How to run a big web music biz (Spotify): Grab more cash from fans, sink deeper into the red

Haters gonna hate, says media upstart

Spotify has taken advice from Taylor Swift and shaken off its haters: the online music streaming upstart is in good shape despite increased losses.

Founded in 2006, Spotify is privately held but published its 2013 consolidated financial results in Luxembourg on Tuesday. Although it's headquartered in London, UK, and Stockholm, Sweden, it has a holding company conveniently housed in Luxembourg.

The figures, according to Spotify, reveal increased revenue: it's up 74 per cent, year on year, to €747m ($931m). It has more subscribers: up 39 per cent to 50 million. It has a greater percentage of paying customers versus those on the freebie subscription: up 3 points to 25 per cent.

And it has paid less money to rights holders as a percentage of its income: 82.5 percent, down from 90.5 per cent in 2012 and 97.9 percent in 2011. So that's $768m in 2013 to rights holders versus $521m in 2012. In other words, all good signs for financial growth.

The losses, which have increased each year the company has been in business, are this time due to aggressive expansion in more than 30 new countries, with marketing spending alone doubling in 2013 to €111m ($138m). Losses for 2013 increased 16 per cent, year on year, to €93m ($116m).

The company is justifiably pleased with itself, telling shareholders: "We believe that music has mass market appeal – and as such, we believe we are just at the beginning of a much larger market opportunity. We believe our model supports profitability at scale."

Spotify's broad strategy appears to be build around the "Libin effect" where Evernote's CEO Phil Libin noticed that the longer people used his free product, the more likely they were to become paying subscribers.

It told stakeholders: "The more time people spend with our product, the more likely they are to become paying subscribers."

Spotify is reliant on paying subscribers, with 91 per cent of its revenue coming from them, and just nine per cent from advertising. It also explains why Spotify was willing to refuse Taylor Swift's request that her music only be provided to paying subscribers – and then suffer the heavy negative press it received when Swift pulled all her music from the service. It sees the free service as critical to getting paying subscribers; take that away, and its business model crumbles.

So long as the trends in 2013 continue moving in the same direction - more people, increased percentage of paying subscribers, lower percentage of revenue paid out to rights holders - then as soon as Spotify stops expanding, it can expect healthy profits through its existing user base.

That also explains why the company is expanding as aggressively as it can: the more markets it can tap, and the greater its user base, the more money it can make and the fewer gaps for competitors.

Revenue went up 74 per cent but losses went up by less than a quarter of that, 16 per cent. So long as that relationship holds true, Spotify will continue running up losses for as long as it can keeping increasing the number of customers.

The only real risk to its business model at this stage is if Apple, Google or Microsoft decide to aggressively take it out, or if the company is squeezed by music companies and forced to pay a greater percentage of its gross revenues to them (currently it is 70 per cent).

Despite some high-profile artists' complaints about the fees they receive, music companies (the owners of the master recording in almost all cases) are unlikely to want to weaken Spotify for two reasons: one, they are receiving actual hard cash at a time when traditional music sales are slumping; and two, they do not want to become reliant on tech super-companies for their income. ®

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