Universal And Spotify’s Deal Is An Even Bigger Deal Than It Looks

Universal Music and Spotify have finally agreed on terms for the streaming service’s new licensing deal which reportedly includes better rates tied to growth targets and premium windowing. Check out Tim Ingham’s piece for detail on the deal. Although the big focus across the industry so far is, understandably, on what this means for Spotify, it is also part of a bigger story, namely that of the maturation of the streaming market and its associated business models.

What It Means For Spotify And UMG

Firstly, what it means for Spotify. As I have written previously, Spotify needs to create a strong narrative for Wall Street if it is going to IPO successfully. Within that narrative it needs to demonstrate that it is embarking on a journey of change even if the destination is some way off yet. Its relationship with the labels is central to that. Paying out more than 80% of revenue for ‘royalty distribution and other costs’ on a cash flow basis is not something potential investors exactly look upon with unbound enthusiasm. In pure commercial terms Spotify actually pays out round about the same amount (c70%) of revenues to rights holders as Netflix does, but because Netflix owns so much of its own rights it can amortize the costs of them to help generate a net profit while Spotify cannot.

The 2 ways of fixing that are 1) owning copyrights, 2) reducing rates to rights holders (which really means labels as publishers are pushing for higher rates). It is probably too early to flick the switch on the ‘Spotify as a label’ strategy as that would antagonize labels at exactly the wrong time. So reducing rates is the main lever left to pull.

However, the labels feel the rates are fair value, in fact many think the rates undervalue their content assets. So Spotify was never going to achieve a dramatic change in rates at this stage. Also, labels are wary of granting better terms to Spotify because Apple and co will immediately demand the same. Hence UMG has tied Spotify’s lower rates to growth targets, which you can rest assured will be ambitious. Why? Firstly the labels need continued big growth. The global music business grew by around 1 billion dollars last year, with streaming growing by 2 billion dollars. Thus without streaming’s growth the music business would have declined by 1 billion dollars instead of growing by that much. The labels cannot afford for streaming growth to be smaller than the amount by which legacy formats decline.

Secondly, Spotify needs better deals more than many of its competitors, so is more willing to agree to ambitious growth targets. Apple and Amazon (who both make their money elsewhere and aren’t prepping for an IPO) are less concerned about better rates and are less likely to be willing to be tied to strong growth targets. So UMG has a win win here. It gets Spotify tied into ambitious growth without a major risk of having to also give lower rates to Apple and Amazon.

What It Means For The Wider Market

With $5.8 billion in revenue in 2016, streaming has more than come of age, it is the beating heart of the recorded music business. But just as young companies have to transition from scrappy start ups to mature companies, this is the stage at which the streaming market as a whole needs to move from a cool emerging technology to a more nuanced and complex marketplace. It needs to develop the sort of sophistication that $5.8 billion market merits. Adding the ability to window new release albums is part of this process. And to be clear, the windowing does not mean that UMG’s new music is suddenly going to disappear off Spotify’s free tier. Instead UMG has the ability to choose to put selected albums behind the pay wall for 2 weeks as Daniel Ek’s press release quote makes clear:

While there is a risk that windowing may give piracy a little boost, those consumers that choose to Torrent rather than upgrade or simply wait 2 weeks were never realistic targets for the 9.99 tier anyway. What we may well see is a spike in uptake of free trials and the ‘$1 for 3 months’ super trials.

Getting The Right Kind Of Growth

The UMG – Spotify deal is more than just an agreement between 2 parties. It is the start of the next chapter in relationships between streaming services and labels. A deepening and strengthening of links. It is of course a unique product of its time (ie Spotify needing to get its house in order ahead of the IPO) but market defining precedents are often born out of such circumstances. Such as the time when AOL Time Warner wanted to ‘get smart with music’ following its recent merger and promptly sent off Warner Music’s CEO Roger Ames with Paul Vidich to carve out the iTunes deal with Steve Jobs.

Back then Apple was focused on trying to jump start iPod sales. Now though the labels need Spotify to start building a sustainable business. It is not enough for Spotify to simply clear the IPO hurdle, it needs to land on its feet and maintain speed. So while it’s great to see that UMG and Spotify have hit upon a framework for delivering better rates in return for better growth, Spotify must be careful to ensure that it grows sustainably and not pursue growth at any cost.

2016 was inarguably a great year for both streaming and the labels. This deal has the potential to lay the foundations for an even better 2017 and beyond.