David Balfour wonders, should music companies be feeling jittery about suggestions of an overheated technology space.

18 September 2014 - Editorial

Billboard this week picked up on concerns being voiced in the venture capital community that the startup space is starting to look dangerously overheated, perhaps to a level not seen since 1999. These concerns emanated from within the venture capital community and were not aimed at music companies specifically. Nevertheless, the fact that some of these very investors are themselves heavily involved in music startups does indeed raise questions about the longterm financial viability of the music tech space.

Operating a digital music service is anything but an easy play, financially or operationally speaking. In the 15-odd years we’ve been reporting on this space, we’ve seen a staggering number of music startups fall by the wayside. In the early days of digital music, new entrants came from all kinds of sectors: from sole traders to independent companies, to heavily-invested VC-backed operations. As time has progressed however, only heavily-invested companies have tended to approach digital music and even then have often struggled to make a success of their businesses. Well-funded services such as Beyond Oblivion, Bloom.fm and Omnifone’s Rara have all failed to deliver on promises to name but three, causing pain for investors and rightsholders alike. Smaller companies now generally absent from the digital music space.

It’s remarkable that in more than a decade since the legitimate digital music business began, there have been so few success stories. It’s worrying how many of those success stories would never had survived at all, had they been looking to make money from digital music revenues alone. iTunes, the biggest success story to date, is part of a much larger operation where profits from music sales are not the primary driver. Amazon, in a similar way, sees music as part of a wider ecosystem and is by no means dependent on it. Another notable ‘survivor’ – electronic download store Beatport – became widely viewed as a success only after being acquired by Sfx Entertainment, a music company but one whose most significant interests are in the live space. In more recent times YouTube has come to be a very significant contributor. Once again however, this company is not making revenue from music sales but instead from the placement of advertising.

It’s actually pretty tough to name a successful business which has thrived from the pure provision of consumer-facing digital music services. Nevertheless, this hasn’t prevented many new companies from entering the space. Notable new entrants from recent years still making a very active bid to succeed include Spotify, Deezer, Aspiro’s WiMP/Tidal service, as well as companies such as SoundCloud or Pandora which, whilst they may not be operating in a music retail space, have nevertheless attracted enormous levels of investment around their businesses where music access is absolutely central to their offering.

When you consider that not one of the companies named above has yet turned a profit, one can begin to understand why some investors might be getting nervy. Currently there’s a huge gulf between perceived market value and actual revenue generated. This is not a gulf which can persist indefinitely. As Union Square’s Fed Wilson commented to Billboard: “At some point you have to build a real business, generate real profits, sustain the company without the largess of investor’s capital, and start producing value the old fashioned way."

One definite unknown at this point is whether the new breed of businesses, which tend to operate in the streaming and access spaces, can make a longterm success of it. Whilst companies such as Spotify and SoundCloud may have been darlings of the investor space for a considerable period, there are definite questions to ask around their potential to eventually become profitable. Such doubts are hardly helped by frequently perceptions that these companies burn through cash at an alarming rate. That said, the cash is theirs to spend, and their investors may even demand such spending from them. They are ultimately only accountable to their investors. 

One emerging trend in recent years is that the investors in digital music startups include the music rightsholders themselves. Services are able to cut a much better deal with music companies if they also cut those companies into the business. Rightsholders therefore need to encourage the success of these companies as never before, lest they lose both an important revenue contributor for the industry as a whole, as well as a hope for growth within their own businesses. Should they echo the investors’ concerns?

The music industry certainly has a lot riding on the future success of Spotify, in particular. The loss of such a service after such deep investment would be a serious blow. However, to suggest that Spotify should fail over the longterm is itself purely speculative. As consumers warm to access models, such companies have a potential to build businesses on a scale never previously seen in the music space. And with huge scale comes a whole new kind of economics.

The stakes are certainly high. Rather than predicting the collapse of the VC-backed music startups however, we’d actually tend to feel quite optimistic that the most intelligent can actually do something that no other company has previously – make profits from pure music use, without reliance on ancillary businesses. Whilst we have strong hopes for the eventual success of the best music startups, there’s also a clear danger that the space that will be anything but diverse - utterly dominated by a handful of players. Yet, as our business becomes increasingly global, we also feel that local specialists can come to find successful niches in many different markets. The stakes and investments required are certainly high but we’d suggest that the opportunities for eventual success are also very real.