Spotify: from a Stockholm basement to a $10 billion valuation

Here at InternAvenue, we love a bit of innovation. We work with a lot of startups to provide them with the talent they need to thrive. So we like to give them a growth story to aspire to every now and then, and this is one of them.

It feels like Spotify has been around forever now, but its current success is the result of a series of expertly executed viral campaigns. Their story is fascinating, taking the scourge of music piracy and using it to push support for a revolutionary service at a time when the music industry was still trying to come to terms with what it had lost.

I read a fantastic article about their history last weekend and I’d like to tell you what I took away from it (also gained a few more tidbits from Spotify themselves). I should say before you read this that I have in the past been a bit of a Spotify fanboy, but I have never owned a paid subscription and am currently listening to my free trial of iTunes radio to make a balanced opinion, so I like to think I’m not too biased! Perhaps you just want to know about the history of one of your favourite apps, or perhaps you are entering the startup scene and want to learn some brilliant growth techniques from those who have taken the impossible and made it available to everyone, I hope either way you get something from this. 

As of June, Spotify has 75 million active users (that’s about 10 million more people than currently live in the whole of the UK, just to put it in perspective) with 20 million paying subscribers to their premium service.
spotify-user-numbers Spotify users increase since launch

So how did they get from that basement in Stockholm to a $10 billion dollar valuation and considering their IPO next year?

We’ll look at several key steps they’ve made on their journey up to today:

  • A product that defines a genre
  • A model that walks the line perfectly between piracy and iTunes
  • Bagging big across the pond
  • Friends with Facebook

We can then endeavour to look into the future:

  • Going global
  • Making the most of mobile
  • Making artists love them again

So what has made Spotify such a worthy pack leader for the streaming music masses?

Trying to pin down the success of a company like Spotify is nigh on impossible, so I’m not going to attempt that, we’re just going to look at the key features that allowed its service to disrupt the music industry on a system wide level.

The dream? Give every person with a computer access to all the music in the world for $10 a month. Imagine the hilarity with which that prospect must have been faced in the early noughties. Thankfully, one of their initial investors, one Sean Parker (the creator of Napster) knew a little bit about annoying the music industry, and was supporting Spotify because unlike the record industry, he knew that the way they did business was dead and they needed to adapt in order to survive.

As he put it:

When you realise that somewhere between 4 and 10 trillion songs are illegally downloaded every year (that’s three songs per day for every single person on earth, just to put it in perspective), compared to only 4 billion legally, you can concentrate on what people are really willing to pay for? The answer is convenience and accessibility

So this is exactly the basis that Spotify has built itself upon, providing the ease of listening to a CD with the almost unlimited music library of the internet. But how did they make their service win out over all the others?

Spotify knew that they had open the doors to universal music streaming and they would not be the only service given the keys to worldwide music streaming, so they had to implement features that would increase the value of their service over any other. They began with discovery. Finding new music used to be the case of going to record stores (remember those? Anyone under 16 probably doesn’t) and listening to new tracks as they were released as singles, and then buying the CD. You could then play it to friends.

But Spotify proposed: what if it could learn what music you liked, and suggest artists with a similar sound that you might not have heard of before? They built an algorithm that would do just that and then instead of resting smugly on their laurels they went on to help you that little bit more. You’re throwing a party later, all your friends are coming, and you fancy yourself as a bit of a DJ, but you haven’t had time to prepare the ‘ultimate party playlist 2K11’ because you had maths homework, Spotify was ready, it had an idea. It could give you a curated playlist of the latest hits, and you could even influence which genre they were from, fantastic.

But what if I really liked Ciaran’s music taste, and wanted to hear this album he was telling me about…At the time I could:

  • Walk to his place through the pouring rain and listen to it on his boombox
  • Buy a copy myself at my local Virgin Megastore
  • Download it illegally on Limewire (which would probably take a few hours pre-broadband) and then ask him on MSN which were the tracks to listen to

Fortunately for my health and social life, Spotify understood the intrinsically social aspect of music and built-in brilliant social features. First created a built-in messenger that would allow you to share individual tracks, albums or even playlists. Then they implemented Collaborative Playlists so your mates could make your road trip list before that drive to Cornwall / KFC. But they left the biggest till last…

In September 2011 Facebook announced a partnership with SpScreen Shot 2015-12-13 at 21.30.41otify to be its built-in music player. However this integration went a lot deeper, it allowed all of your friends to link their accounts on both services and therefore you could see what your friends were listening to, listen to their playlists and see which artists they follow. This cemented Spotify’s position as the social player. And its effects were immediate. As can be seen in the graph to the right, an influx of 1 million users over 4 days following the announcement!

The last major difference between the Spotify model and the others that followed, (be they iTunes, Tidal or Pandora), surprisingly came through a pricing model – freemium. This model which allows the penny pinched students and young people of the world to listen to as much music as they like for absolutely nothing (as long as they’re willing to listen to 20 seconds of adverts every half hour) was revolutionary at the time. This means that they can keep a huge number of loyal users on their service, who may later be converted to paid subscribers even years later. Unlike the iTunes service which only gives you three months.

It was this revolution on which they built the bridge between the Napster and Limewire addicts, (who wanted music to be free, but didn’t want to spend so long waiting for their music to arrive) and the iTunes devout, who wanted to support the artists but wanted more variety and also hated waiting around. And this is what the record companies finally conceded: It was better to have 55 million people streaming through Spotify and paying through advertisers than have them illegally downloading.

So we know why the features of Spotify were so attractive, but that isn’t enough to explain all of their exponential growth, so what did they do to make their service so desirable?

Just like many software innovators they started with a closed beta. This allowed them to fix any initial issues with the software and get feedback on any changes, but infinitely more important was the connection they established with early adopters. This allowed them to gain traction through social media as these influencers of the tech scene experienced their revolutionary product and shared their views on it with their vast reader-bases.

Following this initial beta they made Spotify available on a two tier basis, those willing to pay for the service straight away could get unlimited access to Spotify’s features and library immediately, those as yet unconvinced or unwilling to pay had to wait for a free account invitation. These were made intentionally scarce, but mentioned all over social media in order to hype anticipation.

I remember getting an invitation myself during the early days of Spotify and feeling like I’d got a golden ticket to visit Wonka’s chocolate factory, did I think everyone else was jealous? Yes. And they were. Worldwide, people were coming up with inventive hacks to make Spotify accessible, americans using UK-based proxy servers to trick the service into thinking they were in England not New York, entire forums devoted to getting an invitation.

This international anticipation lead to a very smart alteration made to the free accounts (read: infuriating) that allowed free users totally unlimited desktop listening for the first six months but with ads (to get them hooked) followed by a cap of 20 hours streaming per month. This controversial move divided users, some deciding to upgrade to the Unlimited plan for a measly $5 a month to remove the cap, others deeming this unfair. These limits were eventually removed in January 2014 though. This invitation -> anticipation -> release -> broadening cycle has been very successful for Spotify and it is one they have replicated with each new launch.

World-Map-58-markets-
Spotify’s availability worldwide as of 2015

So how else do they convert new users to paid or attract a different audience? Mobile of course. Initially this service was only provided to those on the Premium subscription, it allowed users to stream playlists on their Android or iOS device but also to download tracks for offline listening (helpful for plane journeys or the morning Tube commute). However for Christmas in 2013, Spotify decided to bring the free users in from the cold and offer them a freemium mobile option too, with some key differences from their premium siblings. Firstly the omnipresent ads, but hey, you come to love them right? It’s just like watching terrestrial TV. Then the unusual lack of control, sorry that sounded dramatic, rather that Spotify only lets you play from a list of curated playlists, and limits the number of tracks you can skip, so not for control freaks.

What it has allowed for is to tap into that growing music market: the fitness fanatics. They have developed Spotify Running which allows the app to detect your running tempo and tailor the tracks it plays accordingly, increasing the tempo when you speed up and giving you a boost when you need it. It will then automatically suggested run-friendly playlists so you don’t have to waste precious time making one yourself or buying one from Ministry of Sound when you could be out hitting the tarmac.

spotify-running

So why haven’t they taken over the world and erased iTunes? What’s holding them back? Artists

Since the first days of Spotify they have struggled against a seemingly impenetrable wall: Artists dislike the royalties methodology of the streaming model. This is because the streaming model works on entirely different assumptions to that of a typical record release.There are a few crucial things to consider:

  • Firstly, many of the new users of Spotify would have been illegal downloaders before, so
    whether they are using the ad-supported system or the paid subscription, this is a positive addition to the artists bottom line, regardless of the amount.

listener-valueAverage-Value-of-ListenerIn fact Spotify have stated that comparing the annual music spending of a Premium subscriber to the average US music listener, Spotify users inject $65 more into the music industry. And that the average value of a US Spotify customer per year (taken as the total Spotify revenue from streams / its number of customers) was $16 greater than the average US music listener.

  • Putting songs on Spotify must be thought of as a longer term investment than releasing a CD. With the architecture Spotify has built, the release date of a track is irrelevant to the amount it is played (and therefore paying royalties). It’s therefore possible that long after the song has been released it can go viral on one of Spotify’s curated playlists, and have millions of listens overnight/

Relative-Figures-Chart

Relative royalties per month 

  • For the indie label artists, which seem to be the source of a lot of controversy for Spotify, they are thinking about the platform in the wrong way. They have the opportunity to skip paying for promotion services, they can get their songs in front of the biggest audience they could ever assemble without having to travel or pay for a support team. They can make their own promotion through the API, even embedding the new album into their Facebook pages.
  • For the more established artists who have had frankly tantrums over Spotify’s ‘pittance’ they have paid you, there are a few things for you to consider. You have tools at your disposal that are unavailable anywhere else:
  1. Firstly, content distribution. You have the ability to engage with your listeners in such a powerful way. You can give them greater insight into your albums than anywhere else, providing a discussion of the different tracks and linking to further content through Facebook integration.
  2. You can have exclusive content which can only be accessed through Spotify, which will draw a greater audience, think about collaborative playlists between artists of their favourite tracks from their tour buses, what they think the best songs of the month are,  or even live recordings of duets or covers that can’t be heard anywhere else.
  3. Make these exclusive options available only to paid subscribers (just like the XboxLiveGold / Netflix / Amazon Prime subscriber systems) which will entice more of your audience to be subscribers, and subscribers give a greater royalty share than free users, resulting in higher royalties.

royalties-over-timeRoyalties paid out over time

spotify-royaltiesHow Spotify works out how much to pay in royalties

We don’t know what will be the next big step in the Spotify story, what is clear is that they will continue to lead through innovation, and if they can make the next step on the music production side of the fence, and thus make artists happy, then maybe they can continue to lead for another few years. 

If you enjoyed this growth story, and want to read about how Airbnb grew to be the hotel industry’s worst nightmare, or how Tinder became the go to source of entertainment for lonely singletons, come back next week for another instalment of Game Changers. 

The article I read was taken from Growth Hackers, so thanks to them for a number of insights, images are taken from Spotify explained. All rights reserved. 

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