The race for the music streaming market can only have one winner

“Upon the Athenian victory over the Persians at the battleground of Marathon, the young runner Pheidippides was sent to deliver the news of success back home in Athens. His journey was a gruelling one that lasted 26 miles. After he finally delivered his message, Pheidippides fell to the ground and passed up to the heavens, having earned his place in history as the ultimate conqueror of endurance.”

The ability to outlast your competition is a core principle in business strategy, particularly in technology. This post sets out to analyse Spotify, a company which is playing one of the longest games of all. While their opponents seem mighty, should Spotify reach the finish line, it’s likely they will be the only company to do so.

As the millennium turned, the consolidated and comfortable music industry was deeply involved in a war with the Internet that had already lasted over a decade. Copyright ownership of backlogged songs had always been the jewel in the crown for the major record labels, and the Internet’s unleashing of peer-to-peer sharing and illegal downloading was aggressively chipping away at this profitable edifice.

Having ridden the early internet wave and made enough money to retire by the end of his teens, Swedish entrepreneur Daniel Ek watched the music industry unravel from the side lines. In 2002, he saw the demise of popular but undoubtedly illegal music service Napster, only to watch the insatiable internet community quickly replace it with another service, Kazaa. It was at this point he saw an opportunity, realising that while laws can help fight against these issues, “you can never legislate away from piracy”. While Ek contemplated how the future of the industry would likely look like given this advent in internet connectivity, many of the established technology giants were already jostling to win using the old rules of the game.

None were more prolific than Apple Inc., who released their premier portable music player and accompanying software in 2001. Within less than a year, the iPod and iTunes had taken the world by storm. Each new variant of iPod sold rapidly, and who could forget the cultural phenomenon of the iPod’s original music adverts? The result for the company was a new market from which they could extract sizeable short-term and long-term revenue. Not only did Apple have a new piece of hardware which they could sell the West’s wealthiest consumers, they could also secure recurring purchases through sales of individual song downloads — at $0.99 a pop!

The success Apple saw with iPod and iTunes cannot be understated when looking at what pathed the way for Ek’s company to come onto the scene. From the music perspective, the release of the first iPhone in 2007 presented a clear opportunity: the new computing power, combined with the dawning of 3G, could easily support listening to music over the internet, without the need for download. This was the future, and Apple had all the necessary components to own it. But the company had, understandably, become addicted to the revenue of its previous successes in the sector. What executive with their head seemingly screwed on would look at Apple’s market-leading music products and conclude that building an entirely new service predicated on streaming rather than owning songs, would be the path forward?

Founder Daniel Ek photographed at the time of Spotify’s direct listing at the start of 2018

And so while Apple continued to build out their iTunes ecosystem, Ek teamed up with fellow Swedish techy Martin Lorentzon to “create a service that was better than piracy and at the same time compensates the music industry”. The concept of streaming was revolutionary to many, and provided a much better user experience than anything iTunes or any other local download service could offer. Suddenly, the average consumer could play any song they wanted, at the touch of a button, without the need to pay for the privilege by ‘owning’ the download. Slowly but surely, Ek’s company started calling into question the rationality of downloading songs, and consumers soon started to listen.

But if the aim of the game was no longer to provide users with the best way to download music, what was it? Ek already had his answer: With song ownership being quickly commoditised by the Internet, the real territory for achieving success was in the user experience. And, as with many tech platforms disrupting old industries, the first part of the value chain to unbundle and improve was in discovery. With users now able to access any backlogged song at any time, choice paralysis would be inevitable. Not only that, the competition from record labels to win consumer attention to listen to newly released tracks would also become vastly more intense. By placing Spotify at the centre of this consumer transaction, its value compared to other music providers — particularly those asking users to pay for songs individually — would be stark. Even the company’s name, Ek reasoned, would point to music discovery as the company’s crux, hence his choice to abbreviate two words which pointed directly at this problem: “Spot” and “Identify”.

And so while Apple chipped away at perfecting iTunes, consumer expectations about music services began changing altogether. Upstart streaming services became wildly popular, and suddenly the technology giants took notice. Feeling the need to compete on similar terms, Apple zeroed in on Jimmy Iovine and Dr Dre’s new streaming service Beats Music, which they had launched in 2012 to compete directly with Spotify by “using technology to provide personalised listening recommendations”. In 2012, Apple acquired the founders’ parent company, Beats Electronics, for £3 billion. While much of the press focused on the Apple’s new hardware opportunity in selling Beats Headphones, the real strategic play was in purchasing the assets of Beats Music, which Apple shut down the following year and replaced with its own steaming service: Apple Music. Amazon and Google launched their own music streaming services soon after. The game of catch up was in full force, and Spotify finally had the competition which had been lacking since Ek had first founded his company some 7 years prior.

Jimmy Iovine and Dr Dre celebrate their company’s acquisition with Apple’s Tim Cook and Eddy Cue

With this context in mind, Spotify’s strategy has long since been to build a music streaming service that offers the ultimate user experience and is thus non-replicable, even by companies wielding much deeper pockets. The longer Spotify can keep its place as the #1 streaming service, the likelier they are to gain more data, improve their algorithms, and thus attract future paying users. This is why Spotify has consistently positioned itself as the streaming service that is available everywhere:

  1. Its ad-supported offering is far more accessible and feature-filled that other providers
  2. Its social sharing options are integrated into almost every social network and messaging platform going
  3. It is usable on any device belonging to any brand, whether that be mobile, computer, tablet or voice assistant

The pursuit of this virtuous cycle is the ultimate strategy of aggregation. And the longer Spotify is able to employ this strategy, the deeper their competitive moat becomes.

Nonetheless, Spotify will need to conquer a feat of endurance if it is to reach this virtuous finish line. The initial enemy it will need to conquer is its first: the major record companies. In a situation in which one party in a given market owns the rights to all assets of historic value, and another party seeks to leverage those assets for their own future growth, it doesn’t take a strategic genius to predict who will come out on top. For Spotify, this manifested into signing deals with the record companies in which the former pays the latter a fixed fee for every stream — sometimes around 70% of total revenue. As Spotify’s investors have pointed out, this defines the company as one whose marginal costs must increase in line with additional revenue; hardly the most attractive of propositions, particularly compared to other ‘similar’ technology businesses where the cost of distributing any additional digital good is essentially zero.

Second, the company is now set to compete fiercely against almost all the technology giants, who will continue to use their huge cash reserves and talent stacks to fund the development and expansion of their own streaming services. One chip on Spotify’s shoulder will be that none of these behemoth competitors rely on music streaming for core revenue or as their way of being accountable to the public markets. This means they can play a longer game than most, and, if necessary, out-compete Spotify by simply outlasting them. Worse still for Spotify, these titans can leverage their default positions on their respective platforms — particularly Apple’s iOS — to promote their own streaming services as egregiously as they like, with no additional advertising costs.

That said, if their competitors’ access to capital is their one of their biggest assets in the technology market generally, then it is their breadth of targets to aim at that could be their downfall when it comes to the music streaming market specifically. Indeed, a closer look at the strategies underlying these companies’ streaming services exposes some confused narratives:

  1. Apple Music: Originally viewed by analysts as a means of driving sales of hardware (i.e. HomePod), now viewed as an important tenant of Apple’s so-called ‘Services Narrative
  2. Amazon Music: likely used as a means of acquiring customers to the wider Prime subscription universe, in order to drive future purchases on core shopping platform
  3. YouTube / Google Play Music: The fact that Alphabet only recently ceased hosting two independent (and competing) music streaming services should be enough to prove strategic confusion

The employees of these titans will continuously battle internally to define the strategy of their music streaming services, as well as where music streaming fits into their wider corporate vision which spans multiple largely unrelated verticals. All the while, Spotify can focus on executing on their point of differentiation: delivering a superior user experience and feeding their virtuous cycle.

U.S. market share of music streaming services (end of 2018)

The competition for the race to win the music streaming race is undoubtedly heating up: Apple has doubled down on its services narrative with Music as a core driver; Alphabet is under pressure to make YouTube a profitable stand-alone business; and Amazon is constantly looking for new ways to expand the Prime ecosystem. Even so, Spotify looks ready to face its adversaries head on. Not only did it finish 2018 as the world’s most popular streaming service with 96 million paying subscribers (up by 25m YoY), it also posted its first ever quarterly operating profit of €94m, and even announced two major acquisitions in the podcasting space. These results point towards a company that is winning incremental battles, even while the war is still raging. While this doesn’t signal the end of their Marathon, these initial victories will certainly be music to Ek’s ears.