(Bloomberg Businessweek) -- Spotify Technology SA wants to be the next Netflix Inc. Both are pioneers in getting people to pay for a digital entertainment buffet—Spotify’s chief financial officer even had the same job at Netflix. During an investment pitch earlier this month, Spotify executives name-checked their idol so frequently, it felt as if Netflix were the one going public.
However much Spotify resembles Netflix in spirit and business approach, the services diverge in a way that makes Spotify’s path to profit significantly trickier. The video streaming company’s programming expenses don’t rise as it lures more subscribers. But as Spotify gets bigger, its streaming music costs increase; it can’t grow its way to profitability. Spotify’s product—35 million songs—costs the company more as more people sign up. Its contracts with music companies are confidential, but generally the business pays the owners of song rights a fee for each paying user or a percentage of company revenue.
In some cases, the royalties it pays decline as it signs up more subscribers or reaches other milestones, according to company disclosures. Spotify also says it pays a lower rate per user from student and family subscriptions. All of this makes it tough to know when the company might reverse years of operating losses. (Spotify, however, did end last year with more cash on hand than it started with.) A representative for Spotify declined to comment, citing regulatory restrictions ahead of its market listing.
Spotify can’t challenge the royalties paradigm, because it’s at the mercy of a few power brokers who control popular music. The three major record labels—Sony Music Entertainment, Universal Music Group, and Warner Music Group—and a consortium of independents hold the rights to almost 9 out of every 10 songs streamed on Spotify. Walt Disney Co. could yank its movies from Netflix, and it wouldn’t be a death blow. One major record label pulling out of Spotify could be devastating.
Company executives have said that increasing its subscriber numbers will improve its economics. “Scale” is their magic word. But Spotify knows it can’t rely only on subscriptions. That’s why, at the end of its three-hour investor pitch, its top finance officer—Barry McCarthy, the one who worked at Netflix—made it clear that expectations for an improving profit margin were predicated on developing other revenue sources, such as selling advertising to promoters hunting for fans or music-listening data to record labels and concert promoters. The company has already managed to negotiate a decrease in the fees it pays, and its gross profit margin improved last year as a result.
The service and its suppliers know they can’t live without each other, and that could help Spotify lower costs even further. The company could take a cue from Netflix and bypass the music labels by signing up musicians directly. But this is an area where Spotify resists the Netflix analogy for fear of panicking the labels, says Mark Mulligan, a media and technology analyst with Midia Research.
So Spotify wants to be compared to Netflix, except when it doesn’t. Mostly, the comparison doesn’t hold up.Shira Ovide is a columnist for Bloomberg Gadfly.
https://open.spotify.com/user/3uix1aingq7hlmcowe7jmn1s9/playlist/6f7BMsgYRKMfcrWHAn1pX9
To contact the author of this story: Shira Ovide in New York at sovide@bloomberg.net.
To contact the editor responsible for this story: Bret Begun at bbegun@bloomberg.net.
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