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.