Does Music Subscriber Growth Cripple Profitability?

With streaming services pushing the paid subscription model, profit for those company's should be growing – but not only are the streaming music giants not making money, they're losing it. Who is to blame?

Guest Post by Jon Maples

I recently wrote about how Rhapsody is facing issues as it expands to a worldwide audience and partners with cellphone carriers in Europe, Latin America and the United States. Part of my analysis centered on shrinking margins from signing up new customers on services and how difficult it becomes to manage the business when you don’t control the customer base. I also pointed out how relying on other companies to do your marketing erodes your brand, leading to a limited retail funnel.

Disclosure: I worked for Rhapsody for nine years before leaving in September 2013.

Rhapsody’s 2014 results were recently released in a RealNetworks’ regulatory filingand there are two conclusions that are easy to draw from the report. (Note: RealNetworks owns 43 percent of Rhapsody and includes the company’s financials in its own 10K SEC filing.)

The growth strategy is working. Outside of the reported two million worldwide customers Rhapsody recently trumpeted, the company also increased revenues by 23 percent in 2014 over the previous year. Rhapsody’s revenues are at $173 million a year, which are rumored to be much larger than those of Deezer, the France-based music service.
The growth is coming at a cost to Rhapsody. The company lost $21.3 million in 2014, up from 14.6 million in 2013. And it’s just not overall losses that are mounting. Rhapsody losses are continuing even when factoring in subscriber growth. Based on its 2014 losses and its reported subscribers, Rhapsody lost $8.53 per subscriber last year. That’s up from $8.44 in 2013, although both numbers are down from 2012, when the company lost $10.19 per subscriber.

Growth and Losses

Rhapsody’s losses are a drop in the bucket when compared to Spotify. In 2013 the company reported operating losses of $128 million. While the company didn’t report subscribers, it has been suggested the company had around nine million paying subscribers at the end of 2013, leading to a $14 loss per sub in that year.

It should be pointed out that Spotify’s paying subs are supporting all the free users who generate very small amounts of money for the company through adverting sales. Spotify says that its average active user (a combination of paid and free) generates $41 per year in 2013, while Rhapsody generated $93 per sub for the same year.

To grow, Rhapsody not only saw losses per sub drift slightly upwards, it also had to eat into its margin. In 2014 revenue per sub sunk to $69. And Rhapsody’s growth isn’t coming anywhere near Spotify. In fact, the Stockholm based streaming giant’s growth is outpacing every company in the industry by a wide margin. It now has over 15 million paying subs and 60 million worldwide users. Spotify picked up six million paying subs to Rhapsody’s one million in 2014.

So what does all this mean? A few conclusions.

Brand Matters: In the excellent MusicREDEF newsletter, my friend Matty Karas recently mused, why when people talk about streaming music, they only refer to Spotify. There are scores of companies with offerings, many of them in business for a long time. But Spotify has broken through and is on-demand streaming’s only household name. Its brand has fueled incredible subscriber and free user growth for the company.
The Model Matters: What makes this so intriguing is the three distinct approaches these companies have taken for on-demand streaming.Rhapsody traditionally focused on all paid customers, utilizing their own retail channel, before pivoting to distribution partners for growth. It has achieved modest growth, but at a significant operational cost.Deezer only operated in territories with carrier partners. The results? Deezer had significant subscriber growth, but the revenues are below Rhapsody. So to the outside world, Deezer looks like a much bigger deal than within the industry. Deezer also is facing competition for carrier deals. In a shift of its model, Deezer launched a high-bitrate service in the US for $20 a month, although the company has not been strongly marketing the product. Despite the massive amount of money raised and worldwide operations, could Deezer be the first huge causality in on-demand streaming?Spotify built its own customer funnel by giving away expensive free music and has found a way to significantly grow free users, paying customers and revenues. The costs have been astronomical, but Spotify is dominating streaming music, dwarfing all its direct competitors and–maybe even more importantly–reaching mass consumer appeal.
Distribution Eats Margin: My last piece on Rhapsody suggested the company’s margins face significant downward pressure because of its cellphone distribution scheme. And now we see the numbers showing that erosion. Rhapsody will have to hope that a) it can sustain or even amplify its growth rate through partners and b) retain its own higher margin customer funnel. If not, Rhapsody’s revenue per sub will continue downward.
The Economics Are The Economics: Regardless of approach or business model, on-demand streaming music is an expensive business to launch and operate. There’s no way around losing millions of dollars just to be one of few who survive. All left standing will require a huge war chest, access to raise even more money and the intestinal fortitude spend a fortune in content, distribution and marketing costs.
More Pain Coming: Apple and YouTube are expected to roll out on-demand music services in 2015. The pressure to grow–and raise more money to pay for the growth–will increase on every company in the market. As the old adage goes: let the beatings continue until the morale improves.

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Does Music Subscriber Growth Cripple Profitability?

Growth and Losses

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