Last month at The Europas – TechCrunch Europe’s version of the Crunchies – a lot of impressive start-ups were honored. But one was clearly cleaning up: Spotify, the sexy online music app that has music lovers in Europe swooning.
Each time the company won, you heard two reactions from the crowd: fan boys screaming with joy and other companies’ founders groaning. “Too big for their boots,” was a phrase heard muttered a lot.
But player hating is just part of life as a hot start-up right? Of course – but Spotify is living in a particular dual reality. It’s caught between the rapture of music lovers who say it’s the site they always dreamed could exist and the cruel reality of the online music business.
And that meant there was a lot more drama than immediately meets the eye behind that reported $50 million funding and $250 million valuation. As one investor who ultimately passed on the deal told us, “This was one of those where you hold your nose and just pay up. Before you’ve done anything the majority of the economics are right out the door to the labels. You need huge scale to pay for all that, and then you’re still in bed with a bunch of numb nuts.”
Someone in the comments of TechCrunch’s previous Spotify story said it was Europe’s YouTube. We don’t know if they meant that in a good way or a bad way—but we agree on both. The problem with the comparison? YouTube found Google; a deep-pocketed public company that was also trying to build a video offering online and was willing to pay top dollar for YouTube’s streams, and their associated business model challenges.
Several VCs we talked to used the words “leap of faith” over-and-over again in describing the decision to invest in Spotify or not. In reality an investor has to take multiple leaps of faith to do this deal, especially at a $250 million valuation. Looking at those leaps explains why so many VCs who were awed by the product ultimately passed – and yet why a few ballsy investors saw the elusive upside worth the role of the dice.
Leap of Faith #1: The Labels Want an Apple Alternative. This seems like common sense, right? But how often do music labels act according to common sense? There’s a whole Internet graveyard full of online music start-ups that VCs invested $20 million or more in, cut deals with labels and the labels happily sucked them dry. It’s a good sign that the labels have been taking equity investments in Spotify, but that hardly makes it certain they’ll support the company. It’s common for big public companies to invest an immaterial amount in a promising start-up in order to keep a close eye on it.
According to people close to the company, the deals being negotiated with labels are similar to past subscription deals. There’s a minimum in royalties that has to be paid, and once that’s cleared there’s a more reasonable revenue share. But that minimum bar is so high, that’s where most subscription services have died. “The labels are entertaining how to work with them in a way everyone can make money, but they’re still clearly taking a pound of flesh,” said one person with knowledge of the negotiations.
Leap of Faith #2: Audio Advertising Will Shift from Radio to Online. So far, the money Spotify is getting from audio ads is likely to be “chump change – less than you could earn from those crappy ads at the bottom of instant messenger clients,” according to one industry expert we talked to. For the service to still have a free element, a larger-than-just-Spotify industry shift is going to have to occur where audio ads move from terrestrial radio to the Web in material amounts. We’re knee-deep in that shift in print, and only beginning to see it in online video. Will it happen in audio? Probably, but not next year.
Leap of Faith #3: Millions Will Pay for Subscriptions. That means the real opportunity for Spotify to build a business is the subscription model – something no online music company has succeeded at to date. Right now the company claims it has “just under 100,000 users” paying $10 a month. Other sources confirm that it’s growing at a fast clip. While impressive, the onerous costs from the labels mean that revenue – $12m a year, before that “crappy” audio ad money - is not nearly enough. For this business to work Spotify needs millions of paying subscribers.
The fact is, Spotify is not only trying to break the online music subscription curse, they’re trying to do something few have done on the Web. To date people have shown themselves unwilling to pay for content and premium services en masse. Even the mighty Netflix only has 10 million subscribers; Match.com has less than 1 million. And again, thanks to the pressures from the labels, Spotify doesn’t have years to get there.
Leap of Faith #4: Apple Won’t Kick Spotify Off the iPhone; Other Mobile Carriers Will Champion it as an iTunes Alternative. Apple isn’t open. It’s territorial. And with good reason—it owns the dominant mobile Web and music platforms. Why on earth would it allow Spotify’s offline music player app to compete on its own hardware with iTunes?
That leaves other mobile devices to champion Spotify as an iTunes/iPhone alternative. That strikes us as highly likely. What’s more: People are more willing to pay $10 a month for a music app that’s not tethered to their computers. This would seem to be the company’s best bet to solve its business model woes and get enough future investment to hit scale.
Leap of Faith #5: US Launch Goes Well. Spotify is saying it will launch in the US by early 2010. That doesn’t seem feasible, given their business model challenges and the fact that this round was only 50 million. Investors who looked at the deal confirmed they’d need a much larger war chest to make that happen. Also, there is some confusion over whether the round is even closed at all – with some close to the company saying it’s still open but the company itself saying it has been closed for two weeks.
Much seems to depend on just how much demand there is to invest in Spotify, which is hard to read. The company claims that it got nine term sheets and a 20% premium on what we understand was a requested €150 million valuation. The latter appears to be true, but we know that the bulk of the major European VCs—including names like Balderton and Index that don’t normally balk at price if a company is good enough—turned down Spotify or offered a term sheet at a substantially lower valuation, due to all these leaps of faith. And, we contacted six of the top US consumer Internet partners who said they weren’t even pitched. This leaves us wondering from where these nine competitive term sheets came. In addition, the deal took a reported five months to close– unusual for a “hot” company.
There are certainly billions in cash in the world of private equity for promising companies, even in this economy. But it’s unclear how much more there is for Spotify while all these questions remain.
Leap of Faith #6: If All the Above Fails, Someone Buys the Company for $100 Million. In other words, what are the odds the incoming investors lose money? We think chances are good they’ll at least make their money back. After all no one disputes the beauty of the product or how many people love it. That’s clearly worth something even in a worst-case, fire-sale acquisition. Any investor worth their salt would have insisted on a liquidation preference given the risks and the high valuation attached to the deal.
It bears noting that while Spotify has been wildly promoting themselves in off-the-record conversations with the press (including us) they have been less than forthcoming with information publicly. In several weeks of reporting this story in the Valley and in London, we talked to more than a dozen people including investors who looked at the deal, people close to the company and other people in the online music industry. We’ve found a host of troubling contradictions that we tried to comb through for this story, with little help from Spotify.
We sent two emails to the company detailing the discrepancies we were hearing on both sides of the pond and got little back but a note saying the founders “wouldn’t comment on financial matters” and “didn’t like (our) tone.” This after their representatives had been providing us, off the record, with hype about subscription numbers and claims about term sheets and increased valuations.
Given the mass of uncertainties in the business and how many users love the service, it’d be nice to see the company be a bit more forthcoming about its future.
[Photo credit: Dirk Lindner for TechCrunch Europe]
I wasn’t aware startups existed outside of the US
Spotify is a great application, but like anything involving the music industry it’s going to end up unused because of all the hoops us consumers will end up jumping through. I can’t see it lasting more than a year with the way the music industry act.
In Sweden, despite being invite only, Spotify has already over a million users. And that’s in a country with 9 million people. So I guess users do like it – a lot.
who the hell would pay to listen to van halen streaming on your iphone?
Both Slacker and Pandora, which are more just a promise of a radio-alternative, tailored to your preferences, currently include audio ads. I don’t know of anyone who stopped listening when they heard the ads. The problem is, though, that there isn’t nearly the tolerance for the number and length of ads you typically find on over-the-air radio and TV. That’s where it’s tough to make up the gap. That being said, I doubt they would have to wait until after 2010 to be able to introduce audio ads, and at least gain some more monetization off of the free accounts.
Not sure i agree. On the radio i would change the station during a long ad, there by hurting the ROI of the advertiser, Pandora on the other hand has short ads that i don’t mind listening to.
This is the same concept that google uses when cracking down on fraudulent clicks.
My money is on Spotify being the Hulu for Music. and probably video too.
Spotify is cool, but it has become massively over-hyped.
The reason is simple – Europe is so starved of success stories that anything resembling a decent startup sends people into hysterics. I bet half of them couldn’t even explain what makes it any different to stuff that’s been around for years. There was a good comment in another article saying it’s actually about the way they handle the details, which is definitely part of the story. Having the balls to recognise the value of a desktop app is another.
I really liked it when I first used it, but it’s less than a year later and I’m already sick of the circle-jerk. ‘Best Design’ winner at the Europas ? Oh come on…
I have a feeling the US market will be a bit disappointed when they actually get to use it. Don’t get me wrong guys, it’s definitely very cool, but more because of the stuff you don’t see than the stuff you do.
P.S. I’m in Europe and I love the Swedes.
Excellent comment, spot on.
One reason why people like Spotify is beacuse the software has faster playback than when playing tracks locally through winamp! I’ve tried many other streaming services and this is the area where they all have failed. Yes, this is one of those little details, but sure is an important one for supreme user experiences.
Spotify is one of those rare products that won’t need any special marketing. The product sells itself.
Funny you say that, considering how their PR is working overtime…
Jay:
The total amount of money Spotify spent on PR in Europe and US is about 8000 thousand dollars (to get the invite system rolling probably). Thats not “overtime”. If´ve you´ve heard about it´s because its viral, and people as well as newspapers are talking about it. Twitter, Skype, Wordpress and some others doesn´t really need proffessional PR either. If a startup needs dedicated PR-people to gett buzz then the product is probably not good enough…..
The US has the Silicon Valley and thats very most of their power comes from. Money and talent gathered in one place. Northern Europe on the other hand has a more
widespread internet savviness amongs regular internet users: 20% of swedish teenage girls have a blog for example. We haven´t really seen the full translation from widespread advanced internet usage into new start ups and services, but I think it may well happen very soon. Fast, uncapped broadband connection to large amounts of people will and in some ways already has played some part in creating interesting services both legal and unlegal, thinking about the Pirate Bay, Skype, Spotify, last.fm, Stardolls Match.com etc. Norwegian television has experimented with torrents to spread their content, and Swedish Television has been streaming large parts of their content since 2005. So Europe is very interesting from an Internet-perspecitive in my opinion.
Regarding Spotify I agree it isn´t particularly flashy, it just works. I think americans having their tolerance for crappy UI forcefully heightened by slightly sub par services like Lala, Imeem, Myspace Music, Jango, Spiralfrog, Rhapsody, Myspace Music. Blip.fm will actually find relief and comfort in a simple thing like Spotify which basically is a Winamp or Itunes with every song in the world two seconds away.
(by the way I think I was the one who wrote the spotify-details comment..but im not sure im the only one who recognizes those specific qualities of the product, at least I hope anyone who spends a few minutes with the service will appreciate the level of work the Spotify team has invested in the small details…)
Anyone familiar with the French company Deezer? In France, they’ve negotiated with record companies so that you can listen to virtually ANY album or song on demand. Really, any song (not just French ones). It’s all the rage here. However, in the U.S. it obviously doesn’t work the same way.
I used Deezer for a while before starting using Spotify and I have to say it was a good service. Still though, sound quality was not that great and I also had some issues with buffering.
I am French, and Deezer is widely used here (Spotify just arrived in France). I don’t know if it works in the US though. they also have an application for mobile phones (included Iphone) that works well.
role the dice?
Well-balanced article Sarah + Paul. Thank you.
cool
Or maybe it is the Joost of Europe.
Joost IS from Europe, it’s a registered company in The Netherlands and has/had offices in London (UK), Leiden (NL) and Thoulouse (F).
I disagree this is a Joost. It’s from the creator of uTorrent. They use cheap distribution (p2p) and offer 100% quality function and if they can keep this development up it will be big.
BTW, how much is Evony paying for ads these days? I see those freakin’ cleavage ads everywhere!
Last.fm monthly subscription is a mere £1.50 per month. Now that is great value & I cannot see how Spotify, even with a service that may deliver more than is available via last.fm can justify a £10 per month fee.
At that price the Spotify subscription service will very much be a niche service & I cannot see them pulling in vast amount of subscribers.
For starters you can actual find music and stream it right away on Spotify. That is a hell in Last.fm since they changed the layout (and I stopped my subscription).
The subscription takes away the ads and makes your music mobile. I do agree it’s a bit much.. maybe a plan for just the mobile music and keep the ads for 5€?
It first I thought 10€ was a bit much, but since I can share the account with my kids it’s well worth it. My kids have (almost) stopped using LimeWire. That proves who great Spotify is.
There’s also the higher streaming quality and the bigger music catalogue.
I used to work at Last.fm, so I’m fond of it, and still believe it has the best recommendation abilities out there. But I have to say, ease-of-use gets users engaged from the moment they start with Spotify, whereas the power of Last.fm only becomes fully apparent once you’ve built up a number of plays and it really starts to know your taste.
I’d be surprised if Spotify has a larger total catalogue than Last.fm but it does have a whole lot more music that’s playable on-demand.
Last.FM, Pandora, Slacker, etc do not allow you choose the track you want to play, at any time.
Spotify does.
Game over, man! Game over!
Leap of Faith #2 is not entirely accurate in my opinion. Fact is, there is an ever-increasing flow of dollars to the internet audio space– and not just at the expense of terrestrial radio. Just as Hulu (presumably) garners dollars from Digital as well as Broadcast budgets, more and more agencies and advertisers realize that the depth of engagement (an admittedly horrible word) afforded online is well worth throwing (media) weight behind— from either bucket or both. Our experience says that folks spend over two-and-a-half hours per online audio session. That session is also two-way in that listeners can weigh in on the music content, which (if any) sponsors they’d like to hear from, what promotions they’re interested in, ticket information they’re looking for… in ways they just can’t otherwise. Advertisers are already taking note of that.
All that said, I’m betting on online audio being more than a rounding error in both Digital and Broadcast budgets in the very, very near future.
Best of luck Spotify!
Patrick Reynolds
CMO, Ando Media
You know, I just subscribed to Last.fm for $3 a month. This after I discovered that site only a week back.
I was very heavily into music at one point, but then after I got busy with work and other commitments, it became just too difficult to keep up with all the new music coming out, and finding new, good tracks to listen to. I subscribed to Last.fm because it really helped me enlarge my song collection and discover artists and genres I hadn’t heard before…for instance, today, I discovered that I really enjoy lounge music – something I didn’t know before.
The only trouble with Last.fm is that I can’t play any song I want to. That’s why I would happily pay $10 a month for Spotify..heck I even contacted them if they have the premium version available in my country – India – at the moment (no response from them)
And all this when I live in India, where $10 is a decent chunk of change.
Serious music lovers will always be ready to pay for music. And they rightly should. I like to believe that there are more than a million of us out there who truly believe in good music.
I just love Spotify! The best music service ever no matter what you say.
too long to read… there should be a 140 character limit.
Sorry to go off-topic, but this seemed the quickest way to get Sarah’s attention. There is user on YouTube using Sarah Lacy’s face as her own: http://www.yout...ser/steph2845mk
It’s mainly clips from the Suze Orman show, and they have a link to this website: JeffDeanReport.com They’re actually paying people on Amazon’s mturk to click on links to these videos and rate them 5 stars.
Sarah, I thought you’d like to know.
First off, I find it odd that a service which is blocked in most of the countries on this planet chose the “A World of Music” as its tagline
Secondly, what is the big deal? Online radio stations, minus/plus ads, social networking or personalized playlists have been around for a while (from the top of my head last.fm, slackr, pandora, deezer, Pronto, Jango, Live365 …the list goes on). What is so exciting about this service? The UI looks and feels exactly like Deezer (Yes, the French startup).
But more importantly, the only way for a company to really make a difference in this space is to resolve the issues of DRM and copyrights on a global basis. The music industry has long been rejecting any reasonable means of digital distribution and refused to recognize that the $18.95 CD with 1 hit and 11 badly produced tracked which cost $0.47 cents to produce is no longer a viable consumer product.
And just as their solution for rights management is to sue the fans, their solution for digital distribution is to enforce web-based music streamers rules that restrict how much of the music you really want can be played based on your needs. The winner in this arena will be the one with the most money who can afford the most creative IP attorneys money can buy. The art of music, technology, fantastic features, UI, branding or the faith of VC’s have nothing to do with this.
The difference is no one has allowed you to play any song, at any time, on demand until now. I can’t name another service (in the US at least) that allows you to do this.
Pandora, and the like are just customized radio stations (though way better than terrestrial), where Spotify is a full blown jukebox.
“no one has allowed you to play any song, at any time, on demand until now”
In France, there’s Deezer. I’ve tried Spotify also, but it lacks real content discovery and is not free. I don’t know for US.
Again another great idea with revenue stream issues. The business world i bet whishes that it could turn back the clock and start the web. Its really hard to get users to pay for anything as there has been so much around for so long with no charges.
“Sarah Lacy and Paul Carr”. ahhh thats sweet.
Spotify has completely changed the way we listen to music and do parties over here. I use it as a radio (if it goes wireless I would pay monthly) and when you have a party or friends over you pay 1€ to get 24hs ad-free. This product is absolutely revolutionary. _Everybody_ I know uses it. Teachers, carpenters, techies, you-name-it. I think that speaks for itself. I really hope they can last until they’re profitable, and that they can solve the offline problem better than the super-shitty integration with 7digital.
Your article fails to mention Rhapsody, a great example of an unlimited music service with a premium subscription. The service has been around for years and has a subscriber base of several 100 000s.
If anyone is gonna make it, it’s Spotify.
Focused on delivering music..fast (leave the social functions to the niche’s), my 75 yr old technophobe dad managed to install it, they got a boat load of music and are positioning it as ‘the’ music platform.
They have plenty of revenue potential. After US the emerging market’s becon – 2.5 billion people in China/India and as a marketer I know western brands are falling over themselves to reach people in those markets.
If I was to bet my fund on music I’d go all in.
Spotify changes everything. Its free, easy to use, and has just about every track I want to listen to, (but no Beatles, Oasis, or ADDC).
For me it replaces music radio, cds, downloading, mp3s the lot. Now I have Spotify I doubt I will ever by another cd again. It is not difficult to see why it is becoming so popular here, it gives the user exactly what they want, free music. No surprise that it is getting so much press coverage here in the UK. (The level of coverage is a bit like Twitter was 6 months ago).
Without Spotify those unwilling to pay for music will return to piracy. This means that the music industry cannot afford for Spotify to fail. Because with Spotify the music industry at least gets some revenue from the ads without it they get none.
My view is that Spotify’s future very much depends on its mobile strategy. If they to engage with one or more mobile operator/s (think Vodafone), and include their subscription cost (discounted and tiered) in the monthly contract charge, they should see a very significant increase in the number of paying customers, not to mention the consequent widespread adoption. An operator would probably embrace the opportunity due to the positioning differentiator and competitive advantage it would provide.
Come to think of it, a truly disruptive model would be to target all the pipe providers and attempt to bundle the subscription charge into their monthly service cost as a premium offering. Obviously, there is no way they could charge $15-20 per month for the privilege, but a large enough userbase paying an extra $2-9.99 could potentially trigger a business model revolution with the labels (subscription vs per track).
They’ve already moved in that direction, at least here in Sweden. One of the major broadband providers (Bredbandsbolaget) had a huge advertising campaign a couple of months ago where the main selling message was that you received Spotify premium for free for a period at least. Spotify is in closed beta and many people signed up just to get their login. I dont know how much Bredbandsbolaget paid for that, but it is an interesting move nonetheless.
The short version of the ad:
http://www.yout...h?v=QO99q4Jt6TM
Jack above summarized Spotify’s value proposition well: every song in the world two seconds away. for free.
That’s why everyone that has spotify loves it.
iTunes could have a comparable amount of songs to sell. But it’s not free. And it’s not two seconds away (as convenient).
Spotify is betting that every song in the world, two seconds away, at cost will also work. If the song selection is wide enough and if they create another level of convenience (like with their mobile app).
And the anti-Spotify camp says that “every song in the world, two seconds away, for a price” will not work.
Full of anticipation for the iPhone app, that’s if it’s not rejected. Last.fm is still the service I depend on for my music at the moment though!
i like
Haven’t used spotify, waiting for an invite. But how is it better than grooveshark?
Grooveshark does not have permission to do what they’re doing from the big labels.
Expect them to go away soon.
I work inside the music industry and my experiences with Spotify have been pleasant, both from a company and consumer perspectives. If they fill in some holes in their catalogue and get a smart phone app -with cached songs- working I’m going to subscribe. And I’m not alone.
And would Spotify need the States to be succesful? Not really, but for being the world number ONE streaming service, surely it’d be good to have Americanos on board. AND we, the European music industry have been working with Spotify for months. It’s is not something new and frightening that is going to get it’s plug pulled. We know what it is and we co-exist.
The real question would be if it becomes too good and especially the US majors (ultimately these companies are controlled from the States) will pull the plug on the expense of a European success story.
Looks like leap #4 has been made. Apple approved their app.