Spotify: Strategic Options

Let’s say that we do see a larger shift of artists to independent labels, how do you look at the game theory, between Spotify and the major labels?

Spotify reached agreements with the major record companies, because it was their cost of entry; it was what they needed, in order to have a legitimate organ. The record companies and publishers, represent a very substantial portion of the revenue that goes to the artist and them. The margin that Spotify has is pretty thin, especially given the nature of their model. Unlike Netflix, Netflix spends X amount of money on content and then it gets more and the more subscribers they have, the cost of content doesn’t go up, per se. They choose to make it go up, but it doesn’t necessarily. In Spotify, if they gain one more subscriber, their margin doesn’t shift.

They’ve got far less operating leverage than Netflix.

Exactly. So it does move because, obviously, you’re getting more, but if you’re trying to extend your business, you’re using a lot of capital to try and keep expanding. Their margins are low and that’s not going to change. It’s not going to change because they’ve set, for themselves and everybody else, the basic underlying economics, between the record industry and them. Now, how do they do that? There are two things they can do. One is to use that data that we’ve been talking about. Use their knowledge to help market and exploit – in a good sense – the music, to create greater value and use that as a way of improving their margin.

The second is to diversify their content. That’s what they’re doing with podcasts. The third one is that we should also remember that the freemium piece, as we used to call it, the economics there are not good and it is an advertising medium. There is still a great deal of room for them to increase their position in advertising. Again, for every dollar that they create, they give a big chunk of it away to the record industry. As we were saying before, there will be margin improvement and that’s just simply because you’ve got more revenue to play with and your fixed costs aren’t going up as much. For them to really come out, they have to have another source of revenue. That’s podcasts. That’s what I believe they think.