Spotlight on Spotify

Spotify:  Good or evil?  

The point of view that I have heard expressed recently - primarily by artists (musicians and songwriters), but also from other people is that Spotify is the second coming of the devil.  There is a littiny of criticism, much of it alleging that Spotify is unfair to artists.  This may be true to some degree, but my thesis is that the issues being cited are not Spotify's "fault" but a direct consequence of digital music economics.  I will explore this topic in this blog post. 

Let's go back to the good old days, long before Spotify.  Before CDs and digital music.  Records were vinyl and analog.  Recording your tune meant paying an exorbitant amount for studio time, record manufacturing, distribution, inventory, marketing, channel costs, etc. A recording was a physical good, something you could touch, hold, keep, trade or sell.  

Economists call such a thing a rivalrous good.  If you possess a rivalrous good (e.g. a vinyl record), it means that your best friend can't also possess it at the same time and if he wants one, he'll need to buy it. This generates additional demand for the record which can be monetized directly, and the creator of the record gets paid (as well as others in the music ecosystem).

It is, indeed, very straightforward to monetize rivalrous goods such as vinyl records - you simply produce and sell them.  Manufacturing each record incurs cost and the idea is to sell them for more than it costs to make.  You'll need to clear your fixed costs (studio costs, overhead, etc.), but once you do, money can be made this way.  This is the classic business model that historically provided a pretty good living for many in the music community.

However, you probably already know where this is headed as we fast forward from the days of vinyl to more recent times... the days of selling CDs.

Initially, CDs behaved as if they were rivalrous goods, just like their 12" predecessors... even though they were digital and you could theoretically 'rip' and share the tunes.  People were at first, unfamiliar with sharing, and besides, it was inconvenient. Plus there was a ton of inertia in the 'old' way of acquiring recordings, one album at a time.  Further, over time, the convenience and acceptable audio quality of the CD drove US recorded music sales to record-high levels in the late '90s - a statistic that still stands today.

However, once music was fully digitized, and people became broadly familiar with music as a file on a computer or your iPod (instead of a physical record or CD), it quickly became a non-rivalrous good.  You and your friend can both own the recording simultaneously, with almost no effort or loss of quality.  It can be shared broadly and conveniently (e.g. Napster, file copying, etc.).  Further, the creator doesn't directly benefit financially when you provide a digital copy to your friend.  You can clearly see the impact in Figure 1.  The entire US music industry was headed off of a cliff in 2009. 

Figure 1:  US Music Sales 1999-2009
https://money.cnn.com/2010/02/02/news/companies/napster_music_industry/ 

Had this trend continued today, there would have been thousands of unemployed people in the music industry and much, much less recorded music produced professionally every year.

What the music industry needed to figure circa 2009 was how a rivalrous good could be monetized.

Economists will tell you that one way to do that is to make the rivalrous good excludable - so you can exclude someone from accessing it.  Then you can charge a fee - a subscription perhaps - for listening to the recording (with built in restrictions to prevent copying).

Digital assets can, indeed, be made excludable by adding copy protection.  The technology has existed for some time and is easily deployed.  However, when folks tried this with audio recordings several decades ago, it went over like a lead balloon.  Nobody would buy these copy protected recordings.  

Why?  The horse was already out of the barn - tons of non-copy protected digital media had already been shipped to the market, and the introduction of copy protection felt like something was being taken away.  Plus the copy protection took away many of the conveniences that digital formats brought to your music collection:  having multiple copies, sharing with friends, etc.  

Note that the movie industry was much more calculating and forward looking than the music industry as it went through a similar digital transition - not only did people continue to expect to pay for movies, they also got used to (semi-strict) copy protection on DVDs.  If the music industry had figured this out in the early '80s and never shipped any non-copy protected digital music, things might be far different today.

By this point in time, the general public was viewing recorded music as a non-excludable, non-rivalrous thing.  Economists call this a public good.    Something like PBS TV.  Central Park.  Open source software.  Something created for the good of the public, which everyone has a right to use, and benefits people broadly.  Something people don't expect to pay for. 

In fact, Wired Magazine published 13 songs in 2004 that were released as "open-source", further establishing that music should be freely available,

Refer to figure 2 below for other examples of non-rivalrous, non-excludable (e.g. public) goods.

Figure 2:  Definition Matrix
https://en.wikipedia.org/wiki/Public_good_(economics)

Everyone enjoys public goods - but the only problem is that the people making, producing, marketing and distributing the music weren't getting paid anymore.  Revenue decreased from $21B a year in 1999 to less than $7B in 2015.  That is quite a haircut and the music industry could not have been sustained in its then-present form had the trend continued.

Enter Spotify (and other streaming services).

The founders of Spotify, of course, realized they could not directly monetize something people perceive as a public good, even though it has a high value.  But what about:

• Providing access to a full collection of (pretty much) all the music ever recorded?  
• Being able to know that the collection will always be up to date with the latest recordings?  
• Enjoying expert curation and sharing of playlists by respected luminaries in the music industry? 
• A place where you can discover the newest material and most recent artists as they are first hitting the scene? 
• The ability to network on recorded music with people you know in your music community (and extending to many people you don't know that share similar interests)?  

All of these features of Spotify are of course non-rivalrous... both you and your friend and everybody else can 'own' them simultaneously.  But they are excludable.  Spotify can monetize by granting access only to those who would pay a subscription fee (or listen to advertisements). And they do exactly that.

The business model of streaming has, indeed, turned the US recorded market around.  As can be seen in Figure 3, in 2017 music revenue was growing again for the first time in almost 20 years.  For the first half of 2021, the RIAA reported US revenues of $7.1B - a run rate of $14.2B for the entire year of 2021 - more than double 2015's revenues.

US Recorded Music Revenues (RIAA) 1977-2017
https://www.visualcapitalist.com/music-industry-sales/

Is Spotify (and other streaming services) the enemy?  It looks to me more like their business model (and innovation around streaming services) might have saved the recorded music industry.  Without the existence of Spotify, it is likely that the music industry would be far smaller than it is today - it would have gone through consolidation, emerging far smaller with much less capital investment (smaller number of recording studios, record companies, distributors, marketing and publicity firms, etc).

Whenever an industry goes through a strategic inflection point such as the one we have been discussing, the entire value chain is almost always disrupted.   There are always winners and losers:  

The consumer very definitely ended up on the winning side of this one - lots of the cash that would have gone into various parties in the music industry flowed right into the consumers' pockets.  People I know used to regularly buy 10-20 CDs a month now pay $9.95 for a Spotify subscription - that is about $190 extra in these particular consumer's pockets every month.  In addition, the digital music experience is much richer in a number of ways (all the Spotify features listed above, for example).  People are getting much more music and a significantly better experience for much less money.

It is clear that the music industry, generally, has also ended up on the winning side.  The recently increasing revenues in Figure 3 above tell this story well.  However, if we look specifically at artists (musicians and songwriters), one can argue that the story is a bit more nuanced.  

Artists have actually ended up both losing and winning.  The downside is that most are unfortunately now receiving only a fraction of the direct revenue that they could have made in the old ecosystem.  On the upside, any musician or band can get their music distributed to 180 million Spotify subscribers - just about for free, anytime they want to.  I'll have much more to say about this as well as how artists can use the huge spotify subscriber base to monetize in other ways (e.g. in a two sided market) in a future post.

To summarize my views on Spotify: it is not their "fault" that many musicians are making less money on their recordings, but, as we have seen above, a direct consequence of the digitization of music.  There are several other economic factors at work too such as supply and demand of music (and even supply and demand of musicians) as well as the retooling of the entire music industry value chain.  I will explore this as well as some significant upsides for musicians and songwriters too, in the next blog post.