical sales of albums and singles were now at $2.4 billion, just 35% of the industry total. Other revenue streams, like the sale of cell phone ringtones and synchronization rights, 2 accrued for less than 5% of the industry revenues.

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Spotify had yet to post a profit. The explosive growth of the company had been accompanied by growing losses, as Spotify expanded into several markets in a very short time. Spotify’s cash flow situation was thought to be secure, as the company had secured several rounds of investment, for a total of $538 million at the end of 2013. lv See Figure 4 for Spotify’s financial data.

2009 Revenues

2011

2012

13.3

73.9

188.1

434.7

Subscriptions

N/A

52.6

156.9

N/A

Advertising

N/A

21.1

27.6

N/A

Other

N/A

0.1

3.6

N/A

Cost of sales

N/A

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2010

76.8

183.8

363.0

104%

98%

84%

Gross profit

N/A

-2.9

4.3

71.7

Operating expenses

N/A

19.0

51.2

130.4

Personnel cost

N/A

8.8

24.4

N/A

Other expenses

N/A

8.1

22.5

N/A

Depreciation

N/A

2.1

4.2

N/A

Operating income

-18.5

-21.9

-46.8

-58.7

Active users (approximation)

2.5M

5M

10M

20M

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Figure 4 Spotify financial data 2009-2012, in millions of euros

Source: Enders Analysis and casewriters’ own elaboration based on public sources.

The single largest expense was the cost of goods sold. This consisted mainly of the royalties Spotify paid to rights holders in order to get access to their catalog and offer it to its customers. Spotify signed several agreements with these right holders, usually the publishing label. The agreements were valid only for a particular country – since laws and contracts could vary wildly between different countries. In order to launch in the United States, Spotify signed deals with all major labels in 2011.lvi Spotify didn’t pay a fixed quantity “per stream.” Rather, it destined a fixed percentage of its monthly revenue to royalty payments. Specifically, in 2013 Spotify claimed that 70% of its revenue was being allocated to royalties.lvii Tracks received an amount depending on how many times they had been streamed vs. the total amount of streams in Spotify. Royalties were allocated on a country-by-country basis, taking into account the revenues and plays of that country. These payments were made to publishers and master holders depending on the particular agreements that Spotify had in place and any applicable laws of that particular country. IESE Business School-University of Navarra

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Artists were then paid by the label or publisher according to their contractual royalty rates. Thus, different artists with the same amount of plays could receive very different royalty payments. See Figure 5 for examples of actual monthly royalty rates.

Niche Indie Album

Classic Rock Album

$3,300

Actual Monthly Royalties for July 2013

$17,000

Breakthrough Indie Album

$76,000

Spotify Top 10 Album

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Global Hit Album

$145,000

$425,000

Source: Spotify Ltd, “Spotify explained,” December 2013.

Yet, despite the large share of revenue destined to royalty payments, Spotify faced increased criticism from artists for the low amounts they received. The largest musician union in the United Kingdom, for example, formally asked in 2013 that a minimum pay rate be set – something that would greatly increase Spotify’s costs if implemented. lviii Spotify defended itself by pointing out that actual royalties received by artists depended on their deals with the labels that published them, but this didn’t stop some high-profile artists from publicly speaking out against the company, some even pulling their songs from the service. For

example, in November 2014, Taylor Swift – one of the top selling artists of the 2010s – removed her entire catalog from Spotify and other streaming services.lix Any changes in the business model to try to put the company on a better financial path, or to diminish criticism from popular artists that could hurt its carefully groomed public image, couldn’t be made in a vacuum. Spotify’s success had brought something other than millions of users; it had brought competition.

The Competition In January 2014, amongst great media fanfare, Beats – a manufacturer of audio accessories and components – launched Beats Music. It was backed by a multimillion-dollar advertising campaign, featuring endorsements by celebrities like Bono, Dr. Dre, Pearl Jam, Eminem, and many others.lx Beats even enlisted several leading music magazines and music blogs to curate its radio stations.lxi Just a few months later, Apple announced the purchase of Beats for $3 billion.lxii Beats was only one of several music streaming services that had been launched since Spotify had entered the U.S. market. In 2013, tech giant Google had launched its own subscription service,lxiii and Apple had followed shortly.lxiv Both iTunes Radio and Google Music Play All

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Figure 5 Monthly royalty rates for 5 anonymized albums

Spotify: Face the Music

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Access came preinstalled in the hundreds of millions of iOS and Android smartphones that were being sold every year. Deezer, a Paris-based music streaming service with five million paid subscribers worldwide, had also announced it was preparing to launch in the United States in 2014.lxv

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Besides new entrants, Spotify also faced competition from several streaming music services already present in the U.S. market, which were reacting and adapting to Spotify’s massive growth. (See Exhibit 4 for a comparison between several streaming music services operating in 2014.)

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The most similar competitors were other on-demand streaming services such as Rhapsody or Rdio. These services worked in a similar way to Spotify, allowing users to play tracks on demand, and differed mainly in catalog size and whether a free version of the service was offered. Other competitors were the so-called “Internet radio” services. These didn’t offer tracks on demand; instead, users could listen to preset radio stations or create customized ones. This model allowed companies to pay reduced royalty rates compared with on-demand streaming services such as Spotify, and therefore allowed for lower pricing. Besides Pandora, iTunes Radio and Slacker Radio were other examples. These streaming services were not standing still as Spotify captured most of the market. For example, Rhapsody acquired Napster in late 2011.lxvi In early 2014, Rdio added a free, adsupported service option to its paid subscription servicelxvii and announced that it would start offering non-music content like talk shows and sport broadcasts.lxviii Pandora had already added non-music tracks in 2011.lxix In May 2011, Slacker Radio added a premium service that allowed users to play tracks on demand.lxx Lastly, YouTube was another strong competitor. Users of the Google-owned video streaming site often uploaded music videos, live performances or even ripped music tracks to the site. While this was not allowed by YouTube and the music labels, the sheer size of YouTube’s video catalog made effective enforcement impossible. Additionally, several publishers uploaded music videos for promotional purposes, which could be watched legally after a short advertisement. YouTube’s global audience size was considerable; while Spotify’s most popular track in early 2014 had been listened to a total of 200 million times, YouTube’s most viewed music video had more than two billion views.lxxi YouTube’s parent company, Google, recognized the potential of leveraging such a massive audience. In late 2014, it started the process of merging its music streaming service GoogleMusic with YouTube; the resulting service would allow users to stream both music and music videos for $9.99.lxxii Thus, as Daniel Ek left Spotify’s U.S. headquarters in New York, several questions might have crossed his mind. Could Spotify become a sustainable business? Could it really live up to its own hype and help the music industry grow again after more than a decade of continuous decline? Industry observers, and Ek himself, often pointed at how Sweden’s music industry grew by 27% between 2008 and 2013, far ahead of other developed countries, with Spotify leading the charge as streaming made up 70% of Sweden’s total music revenue.lxxiii But could this be replicated elsewhere? Ek might not be able to dwell on these questions for too long; yet another threat to Spotify’s market position was in the news: Apple was going to embed Beats Music in all the iPads and iPhones it sold.lxxiv

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Smartphone:

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SM-1613-E Spotify: Face the Music

Exhibit 1

Screenshots of Spotify's user interface in 2014

Spotify: Face the Music

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Exhibit 2 Industry revenue breakdown by source, and streaming growth US Music Industry Revenues 2013

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Digital Downloads 40% Ringtones & Ringbacks 1%

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Physical 35%

Subscription & Streaming 21%

Synchronization 3% Source: FIAA.

Proportion of total Music Industry. Revenues From Streaming

Source: RIAA, "News and Notes on 2013 Music Industry Shipment and revenue statistics", March 2014.

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Exhibit 3 2013 Year-End Recording Industry Revenue Statistics U.S. Unit Shipments and Estimated Retail Dollar Value (in millions, net after returns) Digital Permanent Download 2012

2013

% CHANGE

(Units Shipped) (Dollar Value)

1,392.2 $1,623.6

1,328.9 $1,569.0

-4.5% -3.4%

116.7 $1,204.8 2.0 $3.7

118.0 $1,233.5 3.7 $6.1

1.1% 2.4% 90.6% 67.9%

Music Video

10.5 $20.8

8.4 $16.8

-19.6% -19.6%

Ringtones & Ringbacks2

69.3 $166.9

39.2 $97.6

-43.4% -41.5%

SoundExchange

$462.0

$590.4

27.8%

Paid Subscription4

3.4 $399.9

6.1 $628.1

81.3% 57.1%

On-Demand Streaming (Ad-Supported)5

$170.9

$220.0

28.7%

$4,052.7

$4,361.5

Download Single Download Album Kiosk1

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Digital Subscription & Streaming

TOTAL DIGITAL VALUE

Synchronization Royalties6 Physical (Units Shipped)

$190.6

7.6%

$189.7

-0.5%

CD

198.2 $2,485.6

172.2 $2,123.5

-13.1% -14.6%

CD Single

1.1 $3.2

0.6 $2.4

-41.4% -24.2%

LP/EP

6.9 $160.7

9.4 $210.7

35.2% 31.1%

0.4 $4.7 6.0 $116.6 0.0 $0.2

0.3 $3.0 4.7 $104.7 -0.1 -$0.5

-18.8% -37.2% -21.8% -10.2% -711.1% -371.0%

0.1 $1.3 212.7 $2,772.4

0.0 $1.0 187.2 $2,444.8

-30.8% -27.1% -12.0% -11.8%

Total Retail Units Total Retail Value

182.9 $2,584.3

159.1 $2,267.7

-13.0% -12.3%

Total Units Total Value

1,803.3 $7,015.7

1,685.6 $6,996.1

-6.5% -0.3%

(Dollar Value)

Vinyl Single Music Video DVD Audio SACD Total Physical Unit Total Physical Value

TOTAL DIGITAL AND PHYSICAL

Retail value is the value of shipments at recommended or estimated list price formats with no retail value equivalent included at wholesale value. Note: Historical data updated for 2012 and 2011. Includes singles and albums. Includes master ringtones, ringbacks and, prior to 2013, music videos, full-length downloads and other mobile. Estimated payments in dollars to performers and copyright holders for digital radio services under statutory licenses. Streaming, tethered, and other paid subscription services not operating under statutory licenses. Volume is annual average number of subscribers for subscription services. Ad-supported audio and music video services not operating under statutory licenses. Includes fees and royalties from synchronization of sound recordings with other media. Units total includes both albums and singles and does not include subscriptions or royalties. Source: RIAA, “News and Notes on 2013 Music Industry Shipment and Revenue Statistics,” March 2014.

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2012-2013

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Yes

Yes

26 million 1 million

20 million

N.A.1 2013 2013 2005

2010 2001 2007

Deezer

Google Music All Access

iTunes Radio

Pandora

Rdio

Rhapsody

Slacker Radio

Yes

Yes

Yes

Yes

Yes

Yes

Premium only

Yes

Yes

No

No

Yes

Yes

Yes

Yes

Play Tracks on Demand

Ad-supported 6 track skips/hour

Not available

Ad-supported Shuffle mode on mobile

Ad-supported 6 track skips/hour (24 day maximum)

Ad-supported 6 track skips/hour

Not available

Ad-supported Shuffle mode on mobile

Not available

Ad-supported Shuffle mode on mobile

Free Service

$4.99

Yes

Yes

Yes

$9.99

2

$9.95

$9.99

$24.95/year

iOS only

Yes

$9.99

Android only

$9.99 €9.99

Yes Yes

$9.99

Monthly Premium Fee

Yes

Mobile App

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Source: Developed by the authors.

2 Slacker Radio also offered a $3.99 tier that removed advertising but didn’t enable on-demand playback.

1 Deezer data corresponds to its service as marketed in Western Europe and is provided here for comparison purposes. Deezer had announced plans to launch in the United States during 2014.

13 million

16 million

18 million

20 million 30 million

2014

Beats Music

Yes

20 million

2011

Spotify

Major Label Support

Claimed Library Size

U.S. Launch Date

Comparison of selected music streaming services operating in the United States in 2014

Exhibit 4

Spotify: Face the music

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Spotify: Face the Music

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ix “ISO/IEC 11172-3:1993 – Information technology — Coding of moving pictures and associated audio for digital storage media at up to about 1.5 Mbit/s — Part 3: Audio,” ISO, 1993, http://www.iso.org/iso/iso_catalogue/catalogue_tc/catalogue_detail.htm?csnumber=22412, last accessed April 10, 2014. x “Percentage of Individuals Using the Internet 2000-2012,” International Telecommunications Union (Geneva), June 2013, http://www.itu.int/en/ITU-D/Statistics/Documents/statistics/2013/Individuals_Internet_2000-2012.xls, last accessed April 15, 2014. xi

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2003, 26,

2006,

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iii

Spotify: Face the Music

xxiii

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November

30

SM-1613-E

2011,

xxiv “Apple launches the iTunes Music Store,” Apple Inc., April 28, 2003, http://www.apple.com/pr/library/2003/04/28AppleLaunches-the-iTunes-Music-Store.html, last accessed May 2, 2014. xxv “Apple launches iTunes for Windows,” Apple Inc., October 16, 2003, http://www.apple.com/pr/library/2003/10/16AppleLaunches-iTunes-for-Windows.html, last accessed May 2, 2014. xxvi

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xxix Prince McLean, “Apple’s new iPod nano sports fattest profit margins yet,” Appleinsider, September 9, 2007, http://appleinsider.com/articles/07/09/19/apples_new_ipod_nano_sports_fattest_profit_margins_yet, last accessed July 14, 2014. xxx “Sony Connect Online Music Store Launches Today, Offering Music Fans More Than 500,000 Legal Downloads From Major and Independent Record Labels Around the Globe,” Sony Corporation of America, June 4, 2004, http://www.sony.com/SCA/company-news/press-releases/sony-corporation-of-america/2004/sony-connect-online-music-storelaunches-today-off.shtml, last accessed May 9, 2014. xxxi “Microsoft’s New Zune Digital Media Player on Store Shelves Tomorrow,” Microsoft Corp., November 13, 2006, http://www.microsoft.com/en-us/news/press/2006/nov06/11-13zunelaunchpr.aspx, last accessed May 9, 2014. xxxii Jack Schofield, “Sony disconnects Connect and adopts Microsoft’s DRM for portable players,” The Guardian, September 1, 2007, http://www.theguardian.com/technology/blog/2007/sep/01/sonydisconnect, last accessed May 10, 2014. xxxiii Nick Wingfield, “R.I.P. Zune,” The New York Times, June 4, 2014, http://bits.blogs.nytimes.com/2012/06/04/r-i-pzune/?_php=true&_type=blogs&_r=0, last accessed May 10, 2014. xxxiv “Apple reports first quarter results,” Apple Inc., January 21, 2009, https://www.apple.com/pr/library/2009/01/21AppleReports-First-Quarter-Results.html, last accessed May 8, 2014. xxxv “Amazon MP3 Adds Music Audio Downloads from Warner Music Group,” Amazon.com, December 27, 2007, http://phx.corporate-ir.net/phoenix.zhtml?c=176060&p=irol-newsArticle&ID=1089999&highlight=, last accessed May 8, 2014. xxxvi “The NPD Group: Amazon Ties Walmart as Second-Ranked U.S. Music Retailer, Behind Industry-Leader iTunes,” NPD Group, May 26, 2010, https://www.npd.com/wps/portal/npd/us/news/press-releases/pr_100526/, last accessed June 8, 2014. xxxvii “Changes coming to iTunes Store,” Apple Inc., January 6, 2009, http://www.apple.com/pr/library/2009/01/06ChangesComing-to-the-iTunes-Store.html, last accessed May 8, 2014. xxxviii

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xlv Paul Sloan, “Spotify: Growing like mad, yet still far to go,” CNET.com, March 12, 2013, http://www.cnet.com/news/spotifygrowing-like-mad-yet-so-far-to-go/, last accessed May 11, 2014. xlvi Marina Lopes, “Spotify strikes marketing partnership with Sprint,” Reuters, April 29, http://www.reuters.com/article/2014/04/29/us-spotify-sprint-idUSBREA3S10T20140429, last accessed May 9, 2014.

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xlvii “Spotify Engineering Culture”, Spotify LTD., February 2014, http://vimeo.com/85490944, Last Accessed November 2014 xlviii

xlix “Digital music sales drop for first time since advent of iTunes Store, execs blame streaming,” Appleinsider.com, January 2014, http://appleinsider.com/articles/14/01/03/digital-music-sales-drop-for-first-time-since-advent-of-itunes-store-execsblame-streaming, last accessed April 29, 2014. lAppleinsider.com, Op. Cit. li See data in Exhibit X. lii “Hello America, Spotify Here,” Spotify LTD., July 14, 2011, http://press.spotify.com/us/2011/07/14/hello-america-spotifyhere/, last accessed May 11, 2014. liii Marcus Jerrang, “Documents reveal majors own part of Spotify,” Computer Sweden, August 7, 2009, http://computersweden.idg.se/2.2683/1.240046/documents-reveal-major-labels-own-part-of-spotify, last accessed Nombever 26, 2014 Educational material supplied by The Case Centre Copyright encoded A76HM-JUJ9K-PJMN9I Order reference F249634 CoursePack code C-461-235765-STU

liv Data from Spotify’s entry in Crunchbase startup database, http://www.crunchbase.com/organization/spotify, last accessed November 26, 2014 lv Josh Constine, “Technology Crossover Ventures Funds All Of Spotify’s $250M International Growth Round,” Techcrunch, November 21, 2014, http://techcrunch.com/2013/11/21/technology-crossover-ventures-spotify/, last accessed July 15, 2014. lvi Alex Pham, “Spotify buttons up deals with Warner Music, launches music service in the U.S.,” Los Angeles Times, July 13, 2014, http://latimesblogs.latimes.com/entertainmentnewsbuzz/2011/07/spotify-buttons-up-deals-with-warner-launches-musicservice-in-the-us-.html, last accessed May 11, 2014. lvii “Spotify Explained,” Spotify LTD., http://www.spotifyartists.com/spotify-explained/, last accessed June 8, 2014. lviii Mark Townsend, “Musicians’ Union demands new pay deal from Spotify,” The Guardian, July 20, 2013, http://www.theguardian.com/technology/2013/jul/20/spotify-radiohead-musicians-union-rights, last accessed June 8, 2014. lix Hern Alex, Dredge Stuart, “Taylor Swift vs. Spotify: back catalogue removed from streaming services”, The Guardian, November 3 2014, http://www.theguardian.com/technology/2014/nov/03/taylor-swift-spotify-artists-discography-streamingservices, Last accessed November 5 2014 lx Advertising material on Beats Music YouTube channel, http://www.youtube.com/user/officialbeatsmusictv/videos, last accessed May 11, 2014. lxi “Beats Music Curator Program,” Beats Music LLC, http://www.beatsmusic.com/curators, last accessed May 11, 2014. lxii

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15,

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lxv Romain Dillet, “Deezer Will Launch In The U.S. Next Year And Fight Head-To-Head With Music Streaming Giants,” Techcrunch.com, November 21, 2013, http://techcrunch.com/2013/11/21/deezer-will-launch-in-the-u-s-next-year-and-fighthead-to-head-with-music-streaming-giants/, last accessed May 7, 2014. lxvi

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October

3,

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Purchased by Kateryna Krasnoshchok for use on the Business Strategy Individual Assignment SS2015, at Universitat Wien. Taught by Dr Steffen Keck, from 1-May-2015 to 3-May-2015. Order ref F249634. Usage permitted only within these parameters otherwise contact [email protected]

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Spotify: Face the Music

SM-1613-E

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Purchased by Kateryna Krasnoshchok for use on the Business Strategy Individual Assignment SS2015, at Universitat Wien. Taught by Dr Steffen Keck, from 1-May-2015 to 3-May-2015. Order ref F249634. Usage permitted only within these parameters otherwise contact [email protected]

lxxii Eric Limer, “YouTube Music Key Hands-On: Streaming Music Has Never Been Easier,” Gizmodo, November 20 2014, http://gizmodo.com/youtube-music-key-hands-on-streaming-music-has-never-b-1661089830, last accessed November 26, 2014 lxxiii “Music in Sweden: I have a stream,” The Economist, March 22, 2014, http://www.economist.com/news/business/21599353land-abba-takes-streaming-i-have-stream, last accessed June 8, 2014.

Educational material supplied by The Case Centre Copyright encoded A76HM-JUJ9K-PJMN9I Order reference F249634 CoursePack code C-461-235765-STU

lxxiv Roger Cheng, Joan E. Solsman, “Apple said to be embedding Beats music service into IOS,” Cnet, November 19, 2014, http://www.cnet.com/news/apple-to-embed-beats-music-service-into-ios-software-ft-says/, last accessed November 26, 2014

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