It may take 35,000,000 active users in the USA for the yearly royalties paid by Spotify to equal those paid by iTunes?

Recently at SXSW, Sean Parker apparently predicted that Spotify will overtake iTunes within the next two years—given the former’s present growth rate.  I am going to assume the active measure for comparison here is royalties paid during a year period, or revenue earned, not total number of active users or user accounts.

Let’s check the math, using some of the inputs from Glenn Peoples over at Billboard. For the moment, we will limit this little discussion to the US only. And we will hold iTunes growth at nil, essentially seeing how big Spotify would need to get to equal iTunes music revenue/royalties in 2011.  To account for growth towards 2013, just add your own growth factor to the answers I get.

I will also make two key assumptions:

(1) That 70% of the Spotify subscription price is what goes into the pool for royalties, just as 70% of the iTunes sale (in general) goes into the pool for royalties).  For example, at the $9.99 premium price, roughly $6.99 becomes the royalty pool.  This assumption is not only being made in order to make life simple, but also because this 70% payout appears to be the case (at least according to Glenn@Billboard).  Your mileage may vary.

NOTE: I know I am being a little sloppy here given it would be better to include a more appropriate accounting of mechanical royalties.  However, given that in the US these royalties can flow through the sound recording owners (my emphasis and potential sarcasm added), I am just bundling the whole problem within the 70% for simplicity.

(2) That the “effective” obligation per active FREE user is $1.99 per month, 70% of which is paid as royalties.  Just to be interesting, I will also work with $2.99 and $0.99 as the FREE user value.  In essence, I am treating FREE users as a cost to Spotify on a per subscriber basis (regardless of whether enough ad revenue is earned) and a resulting royalty payment for rightsholders.  Not a perfect treatment, but this technique will permit us to account for the fact that these users do lead to royalties—while free to the user, free users are not free for Spotify.

Glenn stated, over at Business Matters in Billboard:

Billboard estimates there was roughly $2.4 billion of consumer spending on music downloads in the U.S. in 2011, based on Nielsen SoundScan sales figures and rough estimates of per-unit prices. iTunes was assigned a 70% share of the download market, giving it estimated sales of $1.7 billion.

And so we are looking for a kitty about equal to $1.7 billion in the United State for comparison.

Now, Spotify presently claims roughly 10 million active users, 3 million of which pay for the service in some way.  Therefore, at least for the moment, let’s work with 30% of the “active user base” converting to paid users.

The firm has previously stated that about 85% of paying subscribers are at the $9.99 tier, while 15% are at the $4.99 tier. Lets move forward as if this ratio between high/low tier subscribers remains the same.

I could write out some fancy equation right now, but I won’t. Suffice it to say we are looking to find out how many Active users it will take to result in $1.7 billion in pre-royalty revenue (or ~$1.2 billion in post-royalty), given that (a) of these Active Users, 30% will pay for a subscription and (b) 85% of those who pay will pay at the High tier ($9.99) while 15% will pay at the Low tier ($4.99).

Whew.

Alternate Answer #1: 30,000,000 Active Users if Free users are effectively worth/cost $2.99 each month.

A top-line number that would lead to:

30,000,000 Free users -> $753,480,000 in yearly “revenue” pre-royalty
9,000,000   Paid users -> $997,920,000 in yearly revenue pre-royalty

if Free users are effectively worth/cost $2.99 each month.

Alternate answer #2: 35,000,000 Active Users if Free users are effectively worth/cost $1.99 each month.

A top-line number that would lead to:

24,500,000 Free users -> $558,600,000 in yearly “revenue” pre-royalty
10,500,000 Paid users -> $1,164,240,000 in yearly revenue pre-royalty

Alternate answer #3: 42,000,000 Active Users if Free users are effectively worth/cost $0.99 each month.

A top-line number that would lead to:
(number below are corrected from earlier post)

29,400,000 Free users -> $349,272,000 in yearly “revenue” pre-royalty
12,600,000 Paid users -> $1,397,088,000 in yearly revenue pre-royalty

4 thoughts on “It may take 35,000,000 active users in the USA for the yearly royalties paid by Spotify to equal those paid by iTunes?”

  1. Hi David

    Very interesting analysis. Moreover, the underlying assumptions does also seem plausible, save for one thing.

    I do not think that iTunes revenues will remain unaffected by the increasing presence of Spotify in the US market. Rather, a quasi monopoly as held by iTunes will – all other things equal – see (substantial) churn when (a) new substitutable operator(s) enter the market. Consequently, I predict that iTunes will experience a fall in revenues in the US over the comming years.

    So the question is whether Sean Parker’s statement on Spotify’s growth took an iTunes decline in revenues into consideration or – as you have – iTunes’ revenues today!?

    Whereas a decrease of 10% in iTunes revenues does not change much a decrease of 20% or more does – in my view – substantially change the likelyhood of Spotify reaching Sean Parker’s target.

    What are your thoughts on this aspect. What will the streaming servcies and thus the changed competitive situation in the US online market entail for iTunes revenues over the next two (perhaps four?) years? Or perhaps put in another way, how do you see the development of the value of the overall online market in the US over the same period?

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    1. Thanks for your comments and big questions, Hans.

      My sense would be that in the US the impact of streaming services upon iTunes revenues, in the near term, would be nominal. Particularly at the present price points. We have had streaming services here since 2003/4. As the number of subscribers to these services has slowly but steadily increased, so to have iTunes sales increased.

      The best test of the above statement is not the present market of streaming services—Spotify, Rhapsody, MOG, Rdio, Muve—but rather would be in the launch of a subscription service from Apple/iTunes. Or, significant changes in the price points at which these services operate.

      It is far more likely that any stabilization or decrease in iTunes music market would be simply due to the maturity of that market overall. Essentially, tapping out the pool of individuals looking to pay 99cents per track, or $x.xx for an album. That market is only “so big,” and we are probably approaching that ceiling.

      Regardless, each new premium subscriber to a music service is worth more to the music industry (at large) than each new iTunes customer, over the period of a year.

      The above statement is obviously conditioned by the concerns of some artists that each new subscriber is worth less to an artist than a sale.

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      1. Thank you for your reply, David

        Always interesting point of views and highly valid insights from you!

        Best
        Hans Peter

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  2. So Sean Parker’s prediction could well become reality.
    In Sweden 37% of the population who has internet uses Spotify.

    The US has about 270 million people with internet access. 30 million active users in the US would mean little over 10%. Can be done if you ask me.

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