Is a Spotify Free user worth $1.50 per month? Or more…

An ongoing controversy in the land of music licensing relates to the role and value of free music within the complicated financial plumbing of the music industry. Importantly, music is almost always worth something, if not at times a great amount. As a result, free music—like free beer—is rarely, truly worthless.

For example, a simple quesstimate—using recently revealed numbers from Spotify—suggests that Spotify Free users may be worth, on average, $1.50 of revenue each month ($18/year).

[The range for the estimate would be between $1.22/month ($14.64/year) and $1.77/month ($21.24/year), conditional upon whether the true proportion of Paid users within the pool of Total Active Users is 20% or 25%.]

IMPORTANT: If what Spotify really meant to say when it reported the Paid-to-Free user ratio was that the number of Paid Subscribers were 20% of the number of Active Free Users, then the revenue quesstimate above rises to as high as $2.10/month ($25.20/year). Furthermore, if Spotify were over-reporting the proportion of users that are Paid versus those that are Free (for whatever reason), then the figures above would under-estimate the monthly revenue value of Free users.

How did I get to the guesstimate above? The rest of this post describes the algebra on the back of the napkin.

The Back of the Napkin

Recently, the folks at Spotify were kind enough to post “Spotify Explained,” within which the firm uses various data to both describe and justify the underlying business model and impact of the service. Artists may debate whether they like or don’t like the Spotify business model. Regardless, the release of these numbers helps people like me do what we do—attempt to convert little breadcrumbs of data into at least a bit more transparency within this music industry.

Within this report, the firm released one very useful byte of information:

By 2013, the amount of money we earn per user (average revenue per user) has grown to $41 per year. This is an average between our premium users who spend $120 per year and our free users who pay for their consumption by viewing and listening to advertising.

Given the above statement, and the ratio between Premium and Free users (another metric the firm reveals from time to time), we can guesstimate the value of Free users within revenue portfolio. Caveat: Spotify makes reference only to the $120/year ($9.99/month in the US) subscribers in this report, with little to no reference made to the $60/year ($4.99/month) subscriber pool. Therefore, I will work with this simplification of the user pool.

In February 2013, Spotify claimed the service had 6 million Paid subscribers and 24 million total Active Users (Active User =  the pool of both Paid and Free users who had logged into the service during the last 30 days). Spotify also suggested the ratio of Paid subscribers to Active Free Active was “greater than 20%.”

For this analysis, the ratio between Paid and Free users is what matters, rather than the total number of users in either of these bins. Meaning, we would get the same guesstimate regardless of whether there are 6 million, 8 million or 15 million paid subscribers as long as the ratio between Paid and Free Users remains the same. That said, Spotify reveals these numbers in a somewhat confusing way.*

As such, I made use of two bounds for the quesstimate:

(1) The ratio of Free Active Users to Paid Subscribers is 4 to 1;
(2) 25% of Active Users are Paid users, 75% are Free Users.

Note that point (1) above would mean that the number of Paid Users is 20% of the number of Free Active Users + Paid Users; given the 4:1 ratio converts to 1/5 = 20%.

From here, all we have is a question of solving for an unknown within a weighted average that leads to $41 per year in weighted average revenue.

(1) (20% * $120) + (80% * X) = $41

$24 + .8X = $41
.8X = $17
X = $21.25 per year in Free User Revenue
X/12 = $1.77 per month in Free User Revenue

(2) (25% * $120) + (80% * Y) = $41

$30 + .75Y = $41
.75Y = $11
Y = $14.67 per year in Free User Revenue
Y/12 = $1.22 per month in Free User Revenue

NOTE: if what Spotify really meant to say was that the number of Paid Subscribers were 20% of the number of Active Free Users, then the quesstimate rises to $2.10 per month, or $25.20 per year.

ASIDE: Anyone paying close attention to licensing rates and revenues should be able to place that $14.67 – $21.25 per year above in the context of recent iTunes Radio licensing parameters.

* Unfortunately, the user figures from Spotify present the ratio in at least two ways. As such, I chose to quessimate things based upon my understanding of what appeared to be two of these ways for communicating the figures.

On the one hand, the firm refers to 6 million Paid Subscribers amidst a pool of 24 million Active Users. This presentation suggests (reasonably) that some proportion of Paid Subscribers are not Active (i.e., did not login to use the service) in any month. 6 million is 25% of 24 million users.

On the other hand, the firms also suggests that ratio of Premium subscribers (who may be non-active in a month) to Active Free Users is 20%. I find a ratio communicated as a percentage to be a bit confusing. And so, I simply assumed they meant: Paid Subcsribers / (Paid Subscribers + Active Free Users ) = 20%. Or, the ratio of Paid Subscribers to Active Free Users is 1:4.

6 thoughts on “Is a Spotify Free user worth $1.50 per month? Or more…

  1. David,

    I like how you’ve broken this out and I feel that you are on to something close. I say “feel” because of my limited math skills. I also have to admit to not spending too much time worrying about revenue flows into or out of the various streaming music companies. What’s of interest to me, if there is to be a continued debate about revenue streams or lack thereof, (which are the plaints we hear from musicians) is scale.

    The market for music sales via vinyl and CDs and the revenue income from those sales, was always pretty small in comparison to say, the apparel industry – everyone requires clothing, not everyone needs to purchase music. These charts from the RIAA are old, only up to 2009, http://www.businessinsider.com/these-charts-explain-the-real-death-of-the-music-industry-2011-2 but two charts are interesting – one shows recorded music sales per capita where the CD is an aberration and another shows unadjusted raw dollars from recorded music sales. In 1998 recorded music sales peaked at $18 billion. Not a number to be sniffed at but still, not a massive industry either. Today’s sales appear to be about $7 billion driven mainly by the single download sales.

    It would be wrong to point to illegal downloading of music as a major factor in this decline. I would argue that demographics have to be factored in and also the proliferation of other goods that stretch people’s dollar budgets – mobile devices with expensive data plans, Xbox/Playstations etc, gaming in general. When I worked at Intel I saw research that showed people bought 3 CDs a year on average.

    All of this is to say that the streaming music market is small. The subscriber-paid streaming music market is tiny. And yet, should Spotify, Beats Music, YouTube music convert many more people into paying subscribers – from perhaps 10 million today to 50 million by 2020 – then the revenues may be back to 1998 numbers. If I’m correct streaming music services began around 2001 – so 13 years ago. That’s a short period of time. Scale could now occur rather rapidly given society’s aptitude around mobile devices and technology and an understanding of what streaming music actually means.

    I’ve been involved in the online music world since joining eMusic.com in 1998. There has been endless rhetoric plastered in many online forums about the death of the music industry, the end of music, and recently, two famous musicians declaim how the “Internet is sucking up all of the creativity in the world” and how “Silicon Valley is destroying creativity and should be shut down.” The music industry is actually doing fine and the Internet is not destroying creativity.

    I want to change the conversation in 2014 from debating musician’s incomes, to debating the future. Real problems require real answers. Honest discussions will get us to a place where hopefully there is harmony and equality provided by a new system that is even better than the old system. It is systems and patterns that we are dealing with and have to face. It is also the new social construct – music fans want to rent, not own, their music.

    I know that what I have written here is a long way off the subject of your post, but I feel strongly that the lay-person doesn’t spend a lot of time worrying about the mechanics of revenue flows – they want access to their favorite music as easily as possible. And they are willing to pay for it. Musicians and music companies of all stripes need to service that audience.

    • Dave,

      All wonderful comments. Like yourself, I have been around this block for a long time and, on many occasion, have been tired of the rhetoric. To be clear, however, the audience for this site would not be the average music listener, but rather the nerdy types curious about the mechanics of revenue.

      Not to mention, while many people such as yourself believe that people are willing to pay for easily accessible music, the work I do here focuses (at times) upon how much these folks—whether music fans themselves, or the advertisers in search of these ears—appear to in fact be pay (or otherwise willing to pay).

      Beyond the question of scale, there is also the question of monetization. To put this post is further context:

      Presently, Broadcast Radio in the US makes more from Free music than the Recorded music industry earns from Paid music. In the US makes, Radio earns two-times the revenue per capita than the Recorded Music industry—even after extracting that Radio revenue that comes largely from “Talk” programming.

      Broadcast Radio => $17 billion
      minus Talk Radio => $14.5 billion (estimated)
      Revenue per capita => $54
      Revenue per listener => $70

      Recorded Music => $7 billion.
      Revenue per capita => $23
      Revenue per buyer => $50 (estimated)

      The two largest sources for Free streaming music online, Pandora and Spotify, are presently making less than $15/year in advertising revenue per user, if not less than $8. For example, it looks like Spotify may make somehow upwards of $18/year per active Free listener. Pandora is making less than $7.50/active listener (ignoring revenue earned from subscriptions).

      • Yes, I knew that I was preaching to the choir on one side and not addressing the “nerdy types” as you call them.

        In market terms I sense that there has to be a thinning out of the service platforms. I’m surprised that Pandora still lurches along for instance. Rhapsody is struggling to be relevant. Your point of Free music via radio is well taken, but terrestrial radio advertising has always been successful certainly versus in-the-stream advertising online. Radio’s reach is still superior – I mention that in a recent post http://north.com/thinking/musicians-versus-spotify-its-about-scale/

        I think we can agree that the streaming music market is a niche market when gauged by user size and per user income. Meanwhile iTunes has 575 million active users. I only suggest in regard to scale, if some of those free radio users and some of those iTunes customers move over to paid subscriptions on Spotify et al, then your back of the napkin numbers would surely increase, no?

        • Here’s to the Choir!

          I strongly agree that artists/pundits should be a bit more reserved in their conclusions. Music subscription accounts equal roughly 1.5% of mobile phone users (or, a similar proportion of the US population greater than 12 years old).

          Essentially, some people are basing their conclusions for the future of music upon a tiny slice of the market. Even at a larger scale, however, revenue per user or effective royalties per stream would not likely shift.

          In fact, it may be the case that for the total value of the market to increase, the price of these services (and therefore the effective value per listener of each stream) may have to fall.

          Strangely, we in the US have had greater than ten years to adopt subscription services (e.g., Rhapsody, Musicmatch, Yahoo! Music, MusicNet, etc.).

          As such, I fear the big “IF” at $9.99/month has seen its day. This price point is probably stale.

          Modern services (i.e., Spotify, Deezer, etc.) grow by launching internationally. And even with than multi-national expansion, the services are niche–as you describe.

          Artists may need to decide if they want a small amount of money in their pockets, but big coins, or a large amount of money very small coins.

          • Yes indeed. And my line in the sand re artists is that their complaints re revenue/royalties are with the labels, not the music streaming services. And as for the “greater than ten years to adopt” model, I argue that musicians have had two decades to embrace the “containerless” model of the internet. A few have. The rest? Crickets!

            As for the $9.99 model I still find it odd that that was the price we set in eMusic.com in 1998 – .99c a download or $9.99 an album. Then Apple went there too!

            I believe Beats Music will launch with a premium price point that might change the game, we’ll have to see.

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