www.ft.com/content/f1b27624-6e68-11e8-92d3-6c13e5c92914 Spotify shakes record labels by dealing directly with artists
Streaming group cuts out middlemen by licensing music from bands themselves
Anna Nicolaou in New York JUNE 15, 2018
A few weeks before Spotify debuted on the stock market in April, founder Daniel Ek made a promise to the chief executives of the three record labels that control the music industry: Spotify is not looking to own music copyrights or sign its own artists, he told them.
“[Daniel] chose his words very carefully,” said one person with knowledge of the meetings.
Last week it was revealed that Spotify is licensing music directly from some artists and their managers. Record executives were shaken while investors cheered the news, sending Spotify’s market value north of $30bn, a record high.
Spotify’s moves do not technically breach Mr Ek’s promise, or the contracts it has with record labels, which stipulate that the company cannot buy master recordings or compete with them in a meaningful way.
The company will not control the copyrights or “sign” artists, like a record label does; instead it is licensing music from artists who own their rights.
Spotify began sealing these licensing agreements last year and has licensed fewer than 10 artists so far, according to people familiar with the matter. The deals have been limited to small independent artists and are non-exclusive. Spotify pays some bands advances of about $15,000 for their music, these people said.
Wall Street was expecting a rabbit to be pulled out of their hat [in earnings]. This is the rabbit
Mark Mulligan, analyst with Midia Research
While the transactions are small in value, the strategy has big implications for Spotify’s future.
Spotify’s core business has been a middleman: it licenses music from the major record labels, charges customers for access to that music, and then pays the labels a percentage of the sales.
Mr Ek can claim to have revived an industry in decline. But as a public company looking to please investors with quarterly expectations, Spotify’s challenge is to hold on to more of the riches from streaming. The company pays out more than three-quarters of its revenues back to rightsholders, and has never turned a profit.
Wall Street analysts argue that for Spotify to replicate the success of Netflix, it needs to make or own original content.
“This is a soft way in. Direct [licensing] deals are a way to start chipping away at the market and increase margins,” said Mark Mulligan, analyst with Midia Research. “I don’t think anyone is shocked that it happened, but they’re shocked it happened so soon.”
The strategy allows Spotify to cut its costs, because it pays these musicians lower rates than it pays out to the major labels for their songs. Spotify last year paid about 79 cents of every dollar it makes back to rights holders, an improvement from 88 cents in 2015, but still well above Netflix, which paid 66 cents for every dollar of revenue last year.
“Netflix’s original content does give it a material competitive differentiation that Spotify doesn’t have,” said Mark Mahaney, analyst at RBC.
However, the structure of the music industry is more difficult to disrupt than film and television, where Netflix has poured money into production and talent, shaking the incumbents.
Spotify operates in a business controlled by a handful of companies. Four groups own nearly 90 per cent of the music streamed on Spotify, according to a regulatory filing: the “big three” labels, Universal, Sony and Warner Music, along with Merlin, an agency that represents smaller labels.A relatively narrow potential pool exists for Spotify to fish in: indie musicians untethered to a label or to Merlin, plus some older artists, such as Garth Brooks and Janet Jackson, who have chosen to operate independently. Deutsche Bank analysts estimate this group accounts for about 8 per cent of music listening on Spotify.
Michael Sukin, a music lawyer who has worked with the estate of Elvis Presley, said: “They can only do this with artists and writers that have their copyrights available, and the minute you sign with a record company you give those rights away.”
If tensions rise, the labels could threaten to pull their music, leaving a hole in Spotify’s product versus competitors. Spotify negotiates with the labels every few years for fresh licensing agreements.
Two months into life as a public company, Spotify is adjusting to the volatility of the stock market. After its inaugural quarterly earnings report in May, shares dropped as much as 10 per cent. The company unveiled sales that were only in line with analysts’ published forecasts. Barry McCarthy, chief financial officer, attributed the drop to the market “getting ahead of itself”.
After Billboard magazine revealed the licensing deals last week, Spotify shares have jumped more than 6 per cent to $174, versus $149 at the close of its first day trading.
“Wall Street was expecting a rabbit to be pulled out of their hat [in earnings],” said Mr Mulligan. “This is the rabbit.”