Disruption through subscription

Emily Anderson, Business Analyst





Streaming services have been established for a number of years and are very much integrated into our daily lives, but does this business model actually make any money? If so, might we see other industries migrate towards this model in the future?

The digitisation of music and video distribution has allowed new business models to emerge. Music and video streaming services, such as Spotify and Netflix, continue to gain share in their respective markets. These models demonstrate a shift away from content ownership, for example physical purchase or digital download, towards unlimited renting of content. Subscriber numbers are increasing rapidly and company valuations soaring, giving the illusion of success, but does this business model actually turn a profit?

Streaming is transforming the way that we watch TV. Without the annoyances of advert breaks and waiting a week for the next episode, it’s no wonder that subscription video-on-demand (SVOD) services are becoming so popular. The market is seeing an army of new players vying for a share of the growing revenue. This is causing current players to invest heavily in new content in an effort to continue growing their subscriber base and reduce churn.

Netflix are by far the most popular video streaming service, with the number of global subscribers growing by 34% on average each year and reaching 75 million in 2015. However, they posted a modest net profit margin of 2% for 2015, and continue to make a loss on international streaming. This profit margin has decreased from 4.9% in 2014, which Netflix imply is due to their investment in new international markets and original content. This profit squeeze could also reflect the increase in content price caused by the increasingly competitive market.

The music industry has gone through various shifts in its distribution model in the last 30 years. Vinyl LPs and cassette tapes were usurped by CDs in the 90s and then came the digital revolution. In 2014 digital music revenue caught up with physical sales revenue globally, and in 2015 streaming revenue surpassed digital download revenue in the U.S.; the same inflection point globally is expected within the next few years. Two monetisation models are being used within music streaming (ad-supported and subscription) however the top three services by number of subscribers: SoundCloud, Pandora and Spotify, are yet to turn a profit.

Taking Spotify as an example, something needs to change; they posted a net loss of £117m in 2014. Premium subscribers accounted for 91% of Spotify’s revenue, yet only made up a quarter of their subscriber base. The advertising targeted at the 45 million ‘freemium’ subscribers, only generated 9% of Spotify’s revenue. The main attraction of ad-supported streaming platforms is that they provide easy access to free music compared to the alternative of illegal torrenting. There is a risk that if Spotify were to transfer to a subscription-only service, a significant proportion of those 45 million would simply turn to the ‘free’ illegal download scene. Apple, who were late to join the streaming party, are vying to make up for lost time by launching Apple Music as a subscription only service with long free trials and exclusive content. The undoubted leader in the download market, will they be able to do what their predecessors are struggling to and make a profit through music streaming?

One big problem for music streaming is that it doesn’t benefit from economies of scale in the same way that video streaming does. Netflix pay a fixed cost for content, so the more subscribers, the lower the cost of content per subscriber (Netflix were rumoured to have spent around $3bn on content in 2015, approximately 45% of revenue.) However, Spotify and Apple Music are obliged to pay 70% of revenue to the record companies and artists for the content, meaning that regardless of the number of subscribers, the amount they pay for content per subscriber stays exactly the same. This leaves them with 30% of revenue to cover all other costs. So to make a profit in 2014, Spotify would have had to of generated a revenue of £1.17bn, an increase of 33% on the actual figure; it is hardly surprising that Spotify are making a move into the video streaming market. Though considering the market leader Netflix are only making a 2% profit margin, Spotify’s move isn’t going to make a massive dent in counteracting their 15% loss margin.

The main problem for the current streaming model, both video and music, is that the subscription price being charged is not high enough to compensate the high cost of creative content. Unfortunately, this problem is a direct impact of the piracy market. Though people are reluctant to admit it, there is an upper limit on how much we are willing to pay for a service which basically just provides user friendly and convenient access to content which we already have access to through the darker side of the internet. Netflix have potentially combatted this to an extent with their move into original content production; would it be a smart move for Spotify to launch their own record label?

In which other industries would a shift from content ownership towards unlimited renting make sense? Sheet music, books and computer software are potential candidates. Amazon has recently launched the ‘streaming’ service kindle unlimited, initiating the disruption of the eBooks industry. Is this going to trigger a migration through the entire industry, and what factors will govern its success?

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