1. Business Models
Study on the Business Model of
Innovation and making Revenue from a “freemium” model
Submitted By:
Anirban Ghosh
2011PGP545
2. It is 2000 and news broadcasters all across the world are beaming images of Metallica frontman Lars
Ulrich filing a case against Napster, the poster boy of the IT boom of the last century. Metallica, a band
comprising of billionaire musicians filing a case a case of “property theft” against a peer-to-peer sharing
network for “unlawfully” posting one of its songs on its network. This first case of an artist suing peer-to-
peer (P2P) networks set the precedent for a long and continues battle which continues to be played out
in courts today. Cut to 2008 and we are witness to another major website piratebay.org being forced to
change its domain name to piratebay.se. Ranked in the list of the “Top 100” most visited websites across
the world, this network developed by 4 Swedish personnel was found guilty of “facilitating illegal
downloading” and was “the most visible member of a burgeoning international anti-copyright or pro-
piracy movement". Clearly opinion is still divided upon where the jurisdiction ends and technology can
take over.
The world and the internet have come a long way since Shawn Fanning set up Napster from his dorm
room at Northeastern University. Between then and now the world has come a long way, we had a host
of KaZaa, Morpheus, Gnutella, LimeWire etc. which allowed transfer of a variety of media via torrent
and other sharing mechanisms, but where generally under the radar of authorities because they did not
overtly focus on any particular type of media like music or movies.
iTunes concept
The truly phenomenal entry into the music sharing segment was of i-tunes, the music sharing service
developed by Apple Inc. introduced in January, 2001. iTunes is a media player computer program used
for playing, downloading, saving, and organizing digital music and video files on desktop or laptop
personal computers. 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.
iTunes as a service has generated billions of dollars for Apple Inc. The latest trade estimates state that
iTunes will generate atleast 13 billion dollars in revenues by 20131. So in other words ever since its
inception, iTunes attacked the basic fundamental of the bricks-and-mortar retail music industry and
brought in a revolution very few had envisaged. The iTunes business model is based on the concept of
an à-la-carte MP3 store, where individual songs can be purchased all at the same price. Apple signs deals
with all major record labels and in effect acts as an intermediary between the label and the consumer.
For every 99 cents song sold on iTunes, Apple receives a 35 percent cut. iTunes currently boasts a library
of 20 million songs which have been downloaded 16 billion times and still counting, clearly there is very
little that can dislodge iTunes from the top of the mountain, but only until now.
3. Enter disruptive technology in the form of Spotify
Spotify was developed in 2006 by Daniel Ek, A former CTO of “Stardoll”, and Martin Lorentzon, co-
founder of “TradeDoubler”. They incorporated a company called Spotify AB in Sweden.
Their official website states “All the music, All the time” which more than needed explains all that
Spotify is about.
As of May 2012, the service is available in Australia, Austria, Belgium, Denmark, Faroe Islands, Finland,
France, Germany, the Netherlands, New Zealand, Norway, Spain, Sweden, Switzerland, the United
Kingdom, and the United States. As of May 2012, Spotify had a total user base of 20 million users, out of
which almost 3 million opt for the Paid service.
So what does this service do, Spotify aggregates content from right holders, distributes it to
consumers through the technical platform and monetizes both through a free, ad funded service,
and a subscription service.
Before going about discussing the business model of Spotify, it will be good to have a look at the
industry it operates in, the global music industry.
The global music industry
A dynamic market, the global music industry is characterized by many players and fierce competition.
Today the music industry has almost become a business model playground with scores of companies
highlighting the limitations of the brick-and-mortar recording companies.
The music industry ecosystem consists of the following key players:
Key players- consisting of distribution channels and manufacturers
Key activities- consisting of ‘detecting talent’ and ‘marketing and promotion’
Key resources- consisting of ‘copyrighted content’ and ‘portfolio’
Services to offer- hits and wannabe hits
Customer relationships
Customer segment- Mass market
Channels- consisting of retailers, TV, radio and digital channels
Cost structure- involves marketing and promotion, subsidizing unsuccessful artists and royalty payments
Revenue Streams- consists of sales of CD’s, merchandizing, tours and concerts
4. To understand the various business models, we will use the following framework of the music industry:
The problem with the traditional business model was:
5. How Spotify has changed the ‘status quo’
According to strategist Camilla van den Boom “Spotify operates a so-called “multi-sided platform”
business model.” In a multi-sided platform, one player (in this case, the advertising party) finances the
other player (in this case, the one accessing the music). Spotify serves these two customer groups that
cannot exist without each other: the music seeker and the advertiser. Both these segments exist in a
symbiotic coexistence and cannot exist without each other.
Spotify as a service provides a benefit for both of them. The user (”seeking music/fan”) is looking for
music and the experience of music. He is satisfied as long he is able to get the type of music he wants,
irrespective of whether he is paying for it or not. The advertiser is looking for an audience to advertise
for their products. Spotify manages both segments by providing free access to music in a legal way. For
those who do not want advertising, there is always the premium (paid) model. The user can listen to
unlimited music for a nominal monthly fee. For those who do not want to pay, all they have to do is put
up with the advertisements. Through Spotify, the user buys off the rights to listen to the music.
These sentiments are perfectly echoed in the words of Camilla Boom who states “Spotify is a
distribution channel for music rightholders (record companies and artist aggregators). They use Spotify
as a channel to reach their customers.” Thus, Spotify has a mixed advertising or in its own word a
“freemium” business model.
Specifically, there are three pricing tiers:
1. Free: You can download and listen to Spotify for free. However, there are ads (audio and display) and
limitations on listening duration
2. Unlimited: At US$4.99/month, you can enjoy unlimited listening time without any ads
3. Premium: At US$9.99/month, you can enjoy unlimited listening time without any ads and you are
able to take songs mobile on other devices
Represented pictorially, it can be visualized as:
6. Spotify with its new value system added a few dimensions to the existing industry framework, eg:
Inclusion of bandwidth cost and salaries under Cost Structure, Key Activities for Spotify is platform
maintenance and development, similarly on offer is both music and advertising and other few
modifications which are elucidated in the model below.
The ways in which all these interact with each other are:
7. How Spotify’s freemium business model work
The creators at Spotify have clearly understood the human behavior and put the theory of “free drives
paid” into practice. They understand that the user wants to listen to (access) music. And the user is
(under certain circumstances) also willing to pay for music. Therefore, Spotify has two services on the
market: Free and Premium. But then the fundamental question arises, 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. It can be used to play (access) music on any
devices like ones PC, mobile and even a car. The music literally moves with the person who is accessing
it. The application also provides the user with many opportunities and options how to build your playlist
and music library. And the user can easily share it with his/her friends, via email or Facebook or any
other social networking platform. The Spotify user invests much time in building and sharing his or her
music and these investments are 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. The level of customization and personalization is such that
user can play with it the way they want. And after a while, the user starts getting 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.
Will Spotify kill iTunes
Today iTunes still pretty at the top when it comes to online music platforms. On its introduction, it beat
the brick-and-mortar model on selection, convenience, and price. As an online marketplace it had a
fundamental advantage. Since it was online, it was omnipresent, in one’s home, there were no physical
limitations, no inventory, and could beat any existing service offering on price because of its lower fixed
costs.
Now, a decade later we have Spotify. Based on the job of providing music to those who want, anytime
anywhere, Spotify completes this job in much the same way as iTunes does. Spotify is conveniently
located, has a wonderful selection, is compatible with ones computer, smart phone, and tablet (which
are in turn compatible with the stereo and car), and is backward-compatible to play music from any
existing iTunes library.
So on the face of it does not seem Spotify has any fundamental advantage over the incumbent. Even if
Spotify competes in a similar fashion, that doesn't necessarily mean it's better than iTunes. Indeed,
Spotify's library of just 12 million tracks does not even come close to those on iTunes. And though
Spotify is compatible with a handful of important devices, iTunes user base continues to increase day-
by-day. But this is the nature of what Professor Clayton Christensen calls low-end disruption. He defines
it as “at first, a disruptive product fails to deliver a superior offering to the incumbent technology in one
or more characteristics of the job-to-be-done. But consumers switch nonetheless because the disruptor
has a systemic advantage in at least one of these characteristics. We gave up minicomputer
performance for the cost advantage of PCs, we gave up plasma television contrast for the slimness of
the LCD, and we gave up the personality of written letters for the speed of emails.”
8. In an analysis done by Maxwell Wessel at Harvard, he says that Spotify holds a systemic advantage over
iTunes in one particular job characteristic of delivering music: relative pricing. While iTunes and Spotify
both deliver music over the net, Spotify's position as a radio service lets it price far below the level of
iTunes. For $10 a month, one can gain access to unlimited music as long as they are listening through a
Spotify music player. A person doesn’t even have to be connected to the net. Because Spotify pays
record labels only a small royalty by audio stream, it has aligned its business model around this low
pricing, which in itself is a business model innovation.
Though Spotify did not pioneer this disruptive innovation, it is the first time mainstream media is
exposing the American public to it. And we know its disruption because it is a business model,
fundamentally advantaged in one of the characteristics we value in completing the job-to-be-done.
Whether it displaces iTunes or not remains to be seen but according to analysts Spotify is here to stay
for the long haul.
Spotify co-branding with other companies: a strategy for sustained growth
Spotify has partnered with a number of well-known brands in different industries, linking its name and
logo to the ones of those other companies. Let’s have a look at a few of them:
Spotify and Virgin Mobile
Virgin Media is a telecommunication company and a mobile operator based in UK. It offers a three
month Spotify Premium account to the customers that buy one of their Premier or VIP collection
packages (Virgin Media, 2012). With the new offering launched in 2012, they have integrated Spotify
into its TiVo box, which gives users the option of enjoying Spotify on the television. Also those who
subscribe to some selected packages on their phones, get access to a 3 month free premium account.
This was an important collaboration for Spotify because through this their logo got visibility across a
whole range of media. A snapshot of the website in shown in the Exhibits.
Spotify and SEAT
Spotify entered a partnership with a Spanish car manufacturer called Seat. There was another company
which was a part of this partnership Samsung. According to the deal, Seat came up with a model called
Ibiza Spotify with a Samsung smart phone as a gift with Spotify preinstalled on it for 6 months without
any charge. This was advertised in both TV and print media. The Spotify logo was also shown on the Seat
website, websites for car lovers and magazines.
Spotify and Volkswagen
The partnership with Volkswagen, the world’s second largest car manufacturer consisted of a website
created by Volkswagen which would have the functionalities of a music player and users could log on
and suggest songs and post and share the same. The website had the logo of Spotify and it branded both
these 2 brands together in the eye of the user.]
The advertisements for each and snapshots of their websites are mentioned in the Exhibits.
9. Revenues for Spotify: is the “freemium” model making money
Music Ally, an industry wide internet source, published the annual financial statement of Spotify in early
2010. (Statement attached in the Exhibits)
According to them, almost 60 percent of company revenues are coming from subscriptions and rest is
coming from advertising. As of 2009, Spotify had a total of 7 million users of which around 250,000 were
paying subscribers. In July 2010, the company said it had 500,000 payed users, and in late October 2010,
it was rumored to have 650,000 paying subscribers. Roughly speaking, Spotify adds approximately
41,600 new paying subscribers per month.
A cursory look at the revenue statement of Spotify as published on Music Ally shows that the company
lost more than $42 million during 2009 and 2010. This does not present a rosy picture on its own but a
closer look at the revenue statement will show that the loss as a percentage of revenue was much
smaller than the prior year. This shows that as the service matures and gains popularity, it is gaining
scale and also leverage.
The biggest cost item on its income statement is "Cost of sales", which mainly includes music licensing
costs. The music licensing costs were bigger than revenue. This means that even before paying for its
actual business costs-on offices and salaries and database servers, Spotify has spent more than it takes
in. Amongst all this negativity in the numbers, the good thing although is attributed to the following:
Spotify's growth is through the roof: Revenues grew a stunning 458% from 2009 to 2010. That's
impressive for any business, but even more so from one that starts from an already relatively
high base of eight figure revenues. These numbers do not seem to show any sign of abating in
the coming years
Spotify's losses are narrowing: Losses were 147% of revenue in 2009. In 2010 they were only
42% of revenue. Not a very impressive number but taken in the context of an industry in which
it is almost impossible to make money and the growth that is projected, seems likely to narrow
down in the coming years
Cost of sales v/s revenue growth: The biggest cost item on Spotify’s sheet ‘licensing fees’ grew
at a rate of 345% between 2009 and 2010 while the revenue grow at 458% during that same
period. The fact that costs are growing at a lesser arte than revenue suggest a bright future for
the service in the coming years.
According to analysts at a successful website called “business inside”, a successful freemium business
generally has the following attributes:
A large free user base
A low marginal cost to serve each new subscriber
A product whose value to the user increases over time.
10. We can do well to analyse Spotify on each of these parameters individually:
It already has a huge free user base. Spotify already has many millions of free users (see chart in
Exhibits). Its product is highly critically praised. What's more, Spotify has been a large beneficiary of
Facebook's new platform product, which allows music services to turn users' activities into viral social
signals. With a continued presence in the 12 most developed nations and further expansion on the
cards, Spotify's user base should only increase from here.
Spotify also appears to have a low marginal cost per subscriber. The key cost-per-subscriber is the
royalties Spotify must pay to content owners. Once it has made the initial payment there is very less
transaction cost because it does not have to bear the cost of each new subscriber. This is because it
provides a platform akin to a peer-to-peer architecture where users can share their music with others.
We can presume that the pricing structure followed at Spotify is such that most of the users turn out to
be profitable relative to the amount of service they have access to. These profitable subscribers
probably offset the costs of those who consume music 24 hours a day. Right now it can easily raise
money privately and seems to have good relationships with the music industry, but this high cost base is
going to be a problem for Spotify.
The final question is whether Spotify becomes more useful to users over time-and the answer is yes.
And this is important, because it will allow Spotify to convert more free users to paid users over time. As
mentioned earlier Spotify operates on a “free pays paid” model and this is shown in the conversion ratio
it operates on. It boasts of a high conversion rate on active users, around 15% (chart mentioned in
exhibits).These ratios are higher than the average conversion rates seen across this industry. The key,
this person explained, is that Spotify creates an "emotional connection" between the user and the
product (and it is, indeed, a very pleasing product to use).
The underlying idea is the same: freemium products that succeed do so because their value to the user
increases over time.
As explained earlier, at first, Spotify is just music. Then it becomes music, plus their playlists, which they
have taken a lot of time to put together, plus their friends' playlists, which they can access easily in the
software thanks to Facebook integration. Once the "emotional connection" with the product is
accomplished it becomes much more compelling to pay up.
What does the future hold for Spotify
A big step taken by Spotify in the last one year was the launch of its service in the United States. Ever
since its launch in July 2011, the service has become a corner stone of the music industry and this shows
no sign of abating.
It also partnered with the biggest social media platform on the planet Facebook in an effort to help
users access, discover and share more music. As c0-founder Daniel Ek says "Ownership is great but
access is the future, people just want to have access to all of the world's music." With Facebook
integration, users can do exactly this and also almost instantaneously.
11. In November of 2011, the company launched Spotify Apps, offering listeners a more immersive music
experience. For example, when streaming a particular artist's track, a user can access a Songkick app and
see if the artist is performing in their town.
Spotify does not want to add customers who are already using iTunes, it knows that out of 500 million
people listening to music worldwide, a very small percentage is actually tuning in through iTunes, it
wants to reach out to all these 500 million people and the user base of iTunes alone.
With a wave of expansion on the cards and further integration with social networking sites, Spotify is
clearly changing the way music had been perceived till now and distributed. The system seems to be a
win-win for all the members of the ecosystem. There are the record companies which now have a way
to reach out to the global music fan and gets paid for his records. There is the music fan who can now
have unlimited access to his favorite songs for a fee or if he is not irksome about the ads, can also have it
for free. Couple it with the notion of seamless connectivity and integration with social networking
platforms only shoes that Spotify has succeeded where other platforms have failed, in giving the
industry a legal, fast and easy to use service to transfer music. It only remains to be seen if it can fulfill
the expectations everyone places on it, and if numbers are to believed, it will do so.
17. References:
“Branding for Startups- A Case study for Spotify” by Yu Dai and Alberto Pietrobon, presented at the KTH
Industrial Institute, Sweden in 2012
“10 Business Models that rocked 2010”- a study done by analysts at “Board of innovation”
“Business models in the Music Industry” presented at the Eurosonic Noorderslag, January 14, 2011
“A year after launch, U.S. Spotify users have listened to 13B songs, shared 27.8M” by Devindra Hardawar
http://venturebeat.com/2012/07/21/a-year-after-launch-u-s-spotify-users-have-listened-to-13b-songs-
shared-27-8m/ [accessed on August 5, 2012]
“A conversation with Daniel Ek” by Eliot Van Buskirk
http://www.grammy.com/news/daniel-ek-on-spotify-community-and-musics-future [accessed on
August 5, 2012]
“Steven Levy on Facebook, Spotify and the Future of Music” by Steven Levy
http://www.wired.com/magazine/2011/10/ff_music/all/ [accessed on August 5, 2012]
“Spotify’s revenue model”
http://entrepid.sg/spotifys-revenue-model/ [accessed on August 11, 2012]
“How Spotify's Business Works” by Pascal-Emmanuel Gobry, published October 12, 2011
http://articles.businessinsider.com/2011-10-12/research/30269526_1_spotify-revenues-cost [accessed
on August 11, 2012]
“Is Spotify's Business Model Sustainable?” by John Paul Titlow published July 15, 2011
http://www.readwriteweb.com/archives/is_spotifys_business_model_sustainable.php [accessed on
August 11, 2012]
“Free drives paid” by Camilla van de Boom published February 16, 2012
http://www.businessmodelsinc.com/2012/02/16/2150 [accessed on August 11, 2012]
“Why Spotify Will Kill iTunes” by Maxwell Wessel published July 22, 2011
http://blogs.hbr.org/cs/2011/07/why_spotify_will_kill_itunes.html [accessed on August 11, 2012]
Wikipedia entry on Spotify
en.wikipedia.org/wiki/Spotify [accessed on August 13, 2012]
Official Spotify website
www.spotify.com/ [accessed on August 13, 2012]
