How The Copyright Stranglehold Dooms Spotify

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Guest post by Mike Masnick of Techdirt

For many, many, many years, we’ve talked about how the legacy entertainment industry will seek to kill the Golden Goose by strangling basically any innovation that is helping it adapt to new innovations. We saw the same pattern over and over and over again. The simple version of it goes like this: the legacy entertainment industry sits around and whines about how awful the internet is because it’s undermining its gatekeeper business model that extracts massive monopoly rents, but does nothing to actually adapt. Eventually, companies come along and innovate and create a service (a) people want that (b) actually is legal and pays the legacy companies lots of money. This should be seen as a win-win for everyone.

But the legacy companies get jealous of the success of the innovator who did the actual work. They start to overvalue the content and undervalue the innovative service. The short version of this tends to pop up when a legacy entertainment exec says something like “why is innovative company x making so much money when all it’s doing is making use of our content?” Of course, if the service part was so obvious, so easy, and so devoid of value, then the legacy entertainment companies would have done it themselves. But they didn’t. So with the jealousy comes the inevitable demand for more cash from the innovator. And, usually, demands for equity too, which the innovator has basically no ability to resist, because they need to have a “good” relationship with the content companies. But the demands for more (and the jealousy) never go away.

The end result, of course, is that tons of innovative businesses that created amazing services that people liked get crushed. Completely. Venture capitalist David Pakman (who founded one of the companies, which I used way back in the day, that was eventually crushed, called MyPlay) detailed how the legacy recording industry used this strategy to bury more than 150 companies over the past two decades. It’s the same story over and over again. Any company becomes too successful and the legacy copyright holders squeeze them to death, whining the whole time about how they don’t pay enough. As Pakman wrote:

“this is a ‘crisis’ of their own making”

The music industry complains loudly about the “leverage” these giants have over them. First they criticized Apple iTunes for not agreeing to raise prices above $0.99, then they went after Pandora and other webcasters by insisting webcasting rates were too low, then they attacked Spotify for not paying them enough, then they insisted Apple Music pay them more than Spotify did, and now, just as the YouTube licensing agreements are coming up for renewal, they complain YouTube doesn’t pay them as much as Spotify.

But this is a “crisis” of their own making. Many of us argued for years that it was in the industry’s best interest to create a healthy ecosystem of hundreds or thousands of successful companies, all enjoying successful businesses around music. But those arguments fell on deaf ears, and instead the industry fought repeatedly to raise royalty rates over and over again, despite evidence that not a single company ever achieved profitability.

In my mind, it would have been in the best long-term interests of the recorded music business to enable the widespread success of thousands of companies, each paying fair but not bone-crushing royalties back to labels, artists and publishers. But the high royalty rates imposed upon startups, even after clear signs over the past 19 years that the strategy killed companies, has prevented a healthy ecosystem from emerging. It’s a bed the music industry made for itself, and now it is left to lie in it.

Not only does this crush lots of interesting companies, the history of this sort of destruction has served as a giant warning sign to entrepreneurs. Years back we wrote about entrepreneur Tyler Crowley explaining how this kind of history makes entrepreneurs steer clear of doing anything with music. His original post is sadly gone from the internet, but we’ve still got some quotes that highlight the key points. His argument was that there are different options for entrepreneurs, which he describes as “islands” with different rules and conditions to “dock” at those islands:

For tech folks, from the 35,000′ view, there are islands of opportunity. There’s Apple Island, Facebook Island, Microsoft Island, among many others and yes there’s Music Biz Island. Now, we as tech folks have many friends who have sailed to Apple Island and we know that it’s $99/year to doc your boat and if you build anything Apple Island will tax you at 30%. Many of our friends are partying their asses off on Apple Island while making millions (and in some recent cases billions) and that sure sounds like a nice place to build a business.

And what about “Music Biz Island”?

Well, the labels have made it clear you don’t want to dock there.

Now, we also know of Music Biz Island which is where the natives start firing cannons as you approach, and if not stuck at sea, one must negotiate with the chiefs for 9 months before given permission to dock. Those who do go ashore are slowly eaten alive by the native cannibals. As a result, all the tugboats and lighthouses (investors, advisors) warn to stay far away from Music Biz Island, as nobody has ever gotten off alive. If that wasn’t bad enough, while Apple and Facebook Island are built with sea walls to protect from the rising oceans, Music Biz Island is already 5 ft under and the educated locals are fleeing….

That doesn’t seem healthy for music. And that brings us around, of course, to Spotify. The music streaming giant has filed to go public, and Ben Thompson over at Stratechery has done a bang up job highlighting why even this hugely “successful” music platform looks like a disaster from a standard internet investment perspective. Its margins suck. Its margins suck so bad it’s still unclear if Spotify can ever make money. Because it’s the same old story that we described above, where the labels (who own a large chunk of Spotify — remember the equity demands?) are crushing the company in a way that is unlike basically every other successful internet company. Internet companies are built on the idea of huge margins, because the marginal of one more customer is minimal.

But not with Spotify. Spotify has to give over so much of its revenue to the labels that it’s nearly impossible for it to ever be a viable business. Ben points out that the revenue and costs numbers show that Spotify operates like any “well-managed SaaS company.” But it has a “marginal cost problem” in that the label deals (even ones that were restructured recently) guarantee that nearly all of the money that Spotify gets… goes right out the door to the labels.

Spotify’s margins are completely at the mercy of the record labels, and even after the rate change, the company is not just unprofitable, its losses are growing, at least in absolute euro terms:

Ben has all this laid out in his usual nice charts and graphs and such that are worth checking out.

But, what this all comes down to, yet again, is the stranglehold of a messed up copyright system. The fact that the labels can kill the golden goose over and over and over again is because of one simple reason: the artificial monopoly handed to them by the copyright system, and the power it bestows. It’s a market distortion. This isn’t to say that there shouldn’t be any copyright (let’s see if our usual trolls make it this far in the post or if they’ve already dashed off a comment about how I want no copyright at all…). But it certainly demonstrates how the copyright system is so weighted to favor the copyright holder that they can strangle basically any business that touches on copyright, and make those markets entirely different from basically any similar business that isn’t encumbered with copyrights and legacy businesses who, having failed to adapt themselves, now demand a king’s ransom from the companies that did all the adapting for them.