Business Models Inc.

Free drives paid – The business model of Spotify

February 16, 2012 | Camilla van den Boom

“The music business is a cruel and shallow money trench, a long plastic hallway where thieves and pimps run free, and good men die like dogs. “ Hunter S. Thompson

The traditional record label model

No industry is changing as rapid as the music industry. In the past, the record companies fully determined which artists were launched national or international. The production costs, the promotional costs and the distribution costs for an album were significant. The music industry lived for the blockbusters with huge sales from a handful of talents. The core business of a record company was to discover and to launch new talent. In the last ten years, this has all changed. The record companies could not keep up with the rapid developments in the market and lost considerable ground to newcomers.

Piracy

Digitization has made it easier to exchange music. In 2001, applications like BitTorrent, Napster and The Pirate Bay made their entrance in the market. These applications were pioneers in a new era. They presented a new business model in the music industry, the piracy model. Piracy was easy and “for free”, which led to a massive download movement. Users do not pay for copyrighted music and become “pirates” leaving both the artists and record companies empty-handed.

iTunes

In 2003, Apple introduced a new business model in the form of iTunes. iTunes is based on the iTunes store concept and the single song purchase. The user acquires full rights to enjoy music by paying a fee for each number. In this model, the user becomes owner of the music. The acquired songs can freely be moved to an iPod or other mobile devices. The development of iTunes crunched the CD as a medium for music. In response, artists often produce only 4 – or 8-tracks instead of a complete album.

Spotify

Spotify was founded in 2006. Spotify makes music available in legal way by providing (free) access to songs and albums. The Spotify business model (access to music) challenges the business model of iTunes (owning music). Spotify provides music to anyone with an Internet access, via your PC or your mobile device, for free. The Spotify model is based on “music anytime, anyhow, anywhere”. The user determines whether he or she takes the free version (with advertising) or the premium version (without advertising). Spotify introduced the model of “providing access to music”, with or without advertising.

What about the business model of Spotify?

Spotify operates a so-called “multi-sided platform” business model. In a multi-sided platform, one customer segment (in this case, advertisers) finances the other customer segment (in this case, the user). Spotify serves two customer groups that cannot exist without each other: the user and the advertiser. Both customer segments exist in a symbiotic coexistence. Spotify offers a proposition to them both. The user (”global music fan”) is looking for music and the experience of music. The advertiser is looking for an audience to advertise for their products. Spotify manages both segments offering free access to music in a legal way. For those who do not want advertising, there is the premium (paid) model. The user can listen to unlimited music for a monthly fee. In fact, the user buys off the rights to listen to the music. Spotify is a distribution channel for music rightholders (record companies and artist aggregators). They use Spotify as a channel to reach their customers.

But how does that work, a FREE business model?

A “free” business model is risky. In comparable models, the conversion rate from free to premium (paid) is below 10%. How can Spotify make revenue with a free model? Very simple. Spotify embraces the concept ‘Free Drives Paid’. They understand the user better than anyone else. The user wants to listen to (access) music. And the user is (under certain circumstances) willing to pay for music. Therefore, Spotify has two services on the market: FREE and PREMIUM. Why are users willing to pay for music if it is available for free? The application of Spotify is easy to install and easy to use. You can also play (access) your music on any devices you like: your PC, your mobile, now even in your SMART car. The music literally moves with you. The application also provides the user with many opportunities and options how to build your playlist and music library. And you can easily share it with your friends, via email or Facebook. The Spotify user invest much time in building and sharing his or her music. This investment is the driver in the Spotify business model and Spotify make use of this in a good way. The user starts using Spotify in the free version, with advertising. While getting to know the application, a complete new world opens up. You can play anything you like. And after a while, the user is bothered with the advertising and shifts towards the paid subscription model. This concept ‘free drives paid’ is fully understood by Spotify and built into their business model.

What does the future bring?

There is no player in the music industry, which has succeeded in creating a mass market where users once again pay for music. No player can yet claim to be the ‘global standard’. It will be exciting to see which one of the players in the music industry will elevate themselves to become ‘the Facebook of the digital music industry’. Spotify has a good chance.