For learning purposes, we occasionally translate or summarize articles written by foreign experts in blogs, media, and books. This post is one of them. There may be rough and mistranslated parts. Please check if there are any parts that are not translated properly and we will reflect them. Sentences with ambiguous meaning were deleted. This time, it was posted on the Economics & Tech Medium blog.This is a summary.
Spotify is the world’s most popular music streaming service, offering more than 70 million songs to 246 million premium subscribers and more than 626 million monthly active users, outperforming major competitors such as Apple Music and YouTube Music. It is being reaped. Spotify, which operates under a freemium model, allows users to listen to music for free with ad breaks every 15 minutes or listen to music without ads by paying a monthly fee.
Spotify was founded in Sweden in 2006 by Daniel Eck and Martin Lorenzon, who wanted to create a legal alternative to the rampant online music piracy at the time. After much negotiation, Daniel and Martin persuaded major record labels to license their music catalogs to Spotify in exchange for profits and a portion of the company’s equity. Despite becoming the king of music streaming, Spotify has accumulated losses of more than $4 billion since 2009 and has never turned a profit on an annual basis. In 2023, 2,300 employees, or more than 20% of the total workforce, were laid off to reduce costs. Any company that revolutionized the music industry and changed the way we listen to music would naturally expect to be profitable, but Spotify is having a hard time making money from streaming music.
Spotify vs Big 3
The biggest challenge Spotify faces in monetizing streaming music is high royalties. For every dollar Spotify earns from music streaming, $0.70 goes to song rights holders, including record labels, publishers, songwriters, and artists. Therefore, Spotify can only cover 30% of its profits to cover the costs of running the world’s largest streaming service, including employee salaries, marketing, and operating expenses. Because of this, Spotify has struggled with profitability for most of its existence.
So why does Spotify pay such a high percentage of its revenue as royalties? And as a large market player, why can’t we negotiate lower rates? The answer lies in the power imbalance between Spotify and the record labels. Spotify licenses most of the music on its platform from just three companies: Universal Music Group, Sony Music Entertainment, and Warner Music Group, also known as the music industry’s Big Three.
These companies help promote and distribute artists’ music and in return own the rights to the music. The Big 3 control 71% of the music recording and publishing industry, forming a cartel. The Big Three, who control much of the music industry, have significant influence over Spotify, allowing them to determine how much Spotify has to pay to stream its music. Without these licenses, Spotify wouldn’t be able to stream the millions of songs users want to listen to, and would lose customers to competitors like Apple Music, Amazon Music or YouTube Music, which have licenses similar to the big three.
Own music production and Spotify
Like Netflix, Spotify can generate more revenue by producing the content it streams instead of licensing it from other companies. In its early days, Netflix struggled with profitability because it had to pay huge licensing fees for almost every movie and show it streamed. To solve this, Netflix began producing original shows and movies, which allowed it to cut costs by reducing its dependence on other studio content and reducing licensing fees.
However, Spotify cannot produce its own content. The Big Three anticipated this move and, as part of their licensing agreements, forced Spotify executives to sign an agreement that prohibits music content from being produced and streamed exclusively on its platform. In 2018, Spotify attempted to bypass this contract term and license music directly from artists, but gave up on this method after a three-month legal battle.
What differentiates Spotify and Netflix’s bargaining power is their concentration of suppliers. The music record industry is highly monopolized, with the Big 3 market share reaching 71%. However, there are seven major film studios in the film and TV studio industry, and in 2012, when Netflix began producing its first original show, House of Cards, the three major studios had only a 45% market share.
Because there was no monopoly in the film industry, Netflix was able to negotiate more easily with suppliers. Additionally, unlike Spotify, which streams the same music as other services and pays a recurring royalty for every stream, Netflix was able to obtain exclusive streaming rights from some studios, such as Disney, for a flat fee, which allowed it to differentiate itself from other movie streaming services. .
Can podcasts save Spotify?
Spotify realized it needed to diversify away from music streaming. In 2019, Spotify began focusing more on podcasts as it expanded from a music streaming platform to an all-in-one audio platform. Because podcasts are outside the realm of the big three, Spotify can negotiate lower licensing fees for streaming podcasts. Spotify claims that long-term gross margins for podcasts are 40-50%, much higher than the 25-30% it receives from music. So as more Spotify users listen to podcasts rather than music, the share of streaming revenue paid out in royalties will decline sharply. This means more profits.
In recent years, Spotify has been investing heavily in podcasting, spending more than $1 billion to acquire companies in the field, including celebrity podcasts Kim Kardashian’s The System and Archetypes, for which Spotify paid $25 million). It has spent $100 million in 2020 and $250 million in 2024 on streaming contracts such as Joe Rogan’s The Joe Rogan Experience. The costs of this aggressive business diversification have been significant, but Spotify is now reaping the rewards of its investment, with its podcasting division playing a key role in achieving record gross profits of $1.08 billion in the first quarter of 2024.
Most of Spotify’s revenue in 2024 was generated from its podcast business, with average gross margins rising to 27.6% from 25.2% in 2023, thanks to lower podcast licensing costs compared to music. The Spotify journey illustrates the challenges of building a business that relies on exclusive content. Over the past 18 years, Spotify has suffered from poor profitability due to its heavy dependence on the Big Three. However, it appears that the company will be able to transform from a loss-making company into a profitable powerhouse through a strategic shift that goes beyond music streaming.
