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Case Study – How does Spotify pay artists

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Lately I have been following several conversation about online piracy and legal alternatives for streaming music. They all seemed to point out that the only way to reestablish some profit for the music industry is giving more service to the users. This mission is everything but easy, as piracy grew exponentially since the Napster coming in 1999. And because in this last 15 years music labels did nothing to improve the music experience taking advantage of the new technologies. Some rightholders still believe in the power of the storage media, and even Apple had to negotiate hardly to convince them to migrate to its DRM platform iTunes.

What Piracy did better was understanding the change in the users mindset. People are no longer interested in owning music, they just want to listen to music. This has been the biggest challenge of this new millennium: provide a music experience free from any bond. Labels underestimated the power of this approach, finding themselves unprepared when it was already too late to argue. So where rightholders were incapable of competing with Piracy, a bunch of new platforms appeared to give an answer to the users’ needs.

iTunes took the first step to make music a digital experience, but the pay-per-song business model was still incompatible with the need of more freedom. Spotify took a further leap in the right direction, finally making the music ubiquitous. An entire catalogue of more than 20 million songs (some of them never been played), available in every device and without any incremental prices. And on top of that, the possibility to create playlist, follow friends and artists, share music and send it to your wireless speakers.

Understanding and satisfying the user’s needs is only the first part of the Spotify revolution. The second and most important part lays in its business model. So how does Spotify pay artists? Spotify don’t pay a plain fee per stream. More than that, Spotify couldn’t even know hot to calculate it, because it depends on where and when the song has been played. What they do is calculating the total earning of their music platform every month and then they divide the whole revenue by the number of listens per every artist. Well, it is actually a little bit more complex than that:

Spotify Royalty Formula

This is the official Spotify royalty formula from their website, which denote some interesting details about the way they distribute the total earnings. A better way to fully understand this formula is trying to calculate a single artist potential revenue. I apology for the assumptions I have to make in order to calculate the final value, which won’t be 100% accurate. Being Spotify a private company, they don’t need to fully disclose their financial and operational data. Anyway comparing the following results with some Spotify leaks we can ascertain that the approximations are pretty good.

For the case study I am going to use one of the most listened songs in 2013. Get Lucky by Daft Punk. The song has been played 25,467,772 times in its release month. In the same month, people listened to approximately 5,625 million songs in Spotify. Thanks to premium subscriptions, in 2013 Spotify earned around € 60M per month (later on I will explain why I am calculating everything in Euro). These data are enough to calculate the Spotify monthly royalties for this one song.

Get Lucky Royalty Formula

The first month of the Daft Punk hit in the Spotify platform created a paycheck of almost € 190k ($ 260k). This is the total monthly revenue for just one song, their most famous one. The other tracks of the album Random Access Memory have roughly scored the same number of streams than Get Lucky alone. Which means that the total album revenue per month is around € 400k ($ 550k).

I find these results quite promising for a relatively small platform (iTunes has 575M users), and I strongly believe that this business model works not only for big names but also for less mainstream artists. I repeated the experiment with one of my new favorite indie bands, London Grammar. Their album If You Wait collected almost 20 million song streams since its release. It is hard to calculate the monthly revenue, so I will go straight for the overall result: € 150,000. Not bad for a debut album of an indie band.

If we dig a little deeper, we will find out that the Spotify’s business model is really capable of revolutionize the music industry. And the royalty formula tells us a lot more about that than it seems at first glance. The first consideration is about the number of streams. Unlike the old school music cd, in Spotify the artist revenues grow when more people listen to their songs. I remember my teenager’s years when I almost melted the Spice Girls cd (and it’s very awkward to tell). But even if I put it in repeat the all day, the Spice Five only received my parents’ € 15 for that disk. If that would have happened today, they would have received almost my entire premium Spotify subscription (€ 120). And this is a very important innovation for both the artist and the user. The latter gains access to an infinite music catalogue, which would have cost him a billion Euro in the cd era. On the other hand, the artist’s revenues grow when their music is played, so the more people listen to them, the bigger is their monthly paycheck.

But there is a weird situation going on. For the first time in history, two different typologies of platform are coexisting and they remunerate the artist in different ways. iTunes pays a fixed fee of 9 cents for every downloaded song, while Spotify pays per listening. It is clear that the first model rewards the artist when a customer download an entire album and practically never listen to it. The second model pays back better when the customer really enjoys the album (or a single song) and listens to it more often.

So where is the breakeven point between the fixed model and the variable one? Using the above formulas we can determine that the breakeven is quite low, only 12 times. This means that with the current user base, if a user listens to a song for more than 12 times in their life, it would be better if they play it in Spotify. The extreme example is a user who listen to one single song for one thousand times. In Spotify it will generate a considerable benefit for the artist, while doing so in iTunes would only give them 9 cents. The artist is completely missing a potential revenue.

One last observation regarding the above formula. The only coefficient that can increase the unitary payment per stream is the total number of Spotify premium users. Meaning that if the artist wants to increase their economical benefits from every single song has to persuade their fan to join Spotify. It is a win-win solution. More people listen to more music, more benefit per track listen and more overall revenues for Spotify. For the first time, Piracy is starting to lose ground.

 

Important notes about the calculation

  • Why using Euro for the maths? Spotify Premium subscription has different costs in different countries. The most important ones are Europe (€ 9,99), USA ($ 9,99) and UK (£ 9,99). “Get Lucky” first month listeners were approximately distributed in this way: 25% USA, 15% UK, 60% Europe. Mixing the different subscription prices at a current change rate results in a compensation between pound and dollar change rate, so that the overall revenue was almost equal to a 100% Euro mix.
  • What is the Artist’s Royalty Rate and why it disappeared in the final formula? Every label has a contract with their artists defining what percent of the total revenues goes to the artist and what part the label keeps. This agreement is secret, so it is impossible to determinate. Furthermore, most indie bands don’t have a label and consequently they retain the 100% of their royalties.
  • How did you calculate the total number of streams per month? This year Spotify did not provide this data. They only declared that in 2013 their users listened to 4.5 billion hours of music. Assuming that a song has an average length of 4 minutes we can calculate the approximate number of streams in a year, and consequently in a month.
  • What about the Spotify advertisement revenues? Spotify offers a free version of its platform run by advertisements. The total revenues of this option are not available, although Spotify points out that they are much smaller than the premium revenues. The study doesn’t take into consideration this form of earning, underestimating the overall artist revenues.
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  • Funktapus

    Are you sure Spotify pays the same royalty rate for subsequent listens by the same user? I can understand if Spotify pays more for more listens, but there could very well be diminishing returns. It would make little sense from a royalty standpoint to pay significantly more for constant streaming than for a permanent license. I wonder if they have a ‘rent to own’ sort of system behind the scenes…

    • That would be absolutely successful, especially if Spotify would invest a lot of time and resources in discovering future hits and proposing them this permanent license.
      Let’s say they did this for Happy by Pharrel and now they would have saved a huge amount of money in royalties.
      But I am afraid that the Spotify businesses is supported by a high level of transparency with Majors, making it very difficult for them to go in the permanent license way.