Spotify’s Basic Supply Chain Model and its Complications

Spotify recently had its blockbuster NYSE debut in quite a unique fashion. The Swedish company became the largest company in NYSE history to avoid underwriting and legal fees in favor of a direct listing. With a market valuation of $26.6 billion, Spotify made waves in the news. However, the company traded down from its opening price, largely due to concerns regarding the growth potential and practicality of its modern business model within a fierce industry.

Spotify’s supply chain utilizes a “product as a service” model. From a product perspective, Spotify provides music to customers. From a service perspective, Spotify provides an unmatched music-listening algorithm which keeps listeners listening. From the supply side, Spotify pays as little as $0.004 in royalties for each “listen” of a song. To put this into perspective, Drake’s song “One Dance,” which has almost 1.5 billion listens on Spotify, has accumulated as much as $6,000,000 in royalties. Spotify may have significant marketing and operating costs, but those figures are tiny compared to the royalty expenses.

From the demand side, customers are willing to pay $10 per month for Spotify premium unlimited listening. This encompasses the service side of the business. Customers are paying not for the songs themselves, but for the service which curates the songs. This contains the explicit services of providing offline listening, playlist creation, no ad listening, etc. Further, this cost contains the implicit service expectation that Spotify’s services are up to par and that the music curation system is better than competition.

From these two sides of Spotify’s supply chain, we can see one thing: consistency. Spotify’s margins will always be consistent for the average user, and thus for the company as a whole. The only factor which materially affects their financials is their user count. In this sense, investors can rely on Spotify for margin consistency, but any major company growth must be lead by user growth, which can be more difficult to retain in the long term.

Has Spotify’s supply chain design dug them into a hole as some investors think? I don’t think so. Lower royalties or higher subscriber prices seem like the only ways they can sustain long term growth when user growth flattens, but compare $10 a month for unlimited listens to $10 per album for 15 songs, and you begin to see how much consumers need Spotify. Also, look at how streaming has become 75% of the music industry, up from 10% in just 5 or 6 years. Artists need it just as much as consumers. That is the dynamic that gives Spotify the flexibility to improve its supply chain.

Do you think Spotify is here to stay? Will its “product as a service” supply chain model hold? What do you see as the future for this industry?

 

https://www.forbes.com/sites/kevinomarah/2018/04/05/spotify-shows-the-way-to-a-content-economy/#63e826fb72ac

https://www.theverge.com/2018/4/3/17194208/spotify-ipo-nyse-music-streaming-market-valuation

 

What Streaming Music Services Pay (Updated for 2018)

12 thoughts on “Spotify’s Basic Supply Chain Model and its Complications

  • April 12, 2018 at 11:25 am
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    Spotify has gone to great lengths to revolutionize the music industry and challenge iTunes and their market share. Recently, they have announced that they will be going public to raise money for their company to continue growing. It is obviously yet to be seen how this will play out for the company but they have chosen to do something different than the way most companies go public. They will be going public via direct listing which means they will not be doing a road show to gain investors prior to their initial trading day. This will be very interesting.

  • April 12, 2018 at 8:44 am
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    Joe,

    This is a great post on a topic that we are all very familiar with. As I type this comment I am listening to spotify music. My biggest worry for spotify is the increasing number of alternatives for streaming music. While I believe Spotify is the most common among my friends, Soundcloud and Apple Music also play a prominent role in the music-streaming industry.

    I think Spotify’s biggest advantage, and one they need to utilize to increase their number of users, is their use of social media. Most users connect through their Facebook profiles, allowing them to easily share music and playlists with their Facebook friends. In a world where everyone wants to post everything on their social media pages, Spotify must find other ways to employ social media to increase users.

  • April 12, 2018 at 8:39 am
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    Joe,

    I am glad you decided to write your post on Spotify, as they have been at the center of the news all week. Spotify’s product has high-quality, long lasting assets that enable their supply chain to have sustainability which can not be acquired in many industries. The low royalties they have to pay for their product further interests investors because of the massive profit margin they have minus the royalties, management, marketing and other costs.

    Spotify’s supply chain is further sustainable and unique due to the nature of music listening. Almost everyone listens to music at least once a day. Spotify recognizes this fact and created an easy, affordable way to have an individualized experience.

    Spotify also holds great assets, such as their music algorithms. Their algorithm takes the music you listen to, and creates playlists and song suggestions based on what you like. This keeps people listening to their music for longer, and makes them want to do this with Spotify because they can’t find this service many other places.

    SOURCES: https://www.forbes.com/sites/kevinomarah/2018/04/05/spotify-shows-the-way-to-a-content-economy/#389662ba72ac

    https://www.buzzfeed.com/brendanklinkenberg/spotifys-robots-want-to-make-a-playlist-just-for-you?utm_term=.wp8M3QaYR#.ymJ0GLYg2

  • April 11, 2018 at 11:34 pm
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    Joe,

    I really like this post because I am a huge advocate of Spotify. I noticed Jess brought up Apple Music. The discrepancies in the two are interesting to look at. As someone who has been a subscriber of both, I have my own opinions on what is better. It is also important to note that there are other music platforms you can subscribe to, but Spotify and Apple Music are far and away the market leaders. Those other platforms include Google Play, Amazon Music, and YouTube music.

    I used Apple Music for a while until I realized that Spotify had more to offer, and half the cost (for a college student). For a college student, Spotify takes 50% off your monthly fee bringing it to five dollars per month. Apple Music does not have this feature, and in my opinion, that is hurting them. Furthermore, the Spotify family plan is better for a family of at least 4 (and no more than 6) people than Apple Music. Spotify charges a flat rate of fifteen dollars per month for up to six people while Apple Music charges five dollars per month per additional user.

    Spotify also uses different algorithms than Apple Music to determine new music you might want to listen to as the user. Although this is also just my opinion, I believe I find better music through Spotify instead of Apple Music. These are very intriguing processes that these music platforms are going through and I am excited to see what is to come next through these ideas.

    https://www.cnet.com/news/apple-music-vs-spotify-whats-the-difference/

  • April 11, 2018 at 7:57 pm
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    Joe, I completely agree with your point regarding the shift in the music industry to being streaming based. When I was younger, I believe I stated that I would never transition to a streaming based music library, yet here I am as a customer of Spotify. I like that you highlight their supply chain practices. Thanks for the post and for enlightening me to supply chain aspects within a company that one would not necessarily view in the operations lense.

  • April 11, 2018 at 5:24 pm
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    Joe,

    I really enjoyed your article about Spotify. I have always wondered how Spotify can obtain the rights to all of these songs and legally stream them at an affordable price. With that said, the example that you gave with Drake’s song is mind boggling to me. Essentially, Spotify has agreed to pay Drake $6,000,000 dollars for the right to stream ONE song. That’s not to mention all of the other songs that have billions of streams. With this being said, Spotify must know what they are doing because they have continued to grow and grow over the past couple years. And because of this, I believe that Spotify is here to stay. Their business model is too convenient and accessible for consumers to walk away from it anytime soon. Moreover, the graph that you provide shows that the music streaming industry is growing at unbelievable rates. Personally, I believe that Spotify will continue to see a growth trend for the coming future. At least until another company comes along and creates a better product. However, until then, Spotify is the most convenient, economical, and logical way to stream music. Especially if you listen to music every day.

    However, I do believe that Spotify has a large problem that it needs to address should it wish to increase profitability and sustain their growth: large royalty fees. According to an article I found, Spotify is lacking in the profitability realm and only enjoying healthy growth due to the growth in the industry itself. In order to sustain this growth, it will be imperative for them to create partnerships with music labels such as Universal and Sony. Hopefully this will allow them to cut back on expenses, retain some of the cash they are making, and use that to invest back into their company.

    References:
    http://www.abc.net.au/news/2017-09-06/digital-music-streaming-rising-but-spotify-losing-money/8875188

    • April 11, 2018 at 9:07 pm
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      Daniel,

      Your comment on Joe’s post is very insightful. I agree that Spotify is a solid company and will continue to be a successful platform for years to come. I also agree that Spotify needs to address its issue of large royalty fees. The article you added is very interesting. I think that Spotify needs to be cautious of the changing industry and not rely on the fixed idea that this industry will continue to grow at a profitable rate. I think that a solid partnership with a successful music label will help ground them as a successful company in the event that the industry fails or becomes less successful in the future.

  • April 11, 2018 at 2:34 pm
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    Joe,

    I find it ironic that while I am writing this blog post, I am currently listening to Spotify. However, I have chosen not subscribe to Spotify Premium. Since I am not a premium member, my music is interrupted with ads. I do receive the occasional option to receive 30 minutes of ad-free listening if I watch an ad. For the amount of time I use Spotify and when I use Spotify, it is not worth the $4.99 a month (the student discount) to receive the added perks of being a premium member. Therefore, I can see how maintaining user growth could be difficult for Spotify to sustain long-term. This could be a concern for investors since Spotify’s major source of growth is a result of user growth. However, on the other hand, Spotify is known to do a good job converting its free subscribers to paid subscribers. Maybe investors should not be as worried about user growth.

    In addition, with the increasing popularity of music streaming services, more companies such as Apple and Amazon have entered the music streaming market creating more competitors for Spotify. In order to stay ahead of its competitors, Spotify should constantly monitor the business models and music curating techniques of its competitors. In addition, Spotify needs to maintain a competitive advantage over these competitors. Currently, one of their main competitive advantages is that with a premium subscription, members receive a Hulu subscription. This package permits Spotify to compete directly with Amazon Prime. So in addition to unlimitedly streaming music, premium members are able to unlimited streaming of movies and TV shows on Hulu.

    In addition to concerns with Spotify’s ability to maintain growth long-term, investors are considered with Spotify’s business model. Spotify should consider evaluating their business model every set number of weeks, to ensure the efficiency of their supply strategy. Spotify needs to be conscience that its supply chain needs to meet the competitive priorities of the operation strategy. Additionally, Spotify should constantly review its supply chain strategy to ensure costs are reduced and performance is maximized.

    In my opinion, investors should be concerned because customers ultimately control the fate of a company. Additionally, the needs of customers are in a state of constant flux, which are always changing along with the trends of society. For example, vinyl records were once considered outdated, however, over the last couple of years the popularity of vinyl has resurfaced. As, this Forbes article (https://www.forbes.com/sites/billrosenblatt/2018/04/08/in-the-new-era-for-music-streaming-rules-but-human-factors-endure/#450b9e035472) discusses the human factor plays a huge factor in the “new era of music”. Therefore, I think Spotify needs to consider ways it can attract the consumer who wants to own music and have a physical copy in hand while satisfying the consumers who enjoys traditional radio. If Spotify can figure out ways to attract these consumers, I do not think user growth would be a major concern of its investors.

  • April 11, 2018 at 1:48 pm
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    Joe,

    It’s always interesting to apply traditional supply chain concepts (i.e. concepts that were developed around manufacturing or traditional distribution and retail stores). Spotify’s innovative streaming model, and their obvious success, make them a great case study.

    In the traditional framework that we discussed in class, Spotify operates in between listeners and advertisers (customers) and record labels and musicians (suppliers). As we discussed, information, money, and material flows through all three of these parties. Today, I’d like to focus on the money that flows through this framework. A recent New York Times’ article contained an awesome series of graphics that follow $1 of Spotify’s revenue throughout its “supply chain.” The article can be found here: https://www.nytimes.com/2018/03/31/business/media/spotify-streaming-music.html.

    One of the most surprising aspects of the graphic was how an artist’s supply chain decisions (i.e. are they with a major record label, a part of an independent record label, or a self-releasing artist with a distributor) impact the share of Spotify’s revenues that they receive. For starters, about 90% of Spotify’s revenue comes from subscriptions while only 10% comes from advertising (NYT). In every case, Spotify keeps 29 cents of every $1. The breakdown of record label and distributor cuts is outlined below:

    Supply Chain Scenario 1: Major record label: 50 cents of every $1
    SC Scenario 2: Independent record label: 29 cents of every $1
    SC Scenario 3: Distributor for self-releasing artist: 6 cents of every $1

    With that breakdown in mind, the flow of money to the end supplier (the artist) in each of the following supply chain scenarios is below:

    SC Scenario 1: 6 cents of every $1
    SC Scenario 2: 40 cents of every $1
    SC Scenario 3: 64 cents of every $1

    The disparity is quite shocking. Obviously, artists that sign with record labels, especially major ones, are afforded large up-front payments and benefit from talented marketers, advertisers, and PR persons that work at these labels. On the other hand, the intermediaries between themselves and Spotify can be extremely costly if an artist’s song becomes viral and the streaming volume increases exponentially.

    Words: 344

    Source: https://www.nytimes.com/2018/03/31/business/media/spotify-streaming-music.html

  • April 11, 2018 at 1:26 pm
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    Thanks for the post!

    Pretty much every on-demand service offers the same 35 million songs but Spotify has unique factors that distinguish them from the competition. With their hundreds of millions of active users and continuous streaming of 11.5 billion hours in one quarter, Spotify is in a unique position to collect and analyze data to improve the user experience of things like search functionality and content discovery. Spotify uses its data to personalize the user experience, one of the company’s key competitive advantages. the company’s algorithms rely on the aggregated user data and personal data to push the right content at the right time based on the time of day and the user context. This level of personalization is a tough thing to compete with, especially considering the company’s scale. While Apple’s pitch for Apple Music was based on the idea that people want expertly curated playlists, Spotify also recognizes that there is a demand for the ability to create their own playlists and listen to other user’s playlists. Like Netflix and Amazon, similar product-as-service companies, one move that Spotify could make would be to enter the industry of producing their own music. Like you mentioned in your post, Spotify’s largest costs come from the royalties they pay for music, thus original content will give the company pricing power. I don’t think that Spotify is going anywhere, they have created a strong brand image and created an experience that users have become accustomed to. The company should work on increasing their organic user growth – this can be done through different marketing tactics such as unique experiences or different collaborations with artists and other brands.

    https://www.thestreet.com/story/14544562/1/spotify-hasn-t-yet-justified-a-30-billion-valuation.html

    https://www.fool.com/investing/2018/03/01/what-are-spotifys-competitive-advantages.aspx

  • April 11, 2018 at 10:33 am
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    Joe,

    Spotify is an extremely interesting company that I’m sure the majority of students use daily. In fact, there are currently 157 million users worldwide and that number is expected to jump to 200 million by the end of 2018. Of the current users, only 71 million users actually pay for the service which is only around 45%. Because this is where the company is making its money, I was surprised to learn that Spotify is in the process of updating their free service to resemble their paid service more. Especially considering the fact that, at this point, they are not even generating a profit. This update would include easier mobile use, quicker access to playlists, and more control over song selection. Spotify claims that this update is going to prompt more conversion to paid users, but I am unsure. As someone who currently pays for Spotify, hearing about the new free services makes me consider if I will stop my subscription when the new free update because available. I think this is also particularly risky because Apple Music is currently on the rise. While it currently only has 38 million subscribers, Apple has announced that it is growing at a healthy rate. It will be interesting to see in a year from now what these two music services look like.

    Sources:
    https://www.bloomberg.com/news/articles/2018-04-10/spotify-is-said-to-plan-new-version-of-free-music-service
    https://www.npr.org/sections/therecord/2018/04/04/599385111/spotify-is-for-now-the-worlds-most-valuable-music-company
    https://seekingalpha.com/article/4162228-will-spotify-ever-generate-profits
    https://techcrunch.com/2018/04/10/a-revamped-version-of-spotifys-free-service-is-reportedly-in-the-works/

  • April 10, 2018 at 8:13 pm
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    Joe,

    Fascinating post on a “product as a service” that I rely on every single day. According to Fluent, 7 out of 10 American consumers listen to music everyday like myself, and 8 out of 10 Americans get their music fix via a streaming service. The main players in the streaming world are Spotify, Pandora, and Apple Music, but according to the Digital Trends website, Spotify is by far and away the king. Because most people listen to music every day, stream their music, and use Spotify to do so, I agree with you. I think Spotify will be sticking around for the long run. I didn’t realize how large of a cost their royalty expenses are, but I think customers would be willing to pay higher monthly fees to continue to utilize this top-class “product as a service”. Spotify uses incredible algorithms and features unique benefits that blow other streaming services out of the water. Just the “Behind the Lyrics” feature keeps my eyes and ears glued to the app on my phone. There is so much more to Spotify that makes the premium subscription worth it for me and for other users too. I think the combination of products and services in one model will hold, and, for now, Spotify does it best.

    http://www.fluentco.com/insight/disrupting-music-consumption/
    https://www.digitaltrends.com/music/apple-music-vs-spotify/

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