The Spotify Biz Model - a 3-Pot Shuffle?

Helienne Lindvall, whom I saw speak at a recent Chinwag event on music (and whom I thought was fairly sensible) has written an interesting article in the Grauniad about Spotify's business model - or lack thereof. She first got suspicious when she realised all the major labels loved it:

The major record labels – and the bigger indies – that I spoke to seemed unusually positive about Spotify, which made me think that they must have received a pretty hefty payment and/or equity in the company. Sure enough, the other week some of my suspicions were confirmed when it was reported that the majors received 18% of Spotify shares. Merlin, who represent a larege portion of the independent labels, received 1% (as their labels represent 11-12% of Spotify plays, it appears this is a bit disproportionate to the value of their content). What they paid for their shares is still under debate, with ComputerSweden reporting that it was as little as $10,000. Regarding payments, the labels I spoke to said that they're not allowed to divulge these details. But, as it's common for majors to demand such payments, I'd say it's likely they did.

I can see why this puts Spotify in their good books. One of the main reasons why majors have been hesitant to offer their music to start-ups is that they've seen companies like YouTube and Last.fm build businesses, only to sell them off for big bucks without sharing the money with the copyright owners whose music they used.

And following the money, something didn't quite add up:

A source close to Spotify told me he has serious doubts that their business model will add up and that it's a case of "spot the idiot", ie "find somebody stupid enough to buy it before realising that it's too costly to run and that the numbers don't add up to making a profit"

And of course, this goes hand in hand with the traditional "top-of-hype-curve" massive overvaluation based on Jam 2.0 tomorrow:

Spotify is currently valued at $250m, despite, according to The Register, only having an advertising income of £82,000 and just 17,000 UK users signing up to pay £120 a year for Spotify Premium. Having equity in the company ensures that the labels get paid if Ek and his colleagues find said "idiot" and decide to sell up (Ek says they have no intention of selling up, by the way). But what does this all mean for the artists?

Of course they won't sell, this is an attempt to build a family business that will last for generations - to even imply that its just another 2.0 pump 'n dump play using VC wonga is just sordid and unkind . And even worse, Helienne implies that the money is made by withholding the musicians fair share! Another Web 2.0 play practicing Digital Sharecropping Shock Horror!

There are indie labels that, as opposed to the majors and Merlin members, receive no advance, receive no minimum per stream and only get a 50% share of ad revenue on a pro-rata basis (which so far has amounted to next to nothing).

and....

For artists who "signed up to a label" there's a tangible risk that revenue which comes from a possible sale of shares by the label would end up in the proverbial "blackbox" (non-attributable revenue that remains with the label). There's growing concern about this in the artist management community and, a few weeks ago, Bob Dylan decided to pull his back catalogue from UK streaming services.

In other words, the picture emerging is that Spotify is an interesting reconciliation of the standard "de facto" Web 2.0 business model (use other people's stuff and give it away free to build a business and then sell to the dumb money before they twig you're going bust), combined with the standard Music Label model (use the artist's stuff to build a business but scre...ensure you extract the maximum contractual benefit from the artist wherever possible).

Now to be fair, the model of having your big suppliers invest in you is a time honoured one, especially in risky new areas. And if you have labels as your owners, they may well be prepared to give you a bit of a break on the cost per song. You have to admire the logic. Only fly in the ointment is that the labels' suppliers may not get paid. Problems I can see with this type of play therefore are that:

- the number of dumb money players for a quick exit is falling - they've either been stung already or are in dire straits themselves, so the 2.0 approach may not work in the near future (though the P T Barnum thesis implies it will). The "traditional" Web 2.0 model is to sell before the chickens come home to roost, but if time to sell stretches out, the model has to be sustainable.

- Unfortunately, this model is potentially more overt artist screwing, in that in the past the artist has legally signed away a large chunk of their future income for the opportunity to ride on the Label's marketing machine, whereas this is more like a 3-pot shuffle, and may well be challengeable legally by various artists' representative bodies to get dibs on the value being created. User Generated Content has very little legal representation which is why Bebo et al saw little challenge at point of sale, but using Artists directly as the free UGC is different. (In fact I suspect this will be one of the areas of Rights legal conflict going forward)

- Listeners to free music streaming services are by and large young and still (in their terms) enthusiastically ethical. Being seen to stiff the struggling artist is bad PR juice.

- For Spotify, the issue is that the labels are better off splashing it around a bit, ie getting their hooks into a number of such businesses or even doing it themselves once things start to take off. Still, being early and getting great publicity on a shoestring (and funding) is a good asset.

This model fits in with our model of how the new mediums will evolve - the "Pirate World" of small startups scraping the digital sharecroppers is not sustainable, so one way or another they have to find sustainable models (or sell to a sucke...sorry, company that can achieve strategic synergies). In the early days, many of these will be offset models because the emerging "New Media" industry just does not have enough money. The problem Old Order players have is if these competitors are all giving someone else's stuff away for Free!, they cannot follow suit. Thus, a rational business model only occurs if they can both invest in the growth of the new order and create some form of option value for themselves. Investing a small amount in such a play works well if they can argue they then do not have to pay their downstream suppliers.

And this way, if the labels are the owners, then just having a vehicle that drives other (un-owned) players out the free streaming business is probably a "good enough" reason for funding its existence in the early stages. We expect to see quite a few copycat plays (in a way, its not that different from YouTube's play before selling to Google - the Labels are learning).