SPOTIFY. An Analysis of Spotify s Market Strategies

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1 SPOTIFY An Analysis of Spotify s Market Strategies

2 Spotify AN ANALYSIS OF SPOTIFY S STRATEGY Spotify is a Swedish online music streaming service that was launched in Since, its launch Spotify has had a meteoric rise and currently boasts a library of around 15 million music tracks and about 20 million users. Though Spotify still lags behind Pandora, the market leader, it is interesting to understand how Spotify managed to succeed in the competitive music streaming industry. The following report will start off by giving a brief overview of the music industry, Spotify s features and the competition Spotify faces. We will then analyze how Spotify managed to succeed in the competitive music streaming industry. Finally, we will discuss the risks Spotify faces and future strategies it could undertake in continuing its success in the online music streaming industry. DIGITAL MUSIC INDUSTRY The digital music industry can be divided into two submarkets: the streaming market with numerous competitors and the digital download market dominated by itunes and Amazon. Digital music industry revenues have grown by 8% in 2011 reaching a valuation of $5.2 billion. Currently the streaming market only generates 10% of digital music industry revenue but the growth rate of this market is greater than the growth rate of the download market. Competition within the streaming industry is very strong as many companies operate in this market with similar business models. Companies differentiate from one another with variations in packaging, licensed music libraries, regions of operation, and features. Switching costs are quite high for customers as there is limited compatibility and transfer possible between streaming services. Moreover, streaming companies are trying to create network effects among their services by including social components. Several services allow people to follow what their friends are listening to and also allow users to create collaborative playlists. This network effect can attract more customers to a service as it adds value to the product. Record labels are natural and essential partners for streaming companies and thus the market has strong indirect network effects. Content availability is fundamental to attracting customers: the larger the music library, the more the streaming service is likely to become popular. The streaming industry is thus as a two-sided market: companies must be able to create a virtuous circle between record labels and customers. The more users and subscribers a service has, the more record labels will want to have their music available on those services and subsequently, a greater number of customers will be attracted by the large library available. Though obtaining streaming rights to a large library is a key factor in the success of a streaming service, differentiating their product by implementing different features remains a primary tactic in gaining market share. Page 1

3 COMPETITION AND FEATURES Spotify is a music streaming service started in Sweden that offers DRM streaming of licensed music. Spotify currently has more than 18 million users, up from 10 million users after their United States launch. The service requires users to have a Facebook account to use and is split into 3 different product categories: Free, Unlimited, and Premium. Free users are trial periods given to initial registrants for 6 months for them to evaluate the service, after which they restrict music listening to 10 hours per month. Unlimited users are able to stream music without advertisements or restrictions as well as listen to music offline, but only on their computers. The Premium service extends the Unlimited service to mobile devices such as ipods and Smartphones. Users have the ability to see what their friends are listening to via Facebook integration and are able to generate collaborative playlists with them as well. Users are able to set up radio stations where based on their music libraries, Spotify finds songs that it thinks users would most enjoy. Spotify has no standard web-interface but requires users to download a Spotify application to their computers/devices. Currently Spotify is available in US, UK, Sweden, Austria, Belgium, Finland, Norway, Spain, France, Germany, and Denmark. While physical music product markets are deteriorating rapidly, online digital music markets are becoming ever more congested and competitive. Over a dozen large internet music companies across the world are competing for market takeover while hundreds of smaller companies are attempting to become major players in the industry. One thing every company has in common is their segmented region support and fragmented music licenses which is something that Spotify is trying to overcome with their recent launch in the United States and continued support in the many European countries. The easy adaptation of features by other companies makes it difficult for competing firms to strongly differentiate from one another. For example Grooveshark gives users the ability to upload their songs and create their playlists from their existing libraries when Spotify replicated this mechanic for songs that it had licences to. While Spotify has had fast growth in paid subscriptions and total users, Pandora sits comfortably as the king of the hill recently hitting 125 million users in January 2012 up from 100 million just 6 months prior despite being a service only available in the United States and whose primary source of revenue is advertisements from free users who account for roughly 98% of all users and 87% of annual revenue. Spotify s response to Pandora is to have radio stations with unlimited skips that also aims to find music that users would enjoy as well as listen to any of those songs on demand all offered at very similar pricing. Spotify is attempting to differentiate themselves from other companies by having Facebook integration and incorporating social interaction with music via playlist sharing. No other internet music companies require a Facebook account so this tactic is a double-edged sword for Spotify as it brings with it all of the benefits of social media incorporation but the disadvantages of shutting out any users without Facebook accounts. One of the advantages that Pandora, Grooveshark, Deezer, and Rhapsody have is that no social media accounts are required for their use and makes them popular with older demographics. Additionally, services like Pandora, Deezer, and Grooveshark do not sell songs directly from their sites but redirect their users to itunes or Amazon for purchases. But Spotify has incorporated the ability to purchase these songs from their partnered company, 7digital, directly from their program following in the footsteps of Rhapsody. Spotify s premium service is very similar to Rhapsody because users are able to listen to their music offline without purchasing the songs and both employ their own DRM s to ensure Page 2

4 security of the songs. While the consumer market demand is differentiated in products, the ease with which features are copied makes region support and music library licensing more effective in gaining market share. ANALYSING SPOTIFY S STRATEGIES As discussed in the Music Industry section, Spotify has a two-sided market to deal with on one side there are the consumers and on the other, the music providers. At its outset, Spotify thus had to solve the coordination problem in this two sided market. A streaming platform without a sizeable amount of quality music would be of little use to consumers. Spotify thus attempted to solve the coordination problem by subsidizing music labels and artists by providing them lucrative contracts to provide their music on Spotify. Once, music labels and artists started providing music on Spotify, Spotify started attracting consumers to the platform. Spotify aimed to collect revenue from the consumers by charging them with a subscription fee for listening to music on Spotify. However, before users subscribed to the new streaming platform, Spotify had to allow users to get a chance to experience Spotify and get locked in to the service. Hence, a limited free version of the service was provided along with the unlimited subscription based version. Spotify s attempt to solve this coordination problem brought on board music labels such as Sony Music, EMI, Universal Music Group, Warner Music, Merlin and The Orchard. These labels and smaller artists have added more than 15 million tracks to Spotify. The huge collection of music on this rather easy-to-use platform attracted more than 18 million users and has led to about 3 million subscriptions a conversion rate of about 1 subscription for every 6 users. Thus, by subsidizing music labels and artists Spotify brought a large quantity of quality music to its easy-to-use platform and managed to solve the coordination problem in its two-sided market. Having solved the coordination problem in its two-sided market, Spotify worked on maximizing its profits in the online music streaming industry. Spotify s strategies seem to suggest that the company has been carefully versioning and bundling their product to maximize profits. Spotify initially provided only its Free version along with a Premium version. The Free version, allowed 10 hours of free music streaming a month for new users. It basically served as a means to attract new subscriptions. The Premium version, provided users with unlimited music streaming on computers and portable devices. The Premium version could be seen as a bundled product that tried to clump the computer-based users and the portable devices-based users together. However, in 2010 Spotify introduced another version the Unlimited version, which provided the same features as the Premium version but only on computers. Spotify thus introduced a mixed bundling approach where it not only provided a bundled Premium version but also a pure Unlimited version. Interestingly, Spotify did not introduce a pure version targeting the market segment only interested in Spotify on portable devices. Spotify has thus been carefully identifying various market segments and providing a mix of bundled as well as pure products in an attempt to increase profits. Spotify has also been attempting to increase its revenue by attracting new customers currently locked in to its competitors products. It has been attempting to do this by reducing the cost of switching to Spotify and increasing the value of its own product. Spotify has been reducing the cost of switching from its competitors product by providing applications that imitate the working of its competitors key features. For example, Spotify introduced a Radio application to closely mimic a key feature of its main competitor, Pandora. The Radio application Page 3

5 generates a random playlist of songs for a user based on an entered preference for an artist or genre. This feature is similar to the working of Pandora that generates random stations for a user to listen to based on an entered preference for an artist or genre. By providing features similar to those found in its competitors Spotify has made it easier for users to switch to Spotify. Spotify has also reduced switching costs for users by developing robust Spotify applications for various platforms ios, Android, Windows. There is a variety of online music streaming users. Some users use the ios platform on all their devices, some use Windows or Android and others use a mixture of the operating systems for their devices. If Spotify had developed applications for only some of these operating systems, users on other operating systems would face huge switching costs in adopting Spotify. By developing robust applications for most operating systems, we believe Spotify has greatly reduced the cost of switching for potential users and has thus made the product more attractive. These attempts at reducing switching costs have made it easier for Spotify to make inroads into its competitors market share and increase its profits. Spotify significantly increased its user and subscription base when it signed an agreement with Facebook to make it compulsory for anyone trying to access Spotify to have a Facebook account. Though this move may have cause Spotify to sideline some potential users who did not have Facebook accounts, it proved highly beneficial in some other aspects. Tying up with Facebook, added a direct network to the usage of Spotify to make the product more valuable. The direct network effect added to Spotify can be interpreted as follows. Spotify users can now create playlists and share it with their friends on Facebook. With a greater number of users on Spotify, there would thus be a greater utility for the users of Spotify as it allows them to access more playlists. A direct network effect has thus been added to the usage of Spotify, making it more valuable to users. When this valuable product was brought to the notice of Facebook s 900 million strong user base, usage and subscriptions of Spotify sky-rocketed. Initial estimates showed that around 250,000 users were added to Spotify every day, for a few days following the deal. After solving its coordination problem, Spotify has carefully worked on versioning its product, reducing switching costs involved in using its product and making its product more valuable through integration with social media. We believe these sound strategies allowed Spotify to rise quickly to become an important player in the online music streaming industry. However, Spotify should not become complacent. It must keep formulating new strategies in order to consolidate and possibly even expand its strong position in the market. RISKS AND WEAKNESSES Spotify s business model consists of a few risks: copyrights, privacy, and hacking. First, Spotify lacks strict and explicit copyright policies. Although Spotify has a stable and innovative model, because it does not hold a clear intellectual property on its structure and contents, it is difficult for Spotify to keep its competitors from copying their business and operation model. Therefore, this risk prevents Spotify from keeping its competitive advantage in the market as it allow for more competitors to enter the market with low innovation cost. Furthermore, because this music streaming industry (excluding music contents) does not demand high product variety, this is a crucial risk that threatens Spotify s success. Second, when Spotify introduced its new Facebook integration feature, it has also brought about privacy issues. While Facebook integration is a feature that distinguishes Spotify from other music streaming businesses, it also makes Spotify face the same problem Facebook experiences: user privacy. Page 4

6 Facebook integration allowed Spotify to take advantage of network effects that Facebook already possesses, but this also caused any Facebook friend of a user to be able to monitor his/her music taste. Although there are customization features that address this problem, it is hard for the users to manage this well as there are many problems with Facebook privacy model itself. Lastly, as number of user increases, there is risk of negative externality. As Spotify becomes more popular, there are several attempts for the hackers to spread viruses through Spotify. What makes Spotify a target over other streaming services is that they deter their bandwidth costs by employing peer-to-peer uploads. While this vulnerability to hacking is a minor problem for other popular web based business without peer-to-peer connections, and in case of Spotify it spreads with a click of the play button. Spotify administrators should work hard on this in order to preserve its reputation and customers or decide to disable peer-to-peer supplemented bandwidth. In spite of all of these weaknesses and threats, Spotify is a growing business that many investors are looking into. With wider adoption of smartphone, Spotify's market seems as though it will enlarge significantly. Especially with its offline feature with premium purchase, Spotify's attractive model of "mp3 at hand" with virtually endless amount of contents will allow more users to utilize its services. Some independent investors predict that the user pool of Spotify will even surpass itunes in 2 years with static growth of the industry. While this prediction seems excessive as music streaming industry has a great room for innovation, such opinion captures a good essence of expected growth in Spotify's business with high network effect (especially through Facebook) and superior quality (smartphone application function as described above). FUTURE STRATEGIES Spotify has multiple options for future strategies. It can improve its like-based radio stations, partner with other distribution channels, leverage its network effects, and open up its services. It should continue to use its current successful strategies such as bundling and lowering switching costs from competitors. One of Spotify s main competitors is Pandora. Spotify has introduced a like-based radio station similar to Pandora s however Spotify s algorithms are not of the same quality. One possible strategy for improving Spotify s algorithms may be crowdsourcing; Spotify can offer a bounty to whoever develops a more efficient algorithm just like Netflix did for its own algorithms. This allows Spotify to improve its services while not having to use its own resources (other than money). Another option for Spotify is to partner with other distribution channels. A large amount of music is listened to in the car; Spotify could partner with car companies to develop a Sirius radio type Spotify service that streams a user s personalized library to their car. Spotify can also join a party competing in the war for the living room by partnering to add its service to their device. Spotify has begun to do this in Europe, partnering with Sonos to allow premium subscribers to stream songs in any room of their home through Sonos MultiRoom Music System and offering a similar service with Telia in Finland allowing customers to use Spotify through their TV set. Another possible, yet perhaps more risky strategy is to open the platform beyond Facebook. Some potential users do not use Facebook as they may be concerned with privacy issues or just not value the service and therefore will not use Spotify. Facebook should still be a big part of Spotify as it serves their application to a large network of people. Spotify may also want to consider opening its mobile services Page 5

7 to all users. Being unable to use Spotify on mobile devices without paying for the premium service allows competitors with free mobile applications, such as Pandora, to have a substantial advantage. As more and more people rely on their all-in-one mobile devices Spotify is missing out on potential customers. These strategies may be risky as it is difficult to forecast the change in total users and premium users should Spotify adopt these strategies. By pursuing these strategies Spotify should be able to increase its user base and network. This will lead to more artists and producers wanting their content on Spotify and allow Spotify to expand its catalogue which in turn will attract more users. Pursuing these indirect network effects is another strategy which Spotify should keep in mind when considering what to do next in this two sided market. CONCLUSION Digital streaming is a rapidly growing industry. The industry has many players and competition is fierce. Factors such as network effects and two-sided markets make the fight to get the most users of instrumental importance. Spotify should continue to capitalize on the network it has built with Facebook and other advantages that are difficult for its competitors to adapt to. Spotify has shown itself capable of being an industry leader in its solution to the coordination problem and its ability to attract new users. But does have several risks it must watch out for such as hacking and privacy concerns. Spotify, like its competitors, must continue to innovate and use proper strategy to stay in the market. As it stands now Spotify is in a very competitive position in the industry and looks to remain successful in the future. Page 6

8 APPENDIX A.1 Page 7

9 APPENDIX A.2 Page 8

10 APPENDIX B.1 Page 9

11 APPENDIX B.2 Page 10