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Summary:

The trailblazing firm may need more VC cash to cover its losses as it builds a global streaming behemoth, a disclosure reveals. So who gets what value from Spotify, and how could that change after another investment?

Spotify's Daniel Ek And Martin Lorentzon
photo: Spotify

Spotify more than doubled its revenue through 2011/12 after expanding to new countries like the U.S.. But the cost of doing so ballooned by the same proportion. The company spent 97 percent of the the €187.8 million it earned. So annual loss widened to €45.4 million.

In its 2011/12 Luxembourg filing, the company acknowledges: “In a low-margin business dependent on rapid growth to cover fixed costs, it is crucial that the group continues to penetrate existing and new markets as quickly as possible…”

With economics like this, global scale may be the only thing that can make Spotify truly sing. But, with Asia and Latin America build-out next on the horizon, it could be at least another year before roll-out costs ebb to the point where profitability is remotely in sight.

If Spotify is not yet a successful business, it is nevertheless a strategically significant one for others in the music industry. It has become the number-two income source for some labels in some countries. More interesting, however, is its direct relationship with labels, the four majors of which are believed to own 18 percent of the firm.

Through that relationship and through Spotify’s underlying API and third-party apps initiatives, it could yet become the industry’s de facto streaming platform – a fabric used by a thousand other services; part-operated by the labels themselves. As one friend described it to me: “A social not-for-profit for the good of the music industry, a rights clearing house.”

Herein may lay a dilemma…

As Spotify continues laying the costly groundwork for global dominance of subscription streaming, it needs more funding to make up for what is, so far, its unsustainability.

“To cover losses during the expansion phase, the group has been financed by existing and new equity owners,” Spotify’s Luxembourg filing says. “We cannot exclude the need or desire to raise more funds in the future.”

The problem is, if Spotify takes a fifth investment round to go on globalising, as has been rumoured, that could dilute the equity of its most vital partners – the labels.

To the labels, their stake is likely of more strategic than financial value – as already stated, they are helping create a digital streaming API that could bear great fruit. So they may want to hang on to the influence that they currently have.

If a new investment in Spotify diluted the labels, they may start charging Spotify more standard royalty rates, rather than the favourable rates it is believed it has been granted until now. That could mean Spotify’s costs escalate still further.

Spotify could dodge this problem by attracting investors only to spin-off regional subsidiaries in its next two target markets – Asia and Latin America – thereby ringfencing its core from dilution.

Four years after its foundation, trailblazing Spotify is the music business’ greatest chance at meaningful new revenue in a digital generation. But it remains to be seen exactly to whom it will provide the most value.

The well-run company is investing heavily in what could become a very valuable global business. But, until its international expansion is completed, we will be hard-pressed to ascertain its true value.

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  1. This should be a lesson learned for all the VCs dumping money into more dot com companies. If it takes $10 to $1, it’s not a good investment and go back to tested and true business models.

    We are in the second dot com bubble and didn’t learn from our previous mistakes.

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    1. Revenue x 3.. Direct costs will also x 3. But personnel costs also x 3 ? This business hasn’t hit economies of scale yet.

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    2. I dunno – I think, if VC cash is what Spotify needs to fund start-up expansion to the point where it is a global platform and has profitability in front of it… that would be an acceptable (indeed, typical) use of investment cash, wouldn’t it?

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  2. Why doesn’t the loss for the year equal the variance between the revenue and costs? Also, why don’t the costs from the bottom chart match the costs from the top chart?

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  3. If the greedy labels didn’t charge so much,Spotify would profitable.

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  4. This article’s headline is a bit sensationalist.

    Spotfiy’s strategy is clearly growth and dominance in the streaming realm. Its a strategy that has worked to date.

    Amazon took something like 8 years to break an operating profit, Spotify is doing pretty well in comparison.

    If they’ve got the cash to expand then I wouldn’t bet against them in the long term.

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  5. The interesting thing in this article is the shareholding the labels actually have. How do they manage a conflict of interest when a Spotify competitor approaches them?

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  6. Rolphy R. Londoño Monday, September 3, 2012

    Just make it available in Latin America already and you can have all of my monies.

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