Recently, as the world's largest streaming music platform in terms of subscription user base, $ Spotify(SPOT.US) announced a price increase in the United States after nearly a year, with the increase in different packages exceeding 10%. Although the management had hinted at being "ready to increase price" during the previous earnings call, the second price hike exceeded market expectations, leading to a 4% surge in the stock price on the day. Looking at a longer period, since the last price increase in July 2023, Spotify's market value has doubled.

For subscription-based streaming platforms, price increases have always been a recognized investment logic in the capital markets. The platform is like a gatekeeper, as long as it guards the key fortress on the essential path, the subscription model of paying on time is a business of collecting rent effortlessly.

When the platform decides to raise prices after weighing the options, it indicates a strong self-assessment of the company's "fortress" and is a manifestation of the company's core competitive advantage. After a price increase, there may be some fluctuations in traffic in the short term, but as long as the most valued product advantages for users remain unaffected or unshaken by competitors, users who leave will eventually come back. Netflix is a good example, as it has repeatedly overcome user complaints about annual price increases and resistance from some users after cracking down on password sharing with wave after wave of high-quality content.

Although both are leading players in the streaming media industry, the market's enthusiasm for Spotify is far less than that for Netflix, raising three main questions:

（1）Growth: After the pandemic dividend, industry growth has rapidly declined, what will drive future growth?

（2）Competition: Can the monopoly advantage be maintained? How does the competition from giants like Apple, Google, Amazon, etc., look?

（3）Profitability: Why is it harder for music streaming than video streaming to be profitable? Can Spotify be profitable?

Dolphin will analyze Spotify around these three core issues. This article mainly focuses on the industry and major players, discussing questions (1) and (2), while the next part will focus on business models and future predictions to provide a reasonable valuation.

I. Is There a Bright Future for Streaming Music?

In general, the music industry is already considered a mature industry. Like most content industries, each round of exponential expansion in industry scale fundamentally relies on technological changes that make user experience qualitatively leap, thereby further increasing users' willingness to payHowever, there will inevitably be a friction period during the migration of old and new channels—the new channels lower the fee threshold to accelerate user migration, leading to the rapid demise of old channels, resulting in a gap in overall channel revenue during this period. Taking the U.S. market as an example:

The tape era of the 1970s and 1980s (blue in the figure below), the CD and DVD era of the 1990s (yellow in the figure below), and the digital music era that began in 2005 (including the streaming music that began to take shape around 2010, green in the figure below) mark the transition of transmission media.

However, during the transition period of the three eras, when the new media had not yet emphasized monetization but focused on penetrating users with lower payment thresholds, the overall music industry scale was affected by channel switching, leading to a significant decline. Nevertheless, the new technologies ultimately improved user experience, thereby increasing user penetration and willingness to pay for music on a larger scale. Therefore, after each round of channel transition, the overall market size theoretically should improve.

In the current era of streaming music, despite the acceleration from the pandemic, the actual scale, excluding inflation factors, has not yet reached the peak of the CD and DVD era of the previous round. Therefore, purely from the perspective of industry rules, the imagination space for streaming music is far from reaching its ceiling.

II. The Internet develops "fast," but why is digital music expanding "slowly"?

However, looking back at the two figures above, it also indicates that the actual development speed of the music industry in the past 20 years has not exceeded global inflation:

During the transition from the tape to CD technologies in the 1980s to 1990s, the music industry scale reached its peak in 10 years. However, from the beginning of this round of digital music revolution in the early 2000s, it has been nearly 25 years now, and it has only reached halfway. Looking back, perhaps the early "paid download model" led the entire industry to take a big detour.

Entering the era of digital music in 2000, as hardware devices such as mobile phones and network technologies were still in the early stages of development, the scene of music digital downloads was more popular. However, under this business model, there were significant copyright protection loopholes. Due to the lack of a perfect business model to protect copyrights, free piracy flourished. Napster, a website for free sharing of MP3 music, emerged and wreaked havoc on the physical record market.

The three major record giants Universal, Sony, and Warner joined forces to combat piracy, hoping to awaken users' awareness of copyright by leveraging the influence of Apple's iPod and iTunes Store for paid downloads. Although the results did help the record companies recover some losses, freeloading always complies with the "true fragrance law," and digital music without physical albums is more "real."Therefore, it is difficult for Apple to increase the pricing of each copyrighted music—compared to the era of physical records, the value of a single song has been directly halved.

Not to mention, the pricing of singles has broken the "bundling bonus" of album pricing. In an album with 10 songs, it is impossible for every song to be equally popular. In the past, when purchasing physical records, you had to buy the entire album, and unpopular songs were essentially bundled for sale. However, under the single pricing payment model, unpopular songs may never be able to recoup their costs.

To address the above issues, streaming music services that focus more on "subscription (similar to monthly rental) payment methods" and lean towards "real-time playback within the platform" have emerged. Starting from Pandora Radio in 2005, which focused on listening to radio stations and could also play music, followed by Spotify in 2008, and Deezer's transformation and re-entry, streaming music has been developing for nearly 20 years.

Although it seems to have started early, streaming music truly began to have a "presence"—meaning it started contributing a significant proportion of revenue, which can actually be traced back to around 2015, or 10 years ago. As mentioned earlier, streaming music needs to be complemented by mobile networks. Therefore, when mobile internet and mobile devices were rapidly optimized and penetrated more users ( the advent of the iPhone 4 marked the beginning of the smartphone era, and U.S. carriers significantly reduced mobile data fees around 2010), and major music labels actively sought cooperation with streaming platforms to gradually license their extensive music libraries for playback on streaming platforms, streaming music truly took off.

Among the three major label giants, let's take Sony Music as an example:

Sony first mentioned the impact of streaming copyright revenue on overall music revenue in its annual report in 2014. However, due to its small scale in the early stages, it was not until 2018 that streaming revenue (the revenue share paid by streaming platforms) was separately listed from Recorded music. From 2018 to 2023, the CAGR of streaming copyright revenue reached 26% annually, gradually growing to become the pillar business accounting for 70% of Sony Music's overall music copyright revenue.

Therefore, due to the disruption of "paid downloads," streaming music, which has only been developing for 10 years, is naturally far from its peak.

3. Why is music streaming afraid to raise prices?

What is the future growth of music streaming relying on? In fact, the industry leader Spotify has set an example for us early on - raising prices. However, choosing to raise prices at this moment does not necessarily mean that user payment penetration has reached its peak, as at least half of the users are still using the ad-supported tier with low value realization, especially in emerging regions.

Just raising prices has an immediate effect, which is not uncommon in the entire streaming industry in the past two years. For long videos, Netflix follows a rhythm of raising prices every 1-2 years. And the increase in music streaming prices is not only reflected in the increase of standard prices, but also in the reduction of promotional discounts (such as Tencent Music). However, in the end, it all reflects in the increase of the Average Revenue Per Paying User (ARPPU).

But the market also has concerns: Can music streaming raise prices? Worries about how much room there is for Spotify to raise prices under the competition from competitors backed by giants like Apple Music, YouTube Music, and Amazon Music, as well as the blockade of various free ad-supported music platforms.

After all, unlike Netflix, which has a large portion of self-produced films, platforms like Spotify do not produce music themselves (even if they did, it wouldn't matter much, as currently in the music copyright market, the three giants and Merlin collectively hold 74% of the market share), but like their peers, they purchase music copyright from top record companies. They do not have exclusive advantages in terms of copyright. If they simply raise prices, will it instead "force" users to turn to their competitors?

Dolphin believes that compared to Netflix, Spotify's track, bargaining power in the industry chain, and competitive landscape do not currently have an advantage, but this does not affect the overall music streaming industry's ability to have room for unified price increases.

1. In the past 30 years, music spending has not increased but decreased

From physical albums to digital singles, the overall music copyright income per individual user has actually experienced a significant decline, which began to recover after the expansion of streaming media, starting from 2015, as discussed in detail above.

Taking the relatively mature music market in the United States as an example, although the rise of free users has lowered the impact of ARPU, the payment amount of pure paying users has not always increased. Meanwhile, the proportion of per capita payment of long videos led by Netflix in the United States has been steadily increasing in household expenditures during the same period

Looking at the total household expenditure with two additional items, the "no progress but retrogression" of residents' music expenditure is more intuitive. In the 1970s, music expenditure accounted for 0.3%, but since the CD era, it quickly dropped to a low of 0.06%, and then slowly recovered to 0.09% in 2022. In contrast, the proportion of expenditure on film and television has reached 0.2% in 2022. Just looking at the period from 2013 to the present, the development of film and television far exceeds that of the music industry.

Although to some extent, film and television content can mobilize more senses of users and provide a richer entertainment experience than music, it is also unreasonable that music has been lying on the ground since the early days of the digital era due to "piracy" and "low-price downloads".

2. Competition is ongoing, and low prices persist

Comparing Netflix and Spotify, it is found that after fully entering the era of streaming media and experiencing a golden decade, Netflix has raised prices for end users far more than Spotify.

Taking the mature music consumption market in the United States as an example, from 2018 to the present, Netflix has raised prices a total of 3 times, with the standard package price increasing from $10.99 to $15.49, a 41% increase. In the same period, Spotify, including the recent price increase, has only raised prices twice, with the standard price increasing from $9.99 to $11.99, a 20% increase, which is significantly lower than Netflix. This situation is not unique to Spotify, as other competitors like Apple Music also face the issue of "hesitation to raise prices".

Has streaming music development reached a bottleneck? Obviously not.

From the supply side: Looking at the number of songs uploaded to streaming platforms in the United States each year, there was only a decline in the most severe lockdown year of 2020, and the growth momentum quickly recovered after the lockdown. From 2018 to 2023, the annual compound growth rate of songs uploaded to streaming platforms reached 18%.

From the demand side: Over the decade from 2014 to 2023, the playback volume on music streaming platforms in the United States has increased at a CAGR of 28%

Dolphin believes that behind the price increase for end users on platforms, in addition to industry-wide collective price increases, it often reflects their monopoly advantage in the industry. Just like Netflix, over the past five years before and after the epidemic, the continuous success of more than a dozen hit dramas such as "The Witcher", "Bridgerton", "Squid Game", "Money Heist", "Stranger Things" has solidified Netflix's leading position, allowing Netflix to enjoy the dual benefits of raising prices while increasing users.

Similarly, Spotify is also in a leading position in the music market. In terms of subscription users alone, Spotify has 600 million monthly active users globally, with 240 million paying users, enough to dominate the industry. Tencent Music, second only to Spotify globally, also has the advantage of having a large number of users in China (Spotify does not enter the Chinese market). And Spotify's most direct competitor, Apple Music, although it has an equally rich top-tier copyright library as Spotify, and also has hardware channel advantages and user base that Spotify does not have, it still failed to resist Spotify's breakthrough (reasons behind this will be discussed in the next part).

However, because the copyright content is not under its own control (non-exclusive), as a downstream platform, Spotify cannot rely solely on product experience and business models to stay comfortable forever, as competition always exists.

In the early stages of the development of music streaming, it was a battle of the gods. Supported by music record companies and having copyright advantages, Pressplay (Sony & Universal), MusicNet (Warner), iTunes music (later Apple Music) with basic user advantages, Amazon Music, YouTube Music, and the self-made Spotify, Deezer, Soundcloud, all took turns to appear over the past 20 years.

However, faced with high copyright costs, without scale, it is impossible to amortize and make money. Lack of funds means basically no chance of getting top-tier copyrights. In a time when the three major record companies control 70% of the world's song resources, small and medium-sized platforms without strong backing basically bid farewell to the opportunity to catch up again, such as Deezer, born around the same time as Spotify, currently has a market share of less than 2%**

However, under the support of giants, competitors still have the capital to attack at any time, although currently Spotify is the absolute leader, with a market share of 35% of paid users, reaching 46% excluding China, close to half of the market share:

(1) 2015 was the strong period for Apple Music (acquisition of Beats, enriched copyright, low subscription price, free to use for the first three months);

(2) 2017-2020 was the strong period for Amazon (independently from Prime, filling a large amount of copyright resources);

(3) YouTube Music leverages the basic traffic pool of 2 billion mothers, continues to penetrate and expand, and has the strongest platform for attacking Spotify at the moment through music experiences linked with videos, such as acquiring customers by watching MVs for free.

Therefore, starting from 2022, this round of price increases initiated by Apple Music is more based on the industry of music streaming services that have maintained the same price for many years after the pandemic bonus, and there is a general motivation for price increases, rather than the demand for price increases brought by its own competitive advantages.

After the latest round of price increases announced by Spotify, it no longer has a price advantage among the top music platforms.

IV. The stark difference in profitability between Spotify and Netflix, why the same fate but different paths?

Both being streaming platforms for content distribution, Netflix has long been profitable, with stable positive free cash flow now expanding, currently a giant with a market value of 280 billion and an annual income of 40 billion. However, Spotify has been struggling on the edge of profit and loss, with no shortage of judgments in the market that Spotify can never be profitable.

But when comparing the price packages of Spotify and Netflix mentioned above, it is found that the subscription prices for music streaming are not "cheap". In popular perception, the production cost of long videos is higher, so naturally the price should be higher for end users. For example, in the Chinese market, the standard price for the four major long videos of iQIYI, Youku, Tencent Video, and Mango TV is generally between 25-30 RMB, while the standard price for the leading music streaming service QQ Music (Green Diamond) is between 15-18 RMB/monthBasically, it's 60% of the price of long videos. However, Spotify and Netflix had comparable prices in the United States in the early years.

So, what causes two streaming platforms with over 200 million paid users each to have vastly different profitability despite similar pricing?

1. Revenue: Different regions' music development is fragmented, scale does not necessarily mean more economical

Although, like long videos, developed regions have stronger purchasing power for content. But as Netflix and Spotify expand into markets outside of Europe and America, by comparing the difference in per capita spending between the two in North America and other regions, Dolphin found:

The difference in spending power between Spotify's North American region and other regions is more significant than Netflix's, and in recent years, this gap has widened at a faster rate. In other words, users in emerging regions are more price-sensitive to music consumption than to long videos. At least they are not as willing as the North American market to accept subscription prices similar to those of long videos and music streaming.

Therefore, when Spotify expands its scale beyond Europe and America, it cannot reap enough economies of scale. Apart from purchasing local music copyrights, expenses such as customer acquisition, operations, server traffic costs, additional personnel, etc., due to the low-price mentality of users in emerging regions, the effect of offsetting these costs with increased subscription revenue is not as good as with long videos.

Of course, this is not an immutable law. As a new generation of young people born in the mobile internet era with higher demand for music and starting to earn income enters society, their willingness to pay for music will naturally increase. The short-term decline in per capita spending by Spotify in emerging markets actually reflects its accelerated penetration of users in these markets.

2. Costs: Upstream monopoly, low bargaining power in the industry chain

Unlike the long video platforms where Netflix operates, each platform also produces content itself, which is its foundation. Therefore, looking solely at the content providers upstream, the market structure is relatively loose, and the platforms have a higher position in the entire industry chain. However, the music industry is different. With the three giants Universal, Sony, Warner, plus Merlin, an independent music label agent, these four companies hold 75% of the copyright songs in the entire industry.

As a platform without money or background, in order to enter the U.S. market, Spotify was willing to sell its shares cheaply to the three major record companies. However, even after selling itself, the share Spotify gave to these three record companies in the early days was as high as 70% (recording copyright), another 15% went to music publishers (operating agent for copyright), and it also needed to bear a minimum guarantee (if sales targets were not met, a fixed royalty fee still needed to be paid) However, it is fortunate that Spotify easily meets the standards, so the impact of the minimum margin on marginal costs is not high.

However, many times the three giants simultaneously own recording copyrights and operate publishing copyrights, which means that 85% of streaming revenue goes into the pockets of these label companies. As for how record companies and publishers split the revenue with singers and songwriters after receiving 85% of the revenue, it has nothing to do with Spotify. In short, the remaining 15% is all the revenue sources that Spotify uses for its own operations.

In the two years before going public, physical records had almost disappeared. At that time, Spotify, which had 160 million active users worldwide and 70 million paying users, as the leader in streaming media, finally stood up and renegotiated the revenue sharing ratio with several major record companies. The share of recording copyrights, which used to receive 70% of revenue, was reduced to 55%, and then further reduced to 50-52%, allowing Spotify's gross margin to increase to nearly 30%.

However, a 30% gross margin is still low, and this fixed ratio revenue sharing model strongly tied to revenue makes it impossible for Spotify to achieve economies of scale simply by raising subscription prices. In the past 10 years, Netflix has significantly increased its operating profit margin (+15pct), mainly by increasing its gross margin from 30% to 40%, and naturally spreading expenses as revenue expands by 5pct.

Another example of achieving profitability by optimizing costs (growth rate) is Tencent Music, which operates in the same field. According to Dolphin Jun's estimates, after the exclusive copyright unbundling, Tencent Music's copyright costs rapidly declined from a year-on-year growth rate of 50%-100% to below 20%, and even in the past two years, it has shown single-digit growth to a slight decline. Therefore, aside from its own operational efficiency, the profit value of Spotify is more driven by reducing revenue sharing ratios and increasing other sources of revenue to increase gross margin.

(1) There is a possibility of further reducing the revenue sharing ratio

The good news is that internet platforms have broken the constraints of time and space, and with the help of recommendation algorithms, unique music works can also stand out. Therefore, more and more independent music works (non-headline copyright music) are becoming active, and with the improvement of production and distribution of works (Spotify has also launched a platform for independent musicians), the market share of the three major record companies is decreasing year by year. In 2017, they held 87% of the playback share in Spotify, but now it is only 74%

Of course, a 74% market share still constitutes an absolute monopoly. However, as more and more traffic aggregates to the platform, leading streaming platforms such as Spotify now have the capability to challenge upstream giants. The times are quietly changing: top brands are increasingly relying on streaming media—Spotify, Apple Music, YouTube Music contribute 40% of Warner Music's revenue.

(2) Seeking revenue sources beyond paid music copyrights

Due to the strong link between copyright costs and music subscription revenue, Spotify can also increase cooperation opportunities with small and medium-sized labels or independent musicians with low demand for revenue sharing ratios, as well as explore revenue sources beyond music subscriptions, such as podcasting primarily monetized through advertising. Although podcast revenue currently accounts for only 3% of total revenue with a 9% market share, the podcast market also has potential. MIDiA predicts that by 2030, it will be a $10 billion market with a compound annual growth rate of 16%. Recently, Spotify launched a bundled membership subscription package of "Music + Podcasts," priced slightly higher than the standard package, which is expected to accelerate the growth support of podcasting business for overall revenue.

In addition to the impact of user purchasing power and industry discourse power on profitability, Spotify's founder is also more inclined to provide "free services," which was his biggest vision when founding Spotify. However, under the "suggestions" of investors and record companies, it was changed to a "paid + advertising" model. Perhaps the reason why Spotify has been reluctant to raise prices for more than 10 years also lies with the founder.

However, since the third quarter of last year, Apple Music, Amazon Music, and YouTube Music have successively raised prices. Under pressure from investors, Spotify's management may have expressed their readiness to raise prices. This decision was soon put into practice in September last year and June this year, a direction that the capital market is more willing to see.

After the price increase, can Spotify quickly become profitable? What is the long-term ideal profit level it can reach? Spotify vs. Tencent Music, each has its own strengths and weaknesses, whose imagination is greater?Dolphin believes that in addition to optimizing the profit model through price increases, the true value of streaming media lies in leveraging traffic to influence upstream partners and obtaining upfront cash flow at lower marginal costs. The decline in market share of the three major labels is a positive signal, and AI may be another new driver for cost optimization.

In addition, Spotify is more than just music, it has also expanded into the long audio (podcast) market, aiming to increase revenue streams and dilute costs. In the next article, Dolphin will focus on the most concerning "profit issue" of Spotify in the market, further dissecting the business model and business outlook forecasts, and providing reasonable valuations for Spotify under different expectations (conservative, neutral, optimistic).

Risk disclosure and statement of this article: Dolphin Research Disclaimer and General Disclosure

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