Tech

Leila Abboud is a former Bloomberg Gadfly columnist.

Spotify Ltd today is essentially a massive music collection and radio station mashed into one: users can listen to whatever they want, or let the virtual DJ in their pocket recommend tracks and artists.

It's a seductive combination that's attracted 100 million listeners, of whom 40 million were paying subscribers as of September. Yet despite nearly doubling sales last year, the high cost of licensing music from record labels and publishers means the Swedish company has yet to turn a profit. Last year, U.S. rival Pandora Media Inc. had a gross margin of about 47 percent, Apple Music 40 percent and Spotify about 25 percent, according to Bloomberg News. A whopping 84 percent of Spotify revenue went on licensing fees last year, not the easiest of sells to investors when it tries to go public next year:

Streaming Economics
Spotify is growing fast but remains unprofitable in part because of the cost of licencing music from labels and publishers. Those costs consumed between 81-86 percent of annual revenue since 2013.
Source: Company reports

I've looked before at how Spotify could lure more paying customers by offering distinct high and low-end services at different prices. There's something else it might do to improve profits and shore up its power: mimic Netflix by becoming a producer as well as a distributor -- and take other steps to bring more music on board that doesn't cost so much.

That means acting more like a label. Traditional music labels do two big things: discover and nurture artists, and market them. With a trove of user data, a strong brand and global reach, Spotify could do that too. Imagine if it branched out into developing independent-minded artists such as British grime star Skepta. Or if it allowed unsigned acts to upload music to its service in a similar way to SoundCloud or YouTube. Spotify could even try buying independent music labels such as Beggars Group (home of SubPop and Matador Records) or Warp (London's electronic dance music specialist.)

It could then use its control over curated playlists and recommendations to push its own stuff. Over time, this might even give it more clout when negotiating with labels.

If this sounds familiar, it's because Netflix Inc. has shown the way. By becoming a huge producer of TV series -- on track to spend $6 billion next year -- the video streamer has cut its reliance on suppliers such as Twenty-First Century Fox Inc. and NBC. The only problem is that this consumes a lot of cash:

Two Sides
Netflix is burning more cash even as sales rise
Source: Bloomberg

That said, Netflix is profitable and investors haven't fallen out of love yet:

Big Swings
Netflix shares are nearing all-time highs again after falling steeply this year over concerns about slowing subscriber growth and its heavy spending on original content
Source: Bloomberg

The comparison between Netflix and Spotify isn't perfect, of course. Users of the streaming video services don't expect it to have every movie and TV show, whereas Spotify's proposition rests on having everything. Yet an individual only listens to a tiny fraction of its music so it's fair to ask whether the status quo must hold.

Plus Spotify wouldn't need to spend billions. It can be selective and still target loyal heavy metal or dance music audiences, for instance.

The strategy would carry risks. The labels might retaliate by withholding music or other measures. Spotify's in talks with Warner Music Group Corp., Sony Corp. and Vivendi SA's Universal over new licensing deals so this might not be the best moment. Once public though, it'll have access to debt markets and can use shares as takeover currency. As Netflix has shown, investors will back this kind of spending if they believe power can be wrested from traditional producers.

Spotify has, in fact, started developing some content, including songs without vocals. It'll release 12 video shows this year, including mini-documentaries about Metallica and hip-hop guerrilla performances from Russell Simmons. Its so far unsuccessful talks to buy SoundCloud could turbo-charge an original content strategy by bringing in unsigned artists and DJs.

The internet has upended the music business by destroying barriers to market for artists and inventing a new distribution tool with streaming. There's no reason why the new guys should stick to old roles born in an era where records and CDs had to be printed and shipped. Spotify can be something totally different.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Leila Abboud in Paris at labboud@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net