Day 6·Analysis

Why starting a record label could be Spotify's best path to profit

Spotify went public this week but it's still not turning a profit. Tech journalist Simon Owens says that if it wants to make money, it should start signing its own artists.

Netflix made House of Cards. Should Spotify start signing musicians?

A trader is reflected in a computer screen displaying the Spotify brand on April 3, 2018. (Lucas Jackson/Reuters)

By Brent Bambury

When Spotify went public this week, the New York Stock Exchange decided to pay homage to the Stockholm-based streaming giant's roots — and promptly raised the flag of Switzerland.

It was a minor glitch in an otherwise good day for the world's largest platform for music streaming. But Spotify faces serious challenges in the months ahead.

There's plenty of competition, some of it from the world's most powerful companies. And Spotify has never made a profit. Last year, despite bringing in $5 billion in revenue, the company had an operating loss of $461 million.

Simon Owens says it's time for Spotify to innovate.

"I've argued that [Spotify] should take a page out of Netflix's playbook," he says on Day 6.

Owens' proposal? Just as Netflix built a studio, Spotify should launch a record company.

Traders work on the floor of the New York Stock Exchange (NYSE) on the morning that Spotify began trading shares at the NYSE. (Spencer Platt/Getty Images)

Paying off the record companies

Simon Owens is a freelance tech journalist in Washington D.C. He says there would be many advantages to Spotify signing its own music artists, but the main one is that it would cut down on Spotify's costs.

"The problem for Spotify is that unlike other services like Netflix, it has high marginal costs," he says.

"Every single time a song is streamed, [Spotify] has to pay a royalty to one of the major music labels, and it's basically paying 75 cents on every dollar that it's making in these royalty fees."

These record labels are tied to Spotify, so they actually have a monetary interest in seeing it succeed.- Simon Owens

Netflix has an advantage when it comes to these fees. They pay a flat rate to license content, so they're exempt from per-play charges. Even still, Netflix decided to create their own shows.

"[Netflix] realized that the coming competition in streaming would drive up the operational costs for licensing shows," Owens says. "So it started developing its own original content to differentiate itself. So I've argued that Spotify should do basically the same thing."

DJ Marshmello performs onstage at Spotify's "Best New Artist Party" on Jan. 25, 2018 in New York City. (Noam Galai/Getty Images)

But there's a problem. If Spotify were to start producing music, it would be directly competing with the owners of the content it's now distributing.

Owens says record companies would likely accept that — because Sony BMG, Universal Music, Warner Music and EMI are all part owners of Spotify.

"A little-known fact is that early on, in order to make nice with the labels — because when Spotify launched it was an untested business model, so obviously these major record labels were skeptical — it sold equity to them."

"These record labels are tied to Spotify, so they actually have a monetary interest in seeing it succeed."

Record companies may have more than a monetary interest in preserving Spotify. In an industry ruled by music streaming, their survival may depend on it.

Daniel Ek, founder and CEO of Spotify, speaks onstage during Spotify Investor Day on March 15, 2018. (Ilya S. Savenok/Getty Images)

The data advantage

Creating and promoting music is cost intensive and risky, but Owens believes Spotify has a huge advantage when it comes to promoting new artists and helping them reach their audience: data.

Spotify has already demonstrated the influence of their algorithmically-driven playlists, like Discover Weekly and RapCaviar, in promoting new artists and making songs into hits.

"These playlists have real star-making power," he says.

The record companies know this well. In 2015, for the first time in a decade, the industry saw an increase in revenue, and it's all because of streaming. Licensing deals with services like Spotify are turning the industry around.

But what if you take the record companies out of the equation?

Owens argues that if Spotify started making direct deals with artists, both parties would benefit.

"They could offer them higher royalty rates while at the same time paying less in royalty rates overall because there isn't a major record label taking a cut," Owens says.

Still, existing labels would lose — and that could be a mortal blow to the music business' legacy record companies.

Alessia Cara performs at Spotify's "Best New Artist Party" on Jan. 25, 2018 in New York City. (Getty Images for Spotify)

The real competition

The "Big Three" — Universal Music, Sony Music, and Warner Music — can relax for now, because Spotify doesn't appear to be ready to take Owen's advice. Their objective in the coming months will likely be increasing their subscriber base, not creating music.

Spotify may be the world's largest streaming service but the competition — Apple Music and Amazon Prime — have deep pockets.

And in the U.S., Apple Music is growing faster than Spotify.

 "So they can afford to lose money," Owens says. "They're definitely a huge threat to Spotify."

The race is on to attract subscribers. Spotify is diversifying content to include video, podcasts and other multimedia.

But Owens warns that might not be enough. No matter how invincible the most valuable music company on Earth may look this week, it may well be an illusion.

"Look at Pandora," Owen says. "It was the first one on the scene, certainly the biggest on the scene for the first few years, had a huge head start — and now it's barely a blip on the screen."

"Just as MySpace is a warning sign early warning sign to Facebook about, you know, the perils of being on top — Pandora can be the same for Spotify."

Despite a valuation of roughly $30 billion, Spotify has yet to turn a profit. (Dado Ruvic/Reuters)

To hear the full interview with Simon Owens, download our podcast or click the 'Listen' button at the top of this page.