Spotify is in no position to displace the recording industry’s Big 3

Daniel Ek, CEO of Spotify,
which has been pushing to sign up independent
artists.
Kimberly White/Getty
Images

• Spotify has been making waves in the music industry by trying
  to sign up independent artists.
• But don’t expect the company to replace the major recording
  labels anytime soon, UBS analysts said in a new report.
• The company doesn’t have the money to really compete with
  them, and it’s heavily dependent on them, they said.
• Even if it doesn’t become the Netflix of the music world,
  Spotify still has plenty of other opportunities ahead of it, the
  analysts said.

Netflix may be trying to beat Hollywood at its own game, but
don’t expect Spotify to do the same in the music business.

Unlike Netflix, which has become a major player in the video
content business by moving aggressively to produce its own shows
and films, Spotify is in no position to take on the traditional
labels, financial analysts from UBS said in a recent report. In
fact, instead of Spotify or other streaming music “platforms”
significantly cutting into the labels’ business, both sides are
likely to profit as streaming catches on more broadly, the
analysts said.

“Our current view is platform disintermediation is overplayed,
and we see platform-label economics likely to remain broadly
unchanged in the medium term,” they said. They continued: “Our
base case … is the music streaming opportunity is significant
enough for both platforms and labels to benefit.”

There’s been growing talk in recent months of Spotify potentially
trying to cut the labels out of the loop and just work with
artists directly. Last week, the company announced
it would allow artists to directly upload their music to its
service, instead of having to go a music label as a
middleman. Meanwhile, it recent months, the company has been

reaching out to various managers and independent artists,
offering to pay them cash up front to license their music
directly to it.

Such a move could help Spotify’s bottom line. A huge portion of
its costs come from licensing music from the major labels. If it
licensed songs directly from artists, rather than from the
recording companies, it could reduce its costs.

Spotify is unlikely to become the music world’s Netflix

But despite the hype and the potential profit boost, Spotify’s
unlikely to become a real threat to the labels anytime soon, if
ever, the UBS analysts wrote.

Reed
Hastings, CEO of Netflix, which has become one of the leading
producers of video entertainment.
Getty

While streaming is opening up new opportunities for artists,
labels still perform a valuable role in the industry in helping
new musicians establish themselves. Some 6 million songs are
released each year, the analysts estimated. The labels help their
artists be heard above the noise, they said.

The Big Three music labels that dominate the industry — Universal
Music Group, Sony Music Entertainment, and Warner Music Group —
spend about $4 billion each year to discover, promote, and give
advances to new artists each year, they estimated. Universal
Music Group alone spends about $1.7 billion of that.

That’s spending that Spotify can’t even come close to matching
right now, given that it’s likely to post an operating loss of as
much as $321 million this year, they said. 

“Spotify does not have the financials to become a label today or
in the medium term,” they said.

Even if Spotify could afford to spend more to attract and promote
artists, signing up exclusively with it wouldn’t be in the best
interests of most artists. That’s because even though it’s the
leading streaming music provider, it still only accounts for
about 16% of revenue for the recording industry. Only dealing
with Spotify would mean writing off revenue from big-ticket
competitors like Apple Music and YouTube, not to mention the
still sizeable amount of revenue that comes from sales of CDs and
other physical music products.

“Signing up exclusively to Spotify … would limit the size of
the total market opportunity,” the analysts said.

But it’s also not in Spotify’s interests to be too aggressive in
signing up artists, because the company is very dependent on the
labels and can’t afford to alienate them.

Most well-known musicians are already on long-term contracts with
particular labels, which often control the artists’ albums
they’ve produced in perpetuity. Spotify needs access to those
albums. The vast majority of songs played through its service —
some 64% — are songs that are at least 3-1/2 years old, which are
typically controlled by the Big 3, the analysts said.

Spotify has big opportunities in advertising and promotions

Still, Spotify’s financials can improve without it having to
become a major competitor to the Big 3, the analysts said. As the
leading player in the streaming business, the company is set to
benefit as growing numbers of consumers sign up. UBS projects
that the total number of streaming music subscribers will hit 726
million in 2027 from 176 million last year.

But Spotify could get a boost to its bottom line sooner than
that. Its contracts with the recording companies will be
renegotiated next year. Right now, the labels get about 52% of
the revenue Spotify generates from consumers. UBS is forecasting
that amount will go down to 50% in the next contract year, which
would help the company cut its losses.

But the company has other and potentially bigger opportunities to
improve its revenue and profits, the analysts said. Potentially,
the company could attract a significant chunk of the $4 billion
the labels spend on promoting artists by convincing them to tout
new musicians on its service.

Spotify could allow labels to sponsor songs or artists so that
would appear at the top of search lists on its service, the
analysts said. It could also offer advanced analytical services
that the labels could use to track how their songs, artists, and
promotional campaigns are faring.

What’s more, the company could expand its advertising sales
effort. Spotify runs about 6 minutes of ads per hour on its free,
advertising-based services. It could potentially increase the
number of ads its runs significantly, the analysts said. And as
it offers more video-based content through its app, it could make
a more serious play for video ads, which fetch higher prices than
other ads.

“We believe the revenue opportunity [from advertising and
promotions]  is sizeable,” the analysts said.

As part of the note, UBS analyst Eric Sheridan reiterated his buy
rating and $242 price target on Spotify shares. The company’s
stock closed regular trading on Monday up $1.95, or 1%, to
$176.97.