{"id":908,"date":"2015-10-02T15:43:35","date_gmt":"2015-10-02T19:43:35","guid":{"rendered":"https:\/\/digital.hbs.edu\/platform-digit\/submission\/spotifys-business-model-competing-with-network-effects\/"},"modified":"2015-10-03T13:50:33","modified_gmt":"2015-10-03T17:50:33","slug":"spotifys-business-model-competing-with-network-effects","status":"publish","type":"hck-submission","link":"https:\/\/d3.harvard.edu\/platform-digit\/submission\/spotifys-business-model-competing-with-network-effects\/","title":{"rendered":"Spotify\u2019s Business Model \u2013 Competing With Network Effects"},"content":{"rendered":"<p>Digital innovation has drastically reallocated the money associated with music consumption.\u00a0 With physical releases, record labels captured most of the revenue by implementing expensive marketing campaigns and convincing a large swath of users to pay $10-20 for an album upfront.\u00a0 They got paid the same amount, regardless of how much the user ever actually listened to that album.\u00a0 In the consumption model, however, how many times a song gets listened to is <i>exactly <\/i>how labels and artists make money from official releases.\u00a0 Enter the new players in the industry to capture value: tech-enabled music platforms like iTunes and Spotify.<\/p>\n<p class=\"p1\"><span class=\"s1\">What started out as a similar business model (individual song and album downloads) has transitioned into music streaming, led by Spotify and Apple Music.<span class=\"Apple-converted-space\">\u00a0 <\/span>Both services charge $9.99 per month for unlimited music consumption (for the purposes of this analysis, I\u2019m not going to include Spotify\u2019s ad-supported free listening tier).<span class=\"Apple-converted-space\">\u00a0 <\/span>What\u2019s interesting about these platforms is that their consumption incentives are <i>not entirely aligned<\/i> with with those of the labels and artists.<span class=\"Apple-converted-space\">\u00a0 <\/span>Why is that?<span class=\"Apple-converted-space\">\u00a0 <\/span>As I\u2019ll show below, customers that pay for a monthly subscription but don\u2019t listen to a large amount of music are immensely profitable for the music platforms, but almost worthless to labels and artists.<\/span><\/p>\n<p class=\"p1\"><span class=\"s1\">Current per song payout rates from platform to label are about $0.006.<span class=\"Apple-converted-space\">\u00a0 <\/span>If we assume the same 70\/30 revenue split that the download-to-own model is built on, we can assume that $3 of every subscription goes directly to the platform (overhead costs, platform investments, etc), with the remaining $7 being available to fund the amount of individual listening a user does.<span class=\"Apple-converted-space\">\u00a0 <\/span>At the current payout rate, a user would need to stream 1,167 songs per month in order for their $7 to be fully distributed to labels and artists.<span class=\"Apple-converted-space\">\u00a0 <\/span>Based on recent statistics from Nielsen, actual platform listening is considerably lower than this on average.<span class=\"Apple-converted-space\">\u00a0 <\/span>Consumers average 24 hours of music listening per week, which if done <i>entirely <\/i>via a platform like Spotify would equate to about 1,152 songs per week, or about breakeven for Spotify.<span class=\"Apple-converted-space\">\u00a0 <\/span>The reality, however, is that this listening is not entirely concentrated on one platform \u2014 it\u2019s spread out across radio, YouTube, Soundcloud, blogs, etc.<span class=\"Apple-converted-space\">\u00a0 <\/span>So if not all of the $7 is being distributed back to artists and labels, where does it go?<span class=\"Apple-converted-space\">\u00a0 <\/span>It stays with the distribution platforms!<span class=\"Apple-converted-space\">\u00a0 <\/span>The business model of these companies means they prefer users that pay for a subscription but don\u2019t stream enough to make them an unprofitable user.<\/span><\/p>\n<p class=\"p1\"><a href=\"https:\/\/d3.harvard.edu\/platform-digit\/wp-content\/uploads\/sites\/2\/2015\/10\/1-Gb99nDQSWnjRoFEApN_W-Q.jpeg\"><img loading=\"lazy\" decoding=\"async\" class=\"alignnone size-medium wp-image-906\" src=\"https:\/\/d3.harvard.edu\/platform-digit\/wp-content\/uploads\/sites\/2\/2015\/10\/1-Gb99nDQSWnjRoFEApN_W-Q-300x198.jpeg\" alt=\"1-Gb99nDQSWnjRoFEApN_W-Q\" width=\"300\" height=\"198\" srcset=\"https:\/\/d3.harvard.edu\/platform-digit\/wp-content\/uploads\/sites\/2\/2015\/10\/1-Gb99nDQSWnjRoFEApN_W-Q-300x198.jpeg 300w, https:\/\/d3.harvard.edu\/platform-digit\/wp-content\/uploads\/sites\/2\/2015\/10\/1-Gb99nDQSWnjRoFEApN_W-Q-600x396.jpeg 600w, https:\/\/d3.harvard.edu\/platform-digit\/wp-content\/uploads\/sites\/2\/2015\/10\/1-Gb99nDQSWnjRoFEApN_W-Q.jpeg 800w\" sizes=\"auto, (max-width: 300px) 100vw, 300px\" \/><\/a><\/p>\n<p class=\"p1\"><span class=\"s1\">So how does this relate to network effects?<span class=\"Apple-converted-space\">\u00a0 <\/span>It is in the best interests of these platforms to provide enough value for users to justify paying for a subscription.<span class=\"Apple-converted-space\">\u00a0 <\/span>They do this through two methods: offering a paid subscription as an incentive to get rid of advertisements while listening (which are annoying), and by leveraging the platform-enhancing direct network effects.<span class=\"Apple-converted-space\">\u00a0 <\/span>Spotify\u2019s smartest move was to deeply integrate Facebook into the platform, making music listening a social experience.<span class=\"Apple-converted-space\">\u00a0 <\/span>Allowing users to follow artists but also other users opened up an entire social interaction experience through playlist sharing, listening activity feeds, and more.<span class=\"Apple-converted-space\">\u00a0 <\/span>Even though the music library can be considered static beyond a certain point, the more users are on Spotify, the more valuable it is for any individual user to be on that platform.<span class=\"Apple-converted-space\">\u00a0 <\/span>High switching costs are now associated with moving to another platform, where the ability to share and experience music with others is reduced or eliminated.<\/span><\/p>\n<p class=\"p1\"><span class=\"s1\">This is also where Spotify\u2019s free tier came into play.<span class=\"Apple-converted-space\">\u00a0 <\/span>Provide the platform <i>and <\/i>the content for free, recouping some money through advertisements.<span class=\"Apple-converted-space\">\u00a0 <\/span>But gain a massive user base first (75 million total, 20 million of which are paid), gaining enough traction to be able to convince artists and record labels that their content must be present on the platform, and at a rate that makes it profitable for the technology company (even though each free tier listener is unprofitable).<span class=\"Apple-converted-space\">\u00a0 <\/span>With enough users and enough consumption, artists and labels will continue to make more and more money compared to the early post-Napster days.<span class=\"Apple-converted-space\">\u00a0 <\/span>But what they don\u2019t share is the increasing amount of money that they themselves are making on every user (on average).<span class=\"Apple-converted-space\">\u00a0 <\/span>Why shouldn\u2019t this excess money be distributed to the artists and labels instead?<span class=\"Apple-converted-space\">\u00a0 <\/span>For more on this idea, check out this fascinating article on how streaming music is ripping people off: <a href=\"https:\/\/medium.com\/cuepoint\/streaming-music-is-ripping-you-off-61dc501e7f94\"><span class=\"s2\">https:\/\/medium.com\/cuepoint\/streaming-music-is-ripping-you-off-61dc501e7f94<\/span><\/a><span class=\"Apple-converted-space\">\u00a0 <\/span>The outcome of this will likely be a change in how people pay for their streaming accounts: perhaps paying based on amount of consumption.<span class=\"Apple-converted-space\">\u00a0 <\/span>Until that time, the current model will continue to dominate.<\/span><\/p>\n<p class=\"p1\">References:<\/p>\n<p class=\"p1\"><a href=\"http:\/\/www.nielsen.com\/content\/dam\/corporate\/us\/en\/public%20factsheets\/Soundscan\/nielsen-2014-year-end-music-report-us.pdf\">http:\/\/www.nielsen.com\/content\/dam\/corporate\/us\/en\/public%20factsheets\/Soundscan\/nielsen-2014-year-end-music-report-us.pdf<\/a><\/p>\n<p class=\"p1\"><a href=\"http:\/\/www.nielsen.com\/us\/en\/insights\/news\/2015\/everyone-listens-to-music-but-how-we-listen-is-changing.html\">http:\/\/www.nielsen.com\/us\/en\/insights\/news\/2015\/everyone-listens-to-music-but-how-we-listen-is-changing.html<\/a><\/p>\n<p class=\"p1\"><a href=\"https:\/\/news.spotify.com\/us\/2015\/06\/10\/20-million-reasons-to-say-thanks\/\">https:\/\/news.spotify.com\/us\/2015\/06\/10\/20-million-reasons-to-say-thanks\/<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Spotify leveraged network effects to gain a massive user base, and amass (almost) the entirety of the world&#039;s popular music collection.  Now the company is seeking to capture value from its users, which as it turns out are the ones that pay $9.99 per month for a premium subscription.  But the incentive system between the company and its users is broken.<\/p>\n","protected":false},"author":100,"featured_media":909,"comment_status":"open","ping_status":"closed","template":"","categories":[403,398,400,402,229,401,399,59],"class_list":["post-908","hck-submission","type-hck-submission","status-publish","has-post-thumbnail","hentry","category-artist","category-direct-network-effects","category-free","category-label","category-music","category-premium","category-spotify","category-streaming"],"connected_submission_link":"https:\/\/d3.harvard.edu\/platform-digit\/assignment\/competing-with-network-effects\/","yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.3 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Spotify\u2019s Business Model \u2013 Competing With Network Effects - Digital Innovation and Transformation<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/d3.harvard.edu\/platform-digit\/submission\/spotifys-business-model-competing-with-network-effects\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Spotify\u2019s Business Model \u2013 Competing With Network Effects - Digital Innovation and Transformation\" \/>\n<meta property=\"og:description\" content=\"Spotify leveraged network effects to gain a massive user base, and amass (almost) the entirety of the world&#039;s popular music collection. 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