Spotify can’t become the next Netflix unless it signs its own artists

It can be tempting to compare Netflix and Spotify. After all, the two are successful SaaS-like products that have managed to get tens of millions of consumers to pay somewhere around $10 a month for their software product. This is a considerable feat not matched by many other companies. But there are actually several advantages Netflix has that place it in a much stronger position than Spotify

For one, while Netflix has high fixed costs (it plans to spend $8 billion on content in 2018), its marginal costs are almost non-existent. When Netflix licenses a show like Friends, it pays a fixed licensing fee, and so that means every time a new customer streams that show there’s no additional cost to Netflix. Spotify, on the other hand, has to pay a royalty for every stream, so every time it adds a new customer, it’s also increasing its costs. Yes, it’s negotiated with the music labels so that that royalty goes down the more subscribers it adds, but those marginal costs will never go away and are the main reason Spotify isn’t yet profitable despite reaching 70 million paying subscribers.

Secondly, Netflix isn’t expected to carry every television show that’s ever been created in its catalog. For instance, I subscribe to Netflix, Hulu, and Amazon, and I’m perfectly fine with the fact that Netflix doesn’t have episodes of Broad City while Hulu does. This gives Netflix plenty of negotiating power; if a TV network refuses to budge on price, Netflix can walk away. Spotify doesn’t have this luxury; consumers expect any streaming service to contain the entire music library of every song in existence. When Spotify is negotiating with a music label, both sides are aware that it needs that label’s content in order to remain a viable option for consumers.

But perhaps the most important difference between Netflix and Spotify is that Netflix recognized long ago that the streaming space was only going to get more crowded (and would include streaming apps launched by the very TV networks from which it was licensing content), and so it started shifting more and more of its budget to producing its own content, producing early shows like House of Cards and Orange is the New Black. Recently, an executive claimed that Netflix will have 700 original programs on its platform by the end of 2018. In 2013, chief content officer Ted Sarandos famously said that “the goal is to become HBO faster than HBO can become us.”

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This gives Netflix the advantage of having differentiated content on its platform; if someone wants to watch a hit show like Stranger Things, they have no choice but to sign up for a Netflix subscription. But just as important is that the original content shields Netflix from being too reliant on outside content creators. Competing streaming services like Amazon Prime and Hulu are driving up the prices for licensing deals, and some studios are outright refusing to sell to Netflix at all. Disney, fresh off buying Fox Searchlight, announced it was pulling all its content from Netflix so it could focus on its own streaming app. If Netflix had never pursued its original content strategy, this news would have been devastating to its future business prospects.

Now let’s talk about Spotify. It’s almost entirely beholden to the music labels, with a few exceptions (which I’ll get to in a moment). And despite many suggestions that it should, it hasn’t attempted to form its own music label, essentially identifying upcoming artists and signing them exclusively. And its executives have signaled that it has no plans to do this in the near future. And this makes the company extremely vulnerable given that three of its biggest competitors (Apple, Amazon, and Google) are among the most valuable companies in the world and have much larger warchests that could be used to pay off the music labels for things like windowing, which is when one streaming service gets exclusive access to a new song or album for a period of weeks before it’s made available on other platforms. In some cases, big artists like Taylor Swift have actually pulled their songs from Spotify simply because they didn’t like its business terms.

There would be several advantages to Spotify signing its own music artists. Like Netflix did in the development of its shows, Spotify could leverage its massive amounts of internal data for what its users prefer and could even identify up-and-coming indie artists that have been yet to be signed to a music label. It could also use its influential promotional power to grow an artist’s following, inserting their songs into its playlists; one music label has claimed that playlists increase a song’s streams by between 50 and 100 percent.

There are a couple reasons this approach could be a game changer for Spotify. The first is that Spotify would have differentiated content that sets it apart from competing apps that otherwise have the exact same music catalogs. This would hopefully then increase its leverage when negotiating with music labels. But perhaps the most important benefit is that it could simultaneously increase the pay of the artist while paying less for the content overall. How? By increasing the royalty given to the artist while cutting out the expensive middleman that is the music label.

I’d be remiss if I didn’t mention that Spotify has invested in original content in the past, but it was in video, not music. In fact, it paid between $20,000 and $200,000 per episode for the series it commissioned. But the video market it entered was already crowded and dominated by much larger players, not to mention that video isn’t Spotify’s forte. It would be as if, instead of launching its own shows, Netflix had signed on music artists instead. After lackluster viewership from its users, Spotify drastically scaled back its video efforts around the same time that its head of video content departed from the company.

Of course, there’s one little snag in this entire argument, and it’s that Spotify, in its early bid to gain the skeptical trust it needed from the music labels in order to get them to let it stream their catalogs, allowed those labels to invest in the company. This was probably a smart decision for when it was trying to get off the ground, especially since it was debuting a then-untested model, but this may hinder it in adopting a strategy that is antithetical to the labels’ own interest. It’s unclear to me what kind of voting power they have at the company and whether CEO Daniel Ek has the indepence needed to overrule them.

I certainly hope he does. Now that Spotify’s carved out a new market, there are plenty of new competitors on the scene, and even though it’s currently the leader in music streaming, both in free and paid subscribers, it’s in a vulnerable position, the same vulnerable position Netflix found itself in several years ago.

For Spotify to guarantee its long term security and ensure it isn’t held hostage by the very music labels it depends on, it must become a music label itself.

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Simon Owens is a tech and media journalist living in Washington, DC. Follow him on Twitter, Facebook, or LinkedIn. Email him at simonowens@gmail.com. For a full bio, go here.

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Tech and media journalist. Email me: simonowens@gmail.com

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