Music Industry Booming; Revenues Surge... But Spotify Isn’t the Winner

Music is Booming, But Spotify Isn’t the Winner

The global music industry posted its best growth for at least two decades last year, but Spotify’s path to proper profits looks as long as ever

Stephen Wilmot April 3, 2019 10:07 a.m. ET

The music industry is sending off great vibes, thanks in large part to Spotify. A year after the streaming leader went public, however, the real party still isn’t open to stock investors.
Globally, music-industry revenue rose 9.7% last year, the best in at least 20 years, according to data released Tuesday by the International Federation of the Phonographic Industry. Streaming drove the tempo, with growth of 34%, while compact-disc sales slowed it down. But the drag from the decline of CDs, which caused the industry to shrink from 1999 through 2014, is getting weaker as they account for an ever-smaller slice of the pie.
Spotify, which held an unconventional “direct listing” in lieu of an initial public offering a year ago Wednesday, is growing broadly in line with the streaming business it pioneered, despite mounting competition from Apple and Amazon in the U.S. But it has an unresolved profit problem. In the fourth quarter, it made a gross margin—revenue minus payouts to record labels and other variable costs as a share of revenue—of 25.8%, adjusting for one-time effects.

This is far lower than for most dominant technology platforms, reflecting the industry’s unusual power dynamics. To give consumers all the music they might want, as it promises, Spotify has no choice but to license content from the big record labels, Universal, Warner and Sony . These companies—all owned by conglomerates, unfortunately for investors—are the real beneficiaries of streaming.

The labels have every interest in keeping up the prices they charge platforms to stream tracks. Spotify Chief Financial Officer Barry McCarthy told investors at a recent Morgan Stanley conference not to expect the kind of margin increase the company got before its IPO because it wasn’t in labels’ “economic self-interest.” Spotify’s awkward position has also been laid bare this year by a legal battle with Warner over its launch in India.

Spotify is working on ways to improve its negotiating leverage, but these are untested and at a fairly early stage. One option is to move beyond music: The company has made a string of podcasting acquisitions this year. Another is to use its data on customers’ streaming habits as a bargaining chip with labels. “The only way the market improves is if we provide them with some value-added services that don’t exist today,” Mr. McCarthy said.
A more immediate problem than reinventing the business model may be slower industry growth. Apple and Amazon’s determination to grow their own music-streaming businesses “poured fertilizer” on the U.S. market in 2018, says Mark Mulligan, managing director of research company MIDiA, bringing forward growth. U.S. music revenue rose 15% last year while Europe was flat, according to IFPI.
After a year of sound and fury, signifying nothing much, Spotify stock is lower than the price at which it closed a year ago on its first trading day. All but the very most patient investors may be better off selling out. There will be beguiling tunes on the way, but Spotify’s path to proper profits looks as long as ever.


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