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Spotify's New Licensing Deal Is a Good Sign for a Future IPO

If Spotify wants to file for an IPO this year, this deal is a step in the right direction.

By Shona GhoshSenior tech reporter, Business Insider UK
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  • Spotify has made a major concession to its biggest music label partner, Universal, in allowing artists to release new albums to premium users first.
  • That concession has reportedly let Spotify negotiate what percentage of its revenue it pays to music labels.
  • This is important if Spotify's going to demonstrate it has control over its financial independence when courting investors for an IPO.

Spotify caved.

The streaming company signed a deal this week with the biggest music label globally, Universal, to allow "windowing". That means Universal artists can make their latest music available to paying, premium Spotify users for two weeks before the free users get to listen.

That's a victory for Universal musicians, some of whom have kicked up a big fuss in the last two years about streaming. The label has Taylor Swift, Coldplay, and Adele on its books, all of whom have previously held off releasing new albums on Spotify off the bat.

This is a big deal, because Spotify has always hated the idea of windowing.

CEO Daniel Ek has always been wedded to a 'freemium' model - making an amazing product available for free, and then hoping people will love it enough to start paying £9.99 a month.

One label executive told Billboard in 2015: "The problem is, Daniel is so evangelical about the process, you can't change his mind."

That's meant the free version of Spotify has been awesome for a long time, and differentiated from rivals like Tidal or Apple Music. But it also hasn't generated the paid userbase the company needs quickly enough, according to Mark Mulligan, veteran industry analyst at Midia Research.

"At the moment, it's a non-sustainable commercial model," he said. "It hasn't been converting as well in mature markets."

Mulligan added that Spotify needed to "think about what role" its free tier will play in future.

In the meantime, the streaming market has changed considerably. And now Spotify reportedly wants to IPO this year. And that's why the free tier has to change.

Let's look at that first point. Spotify's tagline is "Music for everyone", and Ek started the company after being wowed by the fact he could find any music on Napster for free.

The evolution of the streaming market means "music for everyone" is no longer really true. Look at Beyoncé's "Lemonade", for example, which was initially released only on Tidal, and still isn't available on Spotify. People are getting used to the idea that no one streaming service can be a Google for music.

And on that second point, here's why negotiating new deals with the major labels -- Universal, Sony, and Warner -- is crucial if Spotify is to IPO:

Mulligan said people often compare Spotify to Netflix, which has grown hugely and is profitable. But Spotify has much bigger challenges.

He said: "Netflix has much more control of its own destiny because the TV rights landscape is so fragmented. No one wields the power that the music labels do, they're like a UN Security Council veto."

In short, music streaming services are hugely reliant on third parties, whereas Netflix owns the rights to lots of successful programmes by itself. Spotify isn't a music label, whereas Netflix qualifies as a broadcaster. For investors, that's a worry, because Spotify is vulnerable to the demands of outside parties.

"Investors think about the worst case scenario," said Mulligan. "What if Spotify loses its licenses? It's an empty app."

What Spotify has to do before its IPO is change the nature of those relationships and gain more independence. In the case of Universal, it has caved on windowing but, importantly, has reportedly persuaded Universal to accept a lower share of streaming revenues.

That, said Mulligan, will send the "right message" to investors who will want to see Spotify take greater financial control. It's likely that Spotify has only negotiated a fractional reduction in revenue share, but that's still enough.

"This allows Spotify to [tell investors]: 'As the market grows, we'll be able to persuade labels to reduce their share of revenue from us, because we will deliver so much more overall'," said Mulligan.

Labels win either way, by making Spotify commit to growth targets. If Spotify grows quickly, they'll get more revenue anyway. If it doesn't, the labels can penalise it for failing to meet expectations.

With Universal on board, said Mulligan, it's probable Sony and Warner will sign similar deals. And that puts Spotify in a stronger position for IPO.

What does this backroom deal-making mean for users, though?

Firstly, Spotify's about to get much more aggressive in its marketing. If you don't pay for the service, Spotify will probably try and lure you in with cheaper subscription plans or bundle deals where you get a premium subscription through your mobile provider.

Otherwise, if you're a free user, Mulligan thinks you won't actually feel that much impact. As it stands, Universal artists can choose to window their releases, but that doesn't mean they will. And the type of people who need the free tier are younger.

"They are more playlist-oriented and, Ed Sheeran excepted, don't really listen to albums," said Mulligan. "I don't think that many people will feel the pain, and those that do are the ones that should be paying."

This post originally appeared on Business Insider.

Published on: Apr 5, 2017