few Strategic Decisions on key issues - From the role of CEO - Spotify case study

IESE Business School IES86 University of Navarra October 2021 Spotify: Face the Music (Update 2021) Govert Vroom Isaac Sastre Boquet Abhishek Deshmane In July 2021, Billie Eilish released her new album "Happier than Ever", and in just one day, two of the tracks of the album (the title track "Happier than Ever" and "Getting Older") were each listened to more than one million times on the music streaming service Spotify . Ellish's new album was one of the most awaited releases of 2021, and there was talk of whether it could surpass Bad Bunny's "YHLQMDLG", the top album of 2020, with 3.3 billion streams'. Eilish and Bad Bunny weren't alone at the top: global superstars like Ed Sheeran, Drake, or The Weeknd routinely accrued hundreds of millions-even billions-of streams of their hit songs. Indeed, for many fans streaming had become "the" way to consume music, revitalizing an industry that was seeing double digit growth for the first time since the 1990s. And with its 155 million paid subscribers and 355 million total users, Spotify was undisputedly the most Use outside these parameters is a copyright violation. popular music streaming service in the world. For the year of 2020, it posted record revenues of Authorized for use only in the course BUS6070 - Strategic Management at University of Prince Edward Island taught by Don Wagner from 3/11/2022 to 4/22/2022. 67.88 billion. Yet, despite those numbers, in all its history, Spotify had never been able to post a yearly profit. The company had an operating loss of (293 million in 2020 (with a $581 million net loss) and was projecting an operating loss of E150-E250 million for 2021. Just two days before the release of Billie Eilish's album, Spotify's stock had dipped 10% after weaker-than-expected user acquisition figures'. After years of staggering growth, was Spotify starting to slow down? Spotify's problem was compounded by the fact it couldn't afford to slow down: Apple Music had already gained 72 million subscribers since its launch in 2017, while Amazon Music Unlimited had reached 55 millionS. Both were trying to catch up with- and even surpass-Spotify with new features, exclusives, and integration with their respective ecosystems of apps, services and devices. This case was prepared by Professor Govert Vroom, Isaac Sastre Boquet, case writer, and Abhishek Deshmane, PhD Candidate. October 2021, IESE cases are designed to promote class discussion rather than to illustrate effective or ineffective management of a given situation. Copyright @ 2021 IESE. To order copies contact lESE Publishing via www.lesepublishing.com. Alternatively, write to publishing@iese.edu or call +34 932 536 558. For feedback, please contact Professor Govert Vroom (gvroom@lese.edu). No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means - electronic, mechanical, photocopying, recording, or otherwise - without the permission of lESE. Last edited: 4/10/21Spotify Face the Music (Update 2021) SM-1709-E One of the possible answers to Spotify's predicament was the much-debated "audio strategy", which had seen Spotify spend nearly E1 billion on podcasting companies". CEO Daniel Ek had stressed the importance of this new content: "Audio, and not just music, will be the future of Spotify . But some analysts were not as confident: in January 2021, Citi claimed that subscriber acquisition figures "do not show any material benefit from recent podcast investments Spotify had spearheaded the recovery of the music industry but, ironically, so far had been unable to reap the benefits from it. Was the audio strategy the right plan? Did Spotify have a path to profitability? The History of the Music Industry The Music Industry Before the Digital Era In 1999, the recorded-music industry was at its peak. With $38 billion in global revenues, it was riding a wave of growth as more convenient playback media, such as the CD, had replaced vinyl records and cassettes; CDs combined the accessibility of a small and cheap cassette player with much higher sound quality and fidelity. Recorded music came into existence with the invention of the phonograph by Thomas Edison in 1877, enabling the reproduction of sound using an engraved cylinder, the "record". Recorded music would become popular throughout the 20th century with the emergence of mass media such as the radio, which brought music to millions of homes. Music enthusiasts wanted a way of listening to their favorite songs without having to wait for them to be broadcast again on the radio or television, and sales of recorded music exploded. Use outside these parameters is a copyright violation, Soon, a new business model emerged where recording companies, called "music labels," contracted artists to produce music for them. These labels acted as both producers and Authorized for use only in the course BUS6070 - Strategic Management at University of Prince Edward island taught by Don Wagner from 3/1 1/2022 to 4/22/2022 publishers, coordinating and handling the recording, manufacturing, promotion, marketing and distribution of music. The finished records were sent to final distributors (from small music stores to nationwide chains or department stores or eventually even online retailers such as Amazon), which sold them to the final customer. Recorded music was published in albums of several tracks (usually around 10). Some would-be hit songs were released as singles, which could be sold for a lower price and were also used for promotional purposes, but the transition to compact disc (which had very similar production costs regardless of the length of the recording) reduced the sales importance of the single. By 1999, this business model had remained undisturbed for decades. Over time, the market had become concentrated into the so-called "big five" major labels: EMI, Sony Music, Universal Music Group, BMG, and Warner Music Group. These larger companies often also acted as the distributors of smaller independent companies, who lacked the capacity to develop effective distribution and marketing arms. This increased the major labels' market share even further. However, in June that year, 1999, while the recording industry was enjoying its best year ever, a group of entrepreneurs launched the file-sharing service, Napster. The service allowed users to share files easily through the Internet and became the first step toward unravelling the entire industry as it had been understood up to that point. 2 IESE Business School-University of NavarraSpotify: Face the Music (Update 2021) SM-1709-2 The Digital Medium and the Rise of Music Piracy Two years later, in 2001, Judge Marilyn Hal Patel ordered an injunction against Napster, after the Recording Industry Association of America (RIAA) brought a suit against the company. in Napster users had been using the service to share music in digital format illegally. In just two years Napster had amassed 60 million users, who were swapping more than 165 million songs a day without paying artists of labels.") Music sales had been falling dramatically, which had prompted the RIAA to start an intense campaign against music piracy. Yet, despite its efforts, sales would continue to freefall for years to come, reaching an all-time low of less than $16 billion in 2011." in a little more than a decade, the music industry had been cut in half. Figure 1 shows the dramatic drop in music spending per capita throughout the first decade of the 21st century, compared with the previous state of the industry. Figure 1 US Recorded-Music Revenue, 1973-2020 (in 2020 Dollars) $20,000 $15,000 Use outside these parameters is a copyright violation Value ( Millions) Authorized for use only in the course BUS6070 - Strategic Management at University of Prince Edward island taught by Don Wagner from 3/1 1/2022 to 4122/2022 $10,000 $5,000 SO 2020 LPATP SACO Vinyl Single DVD Audio Paid Subscription B-Track Music Video (Physical) a On Demand Streaming (Ad Support Cassette Downlead Album 12d Ccar Ad-Supported Streaming Cassette Singla Donniess Single SoundExchange Distributions Octer Tapes Ringtones R. Ringback Litrated Ther Paid Subscription CD Download Minic Viceo Synchronization CO Single other Digital Source: RIAA. "U.S. Sales Database." RIAA. Last modified May 18, 2018. https://www.riaa.com/u-s-sales-database/ IESE Business School-University of Navarra 3Spotify: Face the Music (Update 2021) 3 SM-1709-E The industry, in general, blamed piracy for these lost sales, but Ek had his own opinion about what had happened: I realized convenience quite often wins... . It's not that people don't want to pay for music. . It was the only point in time when the stolen product has been much, much better than the one you legally acquired. . . . For me it was a pretty big given why we ended up where we ended up in the music industry is What had happened? Three key developments had ushered in the age of digital music: . MP3 compression technology. In 1993 the Moving Picture Experts Group the group tasked with setting the standards for digital audio and video formats-published the MPEG-1 Layer Ill standard for digital audio, commonly known as "MP3." The MP3 standard reduced the size of a music file by an order of 10, while keeping a quality that was nearly undistinguishable from larger, lossless formats on all but high-end playing devices." The result was that users could rip their audio COs, store their entire music collection on their computers, and easily share it with friends. The rise of the Internet. The Internet became available to the general public in the early 1990s and its use quickly skyrocketed, In 2000, 52% of US adults used Internet, a percentage that rose throughout the years and reached 79% in 2010, and 93% in 2021.15 At first, most Internet connections were slow and it took several minutes to download a single music track. However, soon faster connections were developed and offered by internet service providers. These new broadband connections would eventually allow music tracks and videos to be played instantly. In 2010, it was estimated that there were 72 broadband connections per 100 inhabitants in the United States, and that number rose to 190 in 2020, of which 154 were mobile connections. 16 Use outside these parameters is a copyright violation. New devices. These new digital formats spurred the development of a wide range of Authorized for use only in the course BUS6070 - Strategic Management at University of Prince Edward Island taught by Don Wagner. from 3/11/2022 to 4/22/2022 software and devices capable of creating and playing digital-music files. These devices had greater capabilities than the older analog or CD player technologies. For example, a typical portable digital-music player was able to contain the user's entire music collection, rather than just the 60 to 90 minutes of a typical CD or cassette. Users could browse and play any song easily and they could store and display information such as song title, band name or genre. They could then create playlists of their favorite tracks and easily move music between the player and their computers. All in all, these players possessed features and usability that were unheard of in older technologies. Portable digital players quickly became very popular. Later, the mass adoption of smartphones would further increase the user base and capabilities of devices able to play digital music. Despite the music industry's efforts to stop them, file-sharing networks similar to Napster would inevitably emerge: Gnutella, Kazaa, Torrent, and eMule, among others. Trying to shut them all down became a never-ending game of whack-a-mole. The genie was out of the bottle, and the industry would have to figure out what to do with it. The First Steps to a Digital Industry The first companies that marketed digital music usually lacked support from the recording industry. For example, in 2000, eMusic launched a service offering unlimited track downloads from a library of 125,000 tracks to those who paid a monthly subscription.17 However, only artists from independent labels were available. By way of comparison, in 2017 most leading 4 IESE Business School-University of NavarraSpotify Face the Manic (Update 2021) SM-4709- digital-music services claimed libraries in excess of 40 million tracks. Likewise, in 2001 MP3.com was offering unsigned artists the chance to distribute their music through its website, paying them according to the number of downloads."Both companies would change ownership and (1 1/2022 to 4/22/2022. business models in the following years, MP3.com eventually shut down and sold some of it's assets-including its coveted domain name-to CNET Networks In 2003,10 By contrast, eMusic was still operating in 2017, allowing customers to download a fixed number of tracks (including from an audiobook library) for a set monthly fee. The initial reaction of the major labels to the new technology was litigious. As well as suing the makers and users of music-sharing networks similar to Napster, they also tried-but failed-to obtain an injunction to prevent the sale of the Rio PMP300, the first commercially successful portable MP3 player.20 Indeed, the major labels' first attempts to enter the digital market demonstrated the industry's wariness of the new technology. In the early 2000s, two joint ventures backed by the major recording labels were launched: MusicNet-supported by EMI, Warner, and BMG-and Pressplay, backed by Sony and Universal. Both services had several limitations that made them unpopular with users (such as the limited number of tracks playable per month, and the limited number of tracks from the same artist playable per month). Furthermore, MusicNet and Pressplay only had the music of the labels that backed them, so users needed to purchase two ght violation separate subscriptions if they wanted to listen to all the major artists. Soon the labels abandoned these services: MusicNet was sold in 20053 and Pressplay was sold in 2003, merging with the Napster brand for the latter's relaunch as a legal service." Both MusicNet and Pressplay came joint ninth on PCWorld's list of the "worst tech products of all time."2 The Success of the iTunes Model Use outside these parameters is a copyright v The industry, however, did not have to wait long for its first massively popular digital-music Authorized for use only in the course BUS6070 . Strategic Management at University of Prince Edward Island taught by Don Wagner from 3/11/2022 to 4/2272022 service. In February 2003, Steve Jobs unveiled the iTunes Store during his keynote speech at a special Apple event. At launch, iTunes offered a catalog of 200,000 songs, with backing from major and independent labels, which sold for 99 cents a track." Initially, ITunes was available only for Mac computers but support for Windows was added a few months later, greatly expanding the potential customer base.?'s By the end of the year, the store had already sold 25 million tracks."The service would grow exponentially and, at its peak in 2012, it reportedly reached nearly $4 billion in sales." Despite these numbers, Apple long claimed that the ITunes music sales did not provide the company with significant profits." However, the iTunes sales drove sales of ipods, which had big margins for the company.? On the heels of iTunes' success, several companies replicated its model for selling digital music. For example, Sony launched the Sony Connect Music Store in June 2004, selling tracks and albums at the same price as ITunes. Likewise, Apple's longstanding rival Microsoft launched Zune Marketplace in 2006." These stores were not as successful as ITunes: Sony Connect closed in 2008,32 while Microsoft discontinued the Zune brand and launched Xbox Music in 2012. 3 Major labels fully backed these and other offerings, as they had done with iTunes. Nevertheless, iTunes and other similar stores still came with a significant restriction. Digital rights management (DRM) technologies were embedded in the tracks purchased. These limited the number and type of devices on which these tracks could be used, ensuring that the customer could not distribute the files freely after purchasing them. They also allowed the stores to control how tracks could be used. For example, tracks purchased from iTunes could be played on no more than five devices. HH IESE Business School-University of Navarra 5Spotify: Face the Music (Update 2021) SM-1709-E Moreover, apart from a computer, only Apple devices such as the iPhone, IPod and iPad could play iTunes tracks. As a consequence, iPod sales skyrocketed in parallel with iTunes' success, reaching 22 million in 2009." Likewise, Sony Connect tracks could be transferred only to compatible devices that supported Sony's ATRAC3 format, such as the Walkman or the PSP (Playstation Portable) gaming console. Meanwhile, Zune customers had to procure a Microsoft- certified device, such as one of Microsoft's own Zune-branded line of players. However, the situation changed in late 2007 when a new entrant, the online retailing giant Amazon, launched its own digital-music store. Labels allowed Amazon, unlike its competitors, to sell tracks without DRM." Users could buy from Amazon and play the songs on any number of devices that supported the MP3 format, including ipods, Zune players and Walkmans, Unlike Sony and Microsoft, Amazon was successful and quickly became the second-largest digital-music store in the United States."The competition soon followed in its footsteps: iTunes, the market leader, abandoned DRM in 2009.17 Artists too began to experiment with the opportunities that the digital format presented. For example, in 2007, the high-profile British band Radiohead skipped music labels and released their album In Rainbows directly to their fans as a digital download on the band's website, letting customers choose the price they wanted to pay. No sales figures were released. Attempts like Radiohead's to upset the usual release process were, however, piecemeal. Streaming and the Smartphone Era RealNetworks was a company that had thrived in the 1990s, developing video- and audio- streaming technologies for the fledging Internet. RealNetworks' protocols allowed users to watch videos and listen to audio without downloading the files to their computer. In April 2003, Use outside these parameters is a copyright violation. RealNetworks launched a new service: RealOne Rhapsody (later shortened to Rhapsody). This became the first major label-backed music-streaming service. Authorized for use only in the course BUS6070 - Strategic Management at University of Prince Edward Island taught by Don Wagner from 3/1 1/2022 to 4/22/2022. Rhapsody offered a subscription model where users paid a monthly fee of $9.95 for the ability to stream an unlimited number of songs from a library of 330,000 tracks. Users could not download the tracks directly to their computers. Rhapsody was a moderate success, reaching 800,000 subscribers in 2009. However, its growth rate slowed and ultimately declined. In 2010 it had lost 100,000 subscribers, and analysts at the time doubted its ability to compete with other music services that were not using a streaming model. Rhapsody was spun off from RealNetworks in February 2010, in order to help the parent company achieve profitability.39 In 2013 the now-independent Rhapsody acquired Napster* and started using that brand name, ultimately phasing out the Rhapsody brand in 2016.41 Rhapsody's failure to gain traction in the 2000s seemed to indicate that the market preferred stores with the iTunes model, where users could buy and own digital music. However, other streaming services soon appeared. Pandora launched in 2005 and was followed by similar services such as Slacker Radio and MOG.# Pandora allowed users to listen to customized "radio stations" for free, while it got revenue through advertising. Throughout the 2010s, the use of smartphones exploded. They fused the functionality of a portable media player with a computer with an Internet connection. By mid-2021, it was estimated that there were 6.4 billion smartphone users worldwide." This greatly benefited streaming services, since it untied users from having to use a desktop system in order to access online services. According to Pandora, the introduction of a smartphone app in 2008 practically doubled its growth overnight," and Daniel Ek credited Spotify's free smartphone app with saving 6 IESE Business School-University of NavarraSpotify: Face the Music (Update 2021) SM-1709-E his company in 2013." Ultimately, streaming displaced downloads and became the largest contributor to the industry in 2017", on the back of the continued success of Spotify. By that time, the Swedish company be pany been joined by other large competitors like Apple Music (launched in 2015) and Amazon Music Unlimited (2016). Spotify Daniel Ek and Martin Lorentzon founded Spotify in Sweden in 2006 after having both worked for several Scandinavian-based online start-ups. Ironically, Sweden was infamous for hosting The Pirate Bay, the largest search engine for illegally downloading music and video content on the Internet. Spotify finally launched in October 2008 in Sweden and other Western European markets after announcing deals with all the major labels plus several independent companies that allowed Spotify to stream their catalogs.47 Spotify launched in the United States in 2011 and grew quickly in that market. It expanded geographically, and by 2020, it was available in 85 countries or territories, spanning the Americas, Europe, Asia, and Oceania, By the end of that year, the company claimed 155 million subscribers and 345 million total users, following years of fast growth (see Figure 2). Figure 2 Spotify User Count at End-of-Year (2014-2020) 400 350 300 "Use outside these parameters is at copyright violation. 250 Authorized for use only in the course BUS6070 - Strategic Management, at University of Prince Edward island taught by Don Wagner from 341 1/2022 to 4/22/2022. 200 150 100 50 2014 2015 2016 2017 2018 2019 2020 Paid Subscribers Total Users Source: Spotify. "Spotify - Financials." Spotify -IR Home. Last modified 2021. https://investors spotify.com/financials/default.asox. The company had also gone public: in April 2018 Spotify began trading on the New York Stock Exchange, using a direct listing instead of an IPO. Shares opened at $165.90, up nearly 26% from a reference price of $132 set by the NYSE. The stock ended the session at $149.01, valuing the company at $26.5 billion. 43 Spotify had already announced plans to keep expanding geographically throughout 2021, adding HHHI 80 additional countries in Africa, Asia, and the Middle East, areas which at the time supplied 20% of Spotify's user base . In general, emerging markets posed a big challenge to companies such as Spotify. Piracy was still a major factor in those countries, and some local companies IESE Business School-University of Navarra 7Spotify: Face the Music (Update 2021) SM-1709-E offered popular ad-supported music streaming services. Thus, music subscriptions were still a hard sell. Spotify was testing a new pricing scheme in some of those new emerging markets: Spotify Mini offered a prepaid option (running for a day, or a week) as an alternative to Spotify's traditional recurring monthly subscription. In 2017 Spotify also engaged in an equity swap with Tencent, where Tencent took 9% of Spotify, who took 7.5% of the Chinese social media and retail giant$. Spotify was barred from launching in China due to local restrictions on companies dealing with cultural goods, but Tencent's own music streaming apps had over 600 million users in China (its only market) in 202053. Tencent Music had thrived by offering a free service and then monetizing it with ancillary purchases such as karaoke tools, digital gifts that could be kept or sent to friends, and the ability to watch live concerts. The Spotify Business Model In 2021, Spotify operated a "freemium" business model in most of its markets. That is, it offered two service tiers: one paid, one free. Both tiers allowed on-demand unlimited listening of every song in the Spotify catalog (60 million tracks) for an unlimited number of times from any Management at University of Prince Edward Island taught by Don Wagner from 3/1:1/2022 to 4/22/2022 personal computer or mobile device. Users of the free service had their playback interrupted every few songs by short audio adverts. During the previous years, Spotify had slowly been increasing the number and frequency of the commercials and had added visual adverts to the user interface of free customers. However, premium users could listen to music without being interrupted by adverts, had access to higher-quality audio, and enjoyed other features. Spotify also provided an app that could be installed on many devices, from Android and iOS smartphones and tablets to smart TV receivers and even Internet of Things (loT) devices such as the Amazon Echo. Notably, only premium users could play music on demand using the app. Free users were unable to select a particular song but could create a "station" that would play random music that followed certain user-provided guidelines (such as genre, era or artist). Table 1 shows the differences between the two service tiers. Table 1 Spotify Service Tiers (2021) Free Premium Full catalog access Almost" Yes Playlists Yes Yes Play tracks on demand Partial Yes Ad-free listening No Yes Sound quality (kbit/s) 160 320 Offline mode No Yes Monthly fee so $9.99 Some newly released tracks and albums were held back from Spotify's free version for a few months. Free users on mobile platforms (such as iOS and Android) could select artists, playlists and albums but not the particular track to be played. Users of desktop platforms had unrestricted choice. "Price for the undiscounted baseline premium tier in the United States, Source: Prepared by the authors. 8 IESE Business School-University of NavarraSpotify: Face the Music (Update 2021) SM-1709-E Spotify often ran promotions to try to sign up more customers to its subscription services. For example, by 2021 it was offering a student subscription in several markets for $4.99 or (4.99 a month. In the United States, this even included a free subscription to the video-streaming platforms Hulu and Showtime. The company also offered a Spotify family plan for $15.99 or $15.99, which allowed people to share a single subscription with six family members. Spotify also routinely offered free trials to its premium service, usually for around three months. Spotify's average revenue per user (ARPU) for premium users had been declining for several years, and in 2020 dropped to a low of E4.31. Spotify's functionality was simple. Users could search for any song straight from the home screen, access their list of favorite songs and artists, access their playlists, and browse the most popular track and artists of the moment. The interface also offered access to popular playlists made by other users, playlists curated by Spotify, or a variety of playlists generated using algorithms based on the user's listening habits (i.e., a playlist mixing some of the user's favorite artists, or one suggesting new tracks and bands similar to ones the user regularly listens to). Playlists had become such a popular feature that there were third-party websites devoted to sharing, commenting on and rating Spotify playlists (such as Playlists.net and SharePlaylists.com). Moreover, playlists had progressively become the core of how music was shared and consumed on Spotify, to the point where, for an artist, being placed in a popular playlist was one of the best ways to access new listeners or promote a new song. For example, research found that the first track in Spotify's weekly "New Music Friday" curated playlist obtained, on average, 14,000,000 additional streams in the US during 201752 Spotify had several social features. Inside the app, users could "follow" their friends to see what music they were listening to. Users could also follow artists, bands and other personalities in order to get news about them and be alerted if they released new songs on Spotify. Integration Use outside these parameters is a copyright violation with social media and messaging apps, such as Facebook, Twitter and Telegram, allowed users to share tracks and playlists on social media. Anyone could click on a song or playlist shared on Authorized for use only in the course BUS6070 - Strategic Management at University of Prince Edward island taught by Don Wagner from 3/1 1/2022 to 4/22/2022. social media and listen to it-noncustomers would simply be asked to register an account on Spotify. Nonetheless, Spotify had not added significant new social features in the past years. Spotify for Artists was the platform that artists could use to harness the data generated by Spotify streams of their music, manage their profiles, and engage with fans." Artists were able to check the absolute number of listeners to each of their tracks, down to a geographical area like a city, and could break down listeners by age and gender. They could also get data about the source of those listeners (i.e. whether they had listened to that artist's song in a playlist, or directly searched for that song, etc..), what kind of genre playlists they were added to (hard-rock, pop, etc..) and graph this data over time . Artists could also use Spotify for Artists to promote their tours, sell merchandise, and create and share their own playlists with their fans. As an example of the new platform's potential applications, the heavy metal band Metallica used it to tailor the setlists of its 2018 tour to include songs that were popular in the cities they were playing.$5 The Spotify for Artists revamp was not merely a public relations exercise in response to routine criticism of Spotify by artists. Rather, Daniel Ek viewed it as a cornerstone of Spotify's strategy: The marketplace strategy is important because it's not a win-lose scenario but it's truly a win- win scenario. By building tools and services for the music industry, we can make the music industry more efficient, thereby jointly benefiting together with the music industry at that.$6 Quick innovation and decision-making were key to Spotify's culture. "Success for us will be determined by our ability to move faster than everybody else in this space," Ek said.57 As an example, Ek spoke about how the company had launched its free mobile app the very same day IESE Business School-University of Navarra 9Spotify: Face the Music (Update 2021) SM-1709-E the licensing deals were signed. The company could just not afford a traditional testing calendar at a critical time for it's growth. As Ek put it: "We aim to make mistakes faster than anyone else,"s The company was thus not afraid to tinker with its offering, pivot it's strategies or even backtrack on some of the changes it had introduced. Its engineering culture was also influenced by agile working methodologies, which were adapted and changed as the company grew, with a view to always being quick to launch. By 2020, out of 5,584 Spotify employees, 2,624 worked in R&DS9. Financial Performance When Spotify launched in 2008, it did so with major music labels taking 18% of its shares, for a combined contribution of around 68,800 (then about $13,000)." On the face of it, Spotify's performance during its short life had been nothing less than exceptional, with the company posting staggering growth rates year after year. In 2014 it surpassed E1 billion in revenue, and milestones were reached at a frantic pace: 62 billion of revenue in 2015, 65 billion in 2018, and almost 68 billion in 2020. (See Table 2 for Spotify's financial data.) Table 2 Spotify Financial Data 2014-2020, in Millions of Euros 2017 2019 2015 2016 2018 2020 2014 1,085 1,940 2,952 4,090 5,259 6,764 7,880 Revenues 1,744 4,717 7,135 2,657 . Premium 983 3,674 6,086 542 678 745 . Ad-supported 102 196 295 416 3,241 5,042 Cost of sales 911 1,714 2,551 3,906 5,865 2,868 3,451 4,443 5,126 1,487 2,221 Use outside these parameters is a copyright violation . Premium N/A 373 455 599 739 . Ad-supported N/A 227 330 79 75 74 Authorized for use only in the course BUS6070 - Strategic Management at University of Prince Edward Island taught by Don Wagner from 3/11/2022 to 4/22/2022. 84 74 Total as % of revenue 88 86 174 226 401 849 1,353 1,722 2,015 Gross profit 1,396 ,795 2,308 Operating expenses 365 461 750 1,227 . Research and development 114 136 207 396 493 615 837 Sales and marketing 184 219 368 567 620 826 1,029 . General and administrative 67 106 175 264 283 354 442 Operating income -191 -235 -349 -378 -43 -73 -293 as % of revenues -18 -12 -12 -1 -1 -3 Active users at end of year 60 91 124 160 207 271 345 (millions) Paid subscribers at end of year 15 28 48 71 96 124 155 (millions) Percentage of paid users 25 30 39 44 46 46 45 Paid user ARPU (euros per month) N/A 6.84 6.20 5.32 4.81 4.72 4.31 Figures might not add up due to rounding. Source: Spotify, "Spotify - Financials." Spotify - IR Home, Last modified 2021. https://investors.spotify.com/financials/default.aspx. 10 (ESE Business School-University of NavarraSpotify: Face the Music (Update 2021) SM-1709-E There was a patent caveat in Spotify's growth story. Since its launch in 2008, the company had yet to post an annual profit. The company's explosive growth had been accompanied by losses, However, Spotify's financial situation was thought to be secure. Spotify's rapid expansion had required significant investment, but the company had no trouble raising capital. Since 2007 it had successfully completed eighteen funding rounds, reportedly raising a cumulative total of $2.1 billion. The company had positive cash flows and by the end of 2020 it had 61,151 billion in cash and cash equivalents. Nonetheless, Spotify had already raised prices of some of its plans. The popular Family Plan (up to six accounts in a single household) had gone from $14.99 to $15.99 in the US, and from 14.99 to 617.99 in European markets. The company had also raised the prices of Duo (two accounts) and Student in some markets like the UK. However, Spotify had left its basic plan untouched ($9.99/69.99 in the majority of markets)2 The Royalties Issue in Spotify's accounts, the single largest expense item was the cost of goods sold. This consisted mainly of the royalties Spotify paid to rights holders in order to get access to their catalog to offer to Spotify customers, plus the IT costs of delivering content to the customer. Royalties were regulated by IP laws, which could differ among jurisdictions. Spotify paid two main types of royalties: Songwriting royalties: these cover the lyrics and the music sheet necessary to perform the song. These royalties were split 50/50 between the credited songwriters and the publisher (which could be a label, a smaller independent publisher or a self-published Use outside these parameters is a copyright violation artist). For Spotify, the most relevant subset of songwriting royalties were "mechanical royalties", which were accrued every time a musical composition was reproduced'. Authorized for use only in the course BUS6070 - Strategic Management at University of Prince Edward Island taught by Don Wagner from 3/1 1/2022 to 4/22/2032 In the case of the US, the amounts to be paid were set by the Copyright Royalty Board (CRB), and for streaming services these amounted to 10.5% of the gross revenue minus the costs of delivery, although they had been set to increase to 15,1% in 2022. However, this had been challenged by Spotify in federal courts, and the company had managed to at least force the CRB to delay the increase?. Recording royalties: these covered the actual recorded audio of a musical performance streamed by Spotify. A way to understand the difference between these and songwriting royalties is thinking how a single composition could be recorded by many different artists, in their own styles. These royalties were also sometimes referred to as ownership of the "master recording" or "master copyright". An important difference with songwriting royalties is that the amounts and splits were usually set by bargaining between parts, rather than regulation. These contracts were very complex and could differ for different publishers and territories. Spotify had signed several agreements with major labels in order to get access to their catalogs. The name originated from the practice of "mechanically" creating a copy (i.e. by printing a vinyl) in order to distribute music, although the concept grew to also include digital media, IESE Business School-University of Navarra 11Spotify: Face the Music (Update 2021) 5M-1709-E The duration of these agreements with the labels was generally short, and Spotify had to renegotiate them every 2-3 years, It had just extended them in 2020. Back in 2017, Spotify had been able to bargain a lowered rate for the label's recording royalties in exchange for some concessions. Barry Mccarthy, who was Spotify's CFO at the time, claimed that: The labels were acting in their own self-interest to shore up Spotify's economically- challenged margin structure, because of the growing importance of a healthy Spotify to the entire music industry ecosystem These were the main features of the new agreements: Spotify did not pay a fixed amount per stream. Instead, a percentage of monthly revenue was allocated to royalties, which were distributed according to the market share of each track within the total number of streams Spotify delivered during the period. The rates were tied to the overall user count and the ratio of free to premium. This meant that Spotify had to meet certain targets in other to access the most advantageous rates. The deals incorporated a floor, a minimum amount that had to be paid to the publisher even if the actual royalties accrued would not otherwise reach that figure. The free and premium services had different royalty rates. Spotify paid a larger percentage of its revenue on the free service (which was much smaller on a per-user basis). In 2020, for example, Spotify's cost of revenue for its premium service was 72%, while it was 99% for its free service. Spotify did not pay artists directly (except those who self-published on the platform). Spotify paid the publishers, who in turn paid artists in accordance with their own Use outside these parameters is a copyright violation. particular deals. Authorized for use only in the course BUS6070 - Strategic Management at University of Prince Edward Island taught by Don Wagner from 3/11/2022.to 4/22/2022. Some of the deals incorporated most-favored-nation clauses. This meant that, if Spotify signed a deal with another publisher that was less advantageous to Spotify, the streaming company would need to adjust rates upward for the other publishers. Relations With Artists Artists ask me all the time why they're not making more money. If the music industry is generating so much, then where the hell is it going? These are fair questions. Daniel Ek64 On average, according to estimates, artists on Spotify were being paid $0.004 every time one of their tracks was played. This was far lower than on other services such as Napster ($0.019), Tidal ($0.013) and even Spotify's most direct competitor Apple Music ($0.008), although it was similar to Amazon ($0.004) and still significantly higher than YouTube ($0.00007)$5. To earn the minimum US wage (approx. $1,300/month in 2020), this meant artists on Spotify would need to have their songs played more than 320,000 times each month. Roughly, only 12,500 artists earned over $50,000/year, while 185,000 earned at least $1,0005. This compared to the 472,000 artists that Spotify considered "professional" (they had least 10 tracks on Spotify, and attracted at least 1,000 listeners in 2020), and the pool of 6 million artists registered on the platform. In 2021, a group of 150 British artists-with Paul Mccartney at the helm-sent a 12 IESE Business School-University of NavarraSpotify: Face the Music (Update 2021) SM-1709-E letter to the British government demanding a change in how money was distributed in the industry, asking that