Not becoming an artist might have been one of my smarter choices!

A Game Of Songs. The Music Streaming Challenge

A tale of the music industry’s ongoing struggle for power on the internet.

Streaming is coming.

Recently, Spotify celebrated 50 million subscribers. Overall, more than 100 million people pay for a music on-demand streaming subscription globally. Most tech giants have entered the market by now. Based on this, you might assume that music streaming is a lucrative business. You are not mistaken. But the streaming services aren’t the ones making all the profit. That price goes to someone who, according to common tech industry believe, should have long been written off — and surpassed by a disruptive company from their own ranks.

This someone is, of course, the traditional music industry and, in particular, the major labels. Once upon a time everybody believed they were doomed. It was almost a foregone conclusion that they were going to be the first major industry disrupted by the internet. In reality, however, the labels bounced back since these early days when Napster and peer-to-peer filesharing appeared to be threatening them existentially. In an almost ironic twist of history, you might even argue that music labels today are in the best position of all traditional media companies.

How we got there is a fascinating story. One that contains valuable lessons about innovation, market dynamics and disruption. So, let’s set the stage and introduce the main actors in this nice little drama.


The Contenders

Let’s start with the contenders. That is, the current breed of companies which set out to challenge the music industry’s status-quo: on-demand music streaming services. While there is a long list of such services, only a few deserve being mentioned when talking about contenders for the music industry’s throne.

  • Spotify as The Apparent Heir
  • Apple Music as The Weahlthy Challenger (also known as The Disinherited Successor among the elders)
  • Google Play Music & YouTube (which might end up as one service; both teams have recently been combined) as The Freebie Merchant
  • Amazon as The Great Unknown
  • Deezer as The Local Hero
  • Soundcloud as The Charming Outsider
  • Tidal as The Black Sheep

That’s the list of (somewhat) serious contenders.*


The Incumbents

Please stand up to welcome the reigning kings of the music industry. Object of their henchmen’s open disdain and aspiration simultaneously. Their relationship with the populace follows a similar pattern. The cast:

  • Universal Music Group
  • Warner Music Group
  • Sony BMG

as The Major Labels aka The Big Three.

While they are competitors, always struggling to increase their influence (market share), we will treat them as a united group for most of this story. Also note that there once used to be as many as five kings during the tale’s early chapters. Later, several of them joined lands — first when BMG was acquired by Sony in 2008 and, later, EMI by Universal in 2012 — in order to extend their kingdom. That’s why you will sometimes find references to The Big Five/Four instead of Three.


A Brief History of the Music Wars in 5 Acts

In order to understand our present-day, it’s often useful to know thy history. After all, the present is the result of the accumulated decisions made in the past. Thus, let’s take a look at the history of digital music and make sure we have the important facts right.


Act #1: Napster & Co Attack

In 1999, Napster launched. The file sharing service, founded by Sean Parker and Shawn Fanning, rose to fame quickly among users and record labels alike (although the latter certainly considered it infamous). The service allowed users to share their music files. It was a virtual swap meet for music if you will. No money was exchanged. For a brief period, music on the internet appeared to be limitless and free. The Big Four weren’t amused.

Internet users had already been exchanging files earlier. But they had to use things like ftp servers, IRC or other prehistoric chat software. Napster’s combination of an easy-to-use software and peer-to-peer technology made file sharing convenient for the first time. As a result, Napster grew incredibly fast. While some other services like Audiogalaxy where also founded around the same time, none came even close to achieving Napster’s relevance or size.


Act #2: Legal Battle

Initially, the record labels and Napster engaged in talks to discuss possible partnerships. To no avail. In this excellent oral history of Napster, Elizabeth Brooks, then the service’s vice president of marketing, points to the labels’ fear of scaring off retailers as a major reason for the negotiations’ collapse. That’s likely a biased perspective. The fact that Napster didn’t have a business model in place — or, frankly, no clue how it wanted to turn a profit — certainly contributed as well.

Consequently, it took the RIAA (Recording Industry Association of America) only until December 1999 to file a lawsuit. At first, this primarily contributed to Napster’s increasing popularity (and to the public’s disdain of the reigning throne holders). The debate about its legality and pros and cons took center stage — not only in the industry but also among artists and fans.

One particular testament of the thinking at the time is the famous debate between Metallica drummer Lars Ulrich and Chuck D on Charlie Rose:

But even Public Enemy’s support couldn’t save Napster. The scoundrel had gone to far and the reigning kings wanted to let the world know. An example had to be made! While Napster initially managed to wriggle out of the situation, that was only a temporary victory. The industry stood united (for the most part; one German dude broke rank) and brought the big guns in.

Napster’s fate was eventually sealed on March 5, 2001. On that day the Ninth Circuit Court ordered the company to take down all copyright infringing material. While that didn’t lead to a shutdown immediately, it did seal the service’s demise. Eventually, the once fastest-growing internet service was shut down on July 1, 2001 (we’ll ignore the later, re-opened versions as they, frankly, didn’t matter anymore).

The big four celebrated their victory. Nonetheless, recorded music sales continued to plummet. Napster’s end gave rise to a new breed of (mostly shady, to say the least) peer-to-peer file sharing services like Gnutella, eDonkey or Kazaa. There, user’s continued to download and share music. The rulers of music fought the people mercilessly but it was a tilt at windmills.


Act #3: Steve Jobs to the Rescue

Then, a knight in a black turtleneck appeared. He went by the name of Steve Jobs. The promise he made to the kings: He would free digital music distribution from its stigma and finally turn it into a viable business. The chronicler likes to remind you at that point, that the big four heretofore regarded the internet as a risk to their business first and foremost.¹

In an interview with Esquire, Jobs described the relationship between music and tech companies at the time when he first approached the labels as follows: “There was certainly a war declared between the music companies and the technology companies.” Despite that war, Jobs still managed to convince all four major labels to participate in ‘Operation iTunes’. A feat just short of a miracle. Apple, Jobs’ guild, launched iTunes in April 2003. Including music from all the labels.

It’s easy to forget these days but the iTunes Music Store was a tremendous success at the time. Initially not welcomed with much fanfare by commentators and analysts, the doubters were soon proven wrong. They had underestimated what superb usability and the mere fact that the service was legal added up to, in terms of users’ willingness-to-pay.

As promised, Jobs had single-handedly turned digital music into a sizable market. By 2010, Apple had become the world’s largest music retailer. Apple’s ascent had begun. But for the major labels, the iTunes revenue was merely a drop in the bucket. Their core business continued to shrink, while Apple’s grew — both due to the existence of (unbundled!) songs for 99 cents a piece.

In classical drama structure, the third act represents the story’s climax. In this piece, however, it’s different. One man’s meat is another man’s poison.


Act #4: The Advent of the New Challengers

In 2008, Spotify launched. At first in the company’s home market Sweden as well as the other Scandinavian countries, France, Spain and the UK. Other countries followed successively (with Japan being the latest addition in 2016). Spotify hadn’t been the first company venturing into music streaming. Services like last.fm and Pandora pioneered that category in the early-to-mid 2000s. However, Spotify emerged as the category-defining product.

Its most important distinction: Spotify was the first service to offer on-demand music streaming in the cloud-&-mobile era — as opposed to the radio-like approach of the early services. And the company had managed to cut deals with all the major labels from the get go. That certainly qualifies as a feat (though there had been the Rhapsody precedent, though way to early). Daniel Ek and Martin Lorentzon, Spotify’s founders, deserve respect for having pulled it off. At the same time, the label’s had a very real interest in making something like Spotify happen.

Consider the following: It’s year one after the iPhone launched. Nobody could foresee how successful a product it would eventually become but it was pretty clear by then that smartphones were a thing. 2008 was also the year iTunes overtook Walmart as the US’ leading music retailer.

Apple was on the path to become a dominant force in the Game Of Songs. They owned the most relevant distribution platform as well as the most popular device for consuming digital audio at the time, the iPod. And while it was a highly profitable business for Apple, the labels were still facing a decline of their overall business. Which is to say: The danger of being dependent on the tech firm must have seemed very real. From the labels’ perspective, some competition was highly welcome.

Thus, they allowed the Swedish startup to happen. But not without making sure to dictate the terms (and receive a fair chunk of equity). Terms which, as we will see, present the biggest barrier that stands between streaming services and profitability to this date. The minutiae of the deal structure became public when The Verge published the contract Sony Music and Spotify had struck right before the service entered the US market. Advanced payments and Minimum Revenue Guarantees (MRG) in conjunction with Most Favored Nation clauses — which in the case of Sony’s contract essentially stated it could bill Spotify additional money in case another label managed to negotiate a better deal — were the levers the labels used to cinch their power.

As music industry analyst Mark Mulligan put it when talking about advanced payments:

this is the major record label’s streaming reality distortion field. They get streaming revenue regardless of how well the marketplace actually performs.

In its early years, on-demand music streaming was regarded as somewhat of an obscurity. It didn’t create significant revenue, was considered as hard to pull of because of the label’s dominant position — after all they own the music catalogue — and it wasn’t clear that a large enough number of fans was willing to subscribe. Still, a bunch of other startups attempted to enter the developing market. Many of them, for instance Simfy, Rdio or Grooveshark, had to give up (or sell) in the meantime.

The lesson here: Thanks to the economics of the business and the market’s structure, a company needs to be extremely well funded in order to stand a chance. It has to pay the labels and finance rapid user acquisition at the same time. After all, streaming can only be profitable at scale. Also, it’s a market with winner-takes-all dynamics.³

All those challenges notwithstanding, it was pretty evident by 2013 that streaming would be the music industry’s future. Ten years after iTunes had launched, it saw the song download number drop for the first time (by 5.7%), a development that would continue and even accelerate the following year. At the same time, 2014 was the year when Spotify subscriber growth reached new heights at roughly 66% year-over-year.

The realization that users apparently really liked the model didn’t go unnoticed by the big tech companies. Since the underlying economics favored companies able to finance the necessary upfront investment, it’s little surprising they joined the class of aspiring usurpers.

Google moved first when it launched Play Music in May 2013 (that is, if we ignore YouTube which effectively is the world’s biggest music streaming service and even predates Spotify). Apple, whose iTunes was hurting, moved next when it acquired Beats Music & Beats Electronics in May 2014, which it eventually turned into Apple Music in June 2015. Amazon, meanwhile, started its (comparably limited) Prime Music service as a part of the Prime bundle in June 2014 — before rolling out its full-fledged Amazon Music Unlimited service in October 2016.

Other notable parties hoping to play a leading role in the Game Of Songs one day are: Soundcloud, the Berlin-based social streaming network that is highly popular among DJs and hardcore music fans but had to raise $70 million in debt funding recently, Deezer, the French streaming service with its “local champion” strategy that raised $109 million in January 2016 to finance its US market entry, and Tidal, the Jay-Z-backed service which positions itself as the quality solution with high profile exclusives and which recently sold a 33% stake to Sprint for a reported $200 million (but only made headlines with alleged scandals, lawsuits, and executive firings since).


Act #5: A Delicate Balancing Act

Where we stand today

2016 had been quite a year for streaming. All services combined crossed the 100 million subscribers milestone. According to Nielsen data, from its 2016 U.S. Music Year End report, on-demand audio streams grew 76% year-over-year in the United States. In absolute numbers this amounts to 250 billion audio streams. Add to this another 180 billion music video streams and this renders streaming the dominant way how people consume music (at a 38% consumption share).

source: Nielsen

In terms of popcultural significance, the format also managed to yield its first Grammy winner: Chance The Rapper’s streaming-only album Coloring Book promptly won the important award right after such releases were made eligible.

For the labels, streaming has turned into a significant source of revenue in their recorded music branches. I looked at the big three’s Q4 2016 figures to find out how much streaming revenue contributed to their overall recorded music revenue:

While the exact percentages likely fluctuate quarter-to-quarter (as these numbers from MIDiA Research suggest, according to which Universal had the highest streaming market share in 2016), the general tendency is clear: Streaming is responsible for more than a third of the labels’ overall recorded music revenue.

However, if you now assume that our class of contenders must be on a path to success, hold your thought. While user and subscriber numbers grow along with revenue, profitability is still a stretch goal for any streaming service. The main reason for this: the aforementioned contract structure and advanced payments in particular.

The Major Labels’ Thinking

Let’s take a step back. It is fair to allege the labels looked at the history of digital music — and online media in general — and made three core assumptions:

  1. The internet is massively dangerous for incumbent media businesses, so we need to be wary towards any innovation and new company.
  2. The most important assets in music are the catalogues we own. We need to protect them by all means and make sure to be very selective & careful about the terms when opening it for third parties.
  3. Having a dominant player in music other than us — as we had to temporarily endure during the iTunes era— s*cks. It’s dangerous to our business and must be avoided by all means.

They acted accordingly and managed to remain in a pretty strong position indeed. All the moves of the past years indicate that the optimal streaming scenario from the major labels’ perspective looks somewhat like this:

That tranlates to: A bunch of streaming services which are hardly differentiated, each has a decent, none a dominant market share and all are reliant upon the labels’ catalogues (and goodwill). Optimal conditions for the reigning major labels indeed.

However, reality doesn’t quite look like the above graphic. It’s more like this:

While competition for Spotify has recently intensified — mainly because the type of competitors has changed from other startups to big tech companies —the Swedish service has still managed to outgrow competition. With 50 million paying subscribers it should now be approaching 50% market share in streaming.⁴

A Struggle for Power

That tilts the balance of power into Spotify’s direction (though the starting point was totally tilted in the labels’ favor). Assuming that the revenue Spotify generates for the labels is roughly proportional to its just-below-50% market share, it would contribute a significant chunk to the labels’ streaming revenue: In Q4 2016 alone, the big three reported a combined streaming revenue of $1.1 billion in total. Streaming thereby is the most important driver for the just rediscovered growth in recorded music.⁵ This kind of money is really hard to forgo if you are a record label.

Still, the labels own the most important asset in music: the music. Therefore, it remains true that streaming services aren’t highly differentiated. They try to convince users with things like specific usability touches, better discovery functionality, or other features on the software side. Yet, what users really care about is the catalogue. Do I find all the music I wanna listen to on your service? If so: great! Otherwise: Not so much. Because the big three’s catalogue amounts to 85–90% of the music on streaming services, having access to it is mandatory for any. It’s quite literally a matter of life and death.

What we are currently witnessing, thus, is a delicate balancing act. Both sides try to leverage their assets in order to create an advantage over the other. At the same time, they are so intertwined (including, again, an 18% equity stake the labels own in Spotify) and depending on one another, that pushing the other one down the rope is no option. Still, let’s see what it would look like.

The labels theoretical push is straight-forward: Shutting down their catalogues. But in the case of streaming services? Their move would be to turn into a “label”: working with artists directly in order to own the music and its distribution — without the labels participating at all. Let’s call this doing the Netflix, as the famous video-streaming platform has done exactly that.

Creating exclusive, even fully-owned content is great. Not only can you differentiate your service that way, but it also ends your dependence on licensors and is a much better business model in the long-run. However, streaming platforms have by and large shied away from attempting this. Spotify is even famously opposed to the concept (while that philosophy is certainly the most fan-friendly, I leave it to you to decide how much of that is PR rhetoric and/or the need to nurture the relation with its most important supplier and minority shareholder).

We have seen singular incidences of artists trying the streaming-only path — e.g. Chance The Rapper or Frank Ocean — but no full-blown efforts by the platforms to own exclusive music. Note that the latter would go way further than the marketing practice of (temporarily) having exclusive streaming rights. And labels even despise that! Likely because they regard the practice as a door-opener for more radical approaches.

So it’s obvious why streaming companies don’t force the issue: the labels would likely judge it as an attempted coup d’etat. Which no service would currently risk because catalogue! The labels only need to whisper the magic word and any service — barring suicidal tendencies — will stop thinking about it. However, there might be a tipping point: Once (and if) a streaming service manages to gain such a significant number of subscribers that the revenue it contributes is existential to the labels. That would cause the labels to at least think twice about cutting ties.

The counterargument goes like this: The lack of differentiation between streamers results in low switching-costs. That means, if Streamer A no longer offers your preferred music, you just use Streamer B. Presumably that’s generally true. But platform lock-in is likely higher in music streaming than in video. First, music is more of a social activity you share with friends (thus, btw, network effects). Second, creating playlists, building your collection etc. is key to the experience — and users invest their precious time in it. They would at least be offended if any label decided to pull its catalog off their service-of-choice. Is that enough to stop a label from doing so if push comes to shove? That’s certainly up for debate.

One final variable to consider when observing the current streaming wars is best summarized by the expression pick your poison. Assume users love streaming so much that even the labels recognize it ought to exist. Also assume that streaming is a winner-takes-all (or most) market. Which player would you rather see succeed if you are in the labels’ shoes: A tech giant with a stuffed warchest or a startup you even have a stake in?


Is the Upcoming Season Going to be Any Good?

Like you, I could only speculate, not give a precise prediction. Since I generally avoid baseless guesses, let me instead give you a very general outlook of the next Game Of Songs season.

On-demand music streaming will certainly continue to grow and build its lead as the preferred way of music consumption. Spotify looks like the most promising company to reach “critical scale”. But it’s unclear what this actually means in subscriber numbers — and if the labels will let it happen. Except for Apple Music, most other services appear like long shots. That, however, can change quickly. Amazon is entering the market with aggressive pricing and a product differentiated by the platform it runs upon: The Echo. Should the latter continue to get traction, Amazon might turn out as the casual listener’s preferred option. Google is super-relevant in (free) video streams and try’s to build a subscription model on top. Given the company’s track record, I’m not convinced they’ll be successful at it.

The labels meanwhile are enjoying new-found growth and pulling strings in the background. Always warily maneuvering in order to protect their catalog’s value and influence the balance of power in their favor.

Also, there are rumors that a new group of actors — or rather extras with increased ambitions — might become pretty significant for the plot’s development next season. Simultaneously, a new power play appeared on the horizon which could result in lasting changes. (This paragraph is actually a plug for two follow-up pieces. So don’t forget to subscribe at the end)


The Broader Takeaway

Throughout the history of digital music it has been rather obvious that the labels’ model — which was based on the distribution of physical records — would stop working at some point. Many assumed that this would equal the end of the labels. And it could have. Some might say it should have. Regardless of your position on that, it’s not off the table but the odds certainly decreased.

On the other hand, the label’s endurance is a reminder that disruption doesn’t come easily. Especially when challenging powerful incumbents. It’s one thing to reach for a market of small, isolated entities a la Uber. It’s another to attack large companies in concentrated markets— particularly if they own assets which are a) critical to your own business and b) not easily replicable.

The labels managed to preserve their position without innovating in any meaningful way. Instead, they simply leveraged said assets. It’s not a strategy that get’s applauded by the modern, tech-inspired business community (it likely wasn’t even a strategy). But it does work. Most likely not forever but it buys you time. Time, which any challenger is better equipped to survive. Because it’s often the meantime that kills new contenders. An idea that is generally right isn’t enough to be successful.

Summing it all up, there is one definitive prediction I’ll let myself get roped into: We are guaranteed that the upcoming season contains plenty of drama, intrigue and unexpected plot twists.


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*At least the western world’s version. There is a whole set of players in other parts of the world, for instance China’s NetEase Cloud Music, Russia’s Yandex or India’s Saavn. I will handily ignore them in this piece.

¹ Yes, the labels had also launched some online services on their own— MusicNet and Pressplay — but even mentioning them in a footnote borders on overpraise.

² Apple wasn’t the first service to offer individual songs. Those mentioned in the footnote above did it, as did Listen.com. However, those had silly DRM restrictions and pricing models (e.g. paying $1 per song you burn to a CD) in place and combined subscription models with indivodual payments. Also, no iTunes predecessor did it at the 99 Cent price point.

³ Differentiation might be possible in niches driven by indie labels but this would require an entirely different business/economic model

⁴ The 100 million subscriber mark was crossed in December 2016. Spotify reached the 50 million milestone on March 2nd. The global streaming subscriber base grew at roughly 16.5 million every 6 month for the past 1.5 years each. If that trend continued, the overall market should have been at 105–107 million at the beginning of March 2017. This would equate to Spotify having approx. a 47.2% market share.

⁵ The other one is vinyl but at a significantly smaller level.