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How Spotify Became the McDonald’s of the Music Industry

Thom Yorke and Nigel Godrich caused quite a stir last week by pulling their music off Spotify, demanding that the service pay more to up-and-coming musicians. The thing is, however, that Spotify is already losing money hand over fist, despite expanding its user base dramatically over the last couple of years and only paying out pitifully small per-stream fees to artists. If Spotify can’t make things work paying artists these pissant royalties — and the consensus seems to be that it can’t — then it’s got a problem, especially if the slow trickle of artists moving away from the service starts to speed up and/or emerging artists decide that it’s not worth the time or effort to essentially give away their music for free via the site. So, is Spotify doomed?

A large part of Spotify’s appeal is its catalog — the idea is that you can pay $10 a month for the ability to play pretty much anything. Until now, it’s generally been older, more established artists who’ve been absent from the service, artists who wouldn’t necessarily appeal to Spotify’s market anyway; if you’re into Led Zeppelin, AC/DC, John Lennon, and The Beatles, you’re probably part of a demographic that plays them off physical media on the large stereo in your living room.

Thom Yorke… well, he’s a generation further down the line. His fan base is largely late Gen X/early Gen Y, both of whom start to touch on Spotify’s core demographic. (As per slide 23 in this fascinating presentation, 18-24 is by far the biggest part of Spotify’s user base, accounting for about 1.8 million users, but 25-29 and 35-44 are basically tied for second, with about 900,000 each.)

Godrich and Yorke’s focus was on new artists, and while this is laudable from a moral point of view, for complete newcomers Spotify may well remain a risk worth taking — no one’s paying for your music anyway, so why not have it shared worldwide? If you sign a major label deal, you probably also have no choice but to be on Spotify (this, presumably, is why Radiohead’s music is still there — it’s released via Parlophone, which these days is a subsidiary of WMG).

But there are plenty of artists and labels out there beyond the majors, and every one that pulls its work from Spotify undermines the service’s biggest asset: its catalog. Yorke and Godrich described their actions self-deprecatingly as a “small meaningless rebellion,” but it might be more meaningful than they think — as The Atlantic‘s Spencer Kornaber wrote last week, “Yorke and Godrich’s rejection of Spotify matters for the simple reason that it screws with the service’s appeal… By opting out, Yorke and Godrich won’t shatter the illusion of comprehensiveness that Spotify thrives on. But they’ll dent it.”

The question is how many dents it’ll take to breach Spotify’s hull. What if a bunch of indie labels followed Drag City’s lead, and joined together to decide they didn’t want their artists to be on Spotify anymore? What if there were no Sub Pop, or Merge, or Matador? What if Yorke decided to put his foot down and insist that Parlophone pull Radiohead off Spotify, or simply decided that the next Radiohead record — they’re self-releasing these days, remember — wasn’t gonna be available for streaming? A service that’s “stream a bunch of chart pop and unknowns” isn’t nearly as compelling as “stream everything ever except The Beatles and some other old bands,” is it?

And just as importantly, what if the next big emerging independent artist decided at the outset that it wasn’t worth putting their music on Spotify? People tend to view the service as ubiquitous, but it’s not — it has some five million paid subscribers worldwide, of which about one million are in the USA. It’s not like access to that user base is crucial in breaking an artist — the artists who’ve gotten massive since Spotify’s launch have done so via YouTube and old-fashioned methods like radio airplay, not because Spotify launched them into the stratosphere.

All of which means that, for all that Spotify appears to be in a position of power here, that ain’t necessarily so. Musicians are starting to realize that Spotify needs them just as much as, if not more than, they need to be on Spotify. The company itself seems to have recognized this problem some time ago, and it’s been moving away from marketing itself as just a service where you can stream whatever you want. Take the aforementioned presentation from way back in 2011, for instance, wherein Spotify trumpets its Facebook integration and proclaims, “We’ve gone from a product built around content to a product built around people.” But as the failures of Twitter Music and innumerable other Internet music ventures have proven, the idea of social music as cash cow is largely chimera — there’s no hard data on this, but anecdotally and empirically, people seem to sign up for music services because, well, they want to play music, not because they want to share some sort of profound online experience with their friends.

So what’s Spotify going to do? Beefing up the ads that support its free service isn’t going to help — only 15% of its revenue comes from advertising, and anyway, its ads are so obnoxious that they’re more likely to turn off potential new subscribers than anything else. This is a problem, because new subscribers are what Spotify needs — 84% of the service’s revenue comes from subscription fees.

But here’s the best bit: apparently, the more music those subscribers stream, the less money Spotify makes. Subscribers pay a flat fee, but Spotify pays out royalties per stream. That means that it’s quite possible heavy users cost the company money. Raising fees seems the obvious answer, and/or changing the subscription model to charge users by reference to the amount of music they stream.

The problem with this is that once you’ve sold consumers on the idea of a magic $10-a-month jukebox that allows them to play whatever they want, as much as they want, forever… well, it’s hard to turn around and tell them that they can’t do that anymore. Part of Spotify’s appeal is its almost unbelievable cheapness, and undermining that would undermine its entire appeal. (It’d also risk losing sales to competitors like Rdio and Google Music, who’d all of a sudden be the cheaper option — and if it’s a matter of being a loss leader, Google’s pockets are a lot deeper than Spotify’s are.)

What’s the answer, then? The best case scenario seems to be Spotify functioning as something like a Netflix for music: people know Netflix’s catalog isn’t perfect, but the convenience it offers makes it a sure bet at $8 a month. And Netflix is actually making money — not much, but some — because it isn’t getting screwed as vigorously has negotiated better deals with its content providers, and its per-stream model is significantly different because a movie is something you stream once, not potentially a bazillion times in the course of a week.

The problem is that Spotify can’t really go back to the labels with cap in hand and ask to pay even lower royalties; it’s already paying a pittance to artists, and paying any less would probably lead to a further exodus of the people who provide its content. Again, it’s hoist by its own petard here — its very business model is the thing that undermines its business.

Still, the Netflix model does provide at least one possible additional source of revenue: original content. Netflix’s resurrection of Arrested Development, along with its ventures into creating its own series with Orange Is the New Black and House of Cards, have provided a whole new reason for people who might have had no use for the streaming-old-content idea to sign up.

There’s no reason why Spotify couldn’t do the same thing. Operating as a de facto label would both allow it to market itself as offering content you can’t find anywhere else, and also be more profitable for Spotify itself — it’d just have to pay musicians, cutting out record labels as the middleman. It’s an intriguing possibility, especially since being able to say it’s offering exclusive content is perhaps the one thing that would allow it to raise its prices without pissing off its established userbase completely.

The other possibility is altering that business model to push more sales, rather than streams. You can buy songs via Spotify at the moment, but why would you? Premium subscribers get offline plays and unlimited streams, so there’s basically no incentive to ever buy anything — indeed, that’s Spotify’s entire appeal, the idea that you never need to buy anything. Again, it’s hard to see a solution like, say, allowing a certain number of free streams and then requiring a paid download as anything but a non-starter, given how much it’d alienate the site’s user base.

But, in any case, let’s say Spotify’s army of VC backers decide that it’s not worth throwing good money after bad anymore, and the service does fail. What happens then? The funny thing is, you get the feeling that the major labels that are backing Spotify don’t really care if the service fails or succeeds — as Godrich pointed out in one of his tweets, “It’s about establishing the model which will be extremely valuable.” That’s very true, as is his observation that “The model massively favors the larger companies with big catalogues… the smaller producers and labels get pittance for their comparitvely few streams.”

For the major labels, Spotify is a win-win situation: it’s a proof-of-concept that people will still pay for music, albeit a far lower price than they used to, and also a means of ensuring that it’s the labels that continue to reap the majority of the profits from those low, low prices. If there’s no more Spotify, fine — consumers who’ve been weaned onto this diet will just move onto Rdio, or Google Music, or whatever similar service steps up next to try to make money out of subscription-based streaming.

But for consumers, it’s the cultural equivalent of a McDonald’s burger: an unrealistically cheap product whose costs are externalized onto society. It’s a high-volume, low-margin model that squeezes producers for content in just the same way that fast food restaurants squeeze farmers for beef. It’s bad for everyone, including Spotify itself, which has been existing on an unhealthy diet for far too long.

So, where to from here? For a consumer, the answer is pretty simple: if you want to support an artist (and especially an emerging one), then buy tickets to their shows, and buy their music directly from them, either at shows or via services like Bandcamp where it’s artists who get the majority of the revenue. And Spotify? Perhaps one day we’ll look back at it like Boo.com or Friendster, a startup that pioneered a viable idea but couldn’t monetize it. It’s certainly changed the face of online music, but the face that stares back out of the mirror these days is a pretty ugly one.

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