Spotify IPO, Re-Intermediation & “The Jesus Phone”

Spotify plans to become a publicly traded company. Its CEO Daniel Ek wrote a letter to investors talking about the plans. It talks about many things, but some have read parts of it as that Spotify wants to provide a way for artists to reach its audiences directly, without intermediaries. This is a re-occurring idea among creators: what if we could do away with the producers, investors and marketers who keep interfering with our art, messing up our launches and take a big chunk of the money. In a perfect world, would not art be judged on its own qualities with no need for packaging or PR stunts? It is also a favourite topic for starry-eyed tech startups high on disruptive innovation: let’s break up the value chain, take out the fat cats, the intermediaries who don’t add value but only seek rent. It can be travel agents, banks, real estate brokers, lawyers… you name it: any market with specialist intermediaries is ripe for disruptive innovation. That’s not about technology, that’s about commercial opportunities in disrupting the way business is done. In the case of Ek’s letter, these two come together. Can Spotify bring the gift of direct contact with the audience to artists? Can it deliver on the ancient promise for art to be judged on its quality only?

Let’s take a look at a similar industry where the same thing happened ten years ago. An industry I know well: video games. Game developers of course dreamed the same dream as other creators. What if we could get rid of these publishers who keep interfering with our creative decisions and limit our resources with launch dates and budget cuts? In 2008 that dream came true. The Iphone Appstore solved all the problems game developers had struggled with in one stroke: an integrated market place and payment system, convenient for the player, delivery straight to the device. The device itself sleek, beautiful, lots of computing power and a big screen. Perfect for players, perfect for developers. And no intermediaries, except of course for the Appstore which took 30 percent of revenue (after sales tax). That was a small price to pay for a dream come true. One developer I know called the Iphone “The Jesus Phone”. (I guess Appstore may have been the cathedral.)

What happened? Turns out a lot of people had the same idea. A lot more games were published. More than 1000 games per month only on the Iphone Appstore. More than anyone could play. Demand grew too, but nowhere near as fast as supply. In basic economic theory, what happens if supply exceeds demand? Prices drop. If the first Iphone hit games, like Angry Birds, were “premium” – sold at a price of around one euro – soon the downward price pressure led to the dawn of the “free-to-play”-model: play the game for free, buy things in the game if you want. A small number of players, maybe 2-5% actually buy something in the game. The other 95-98% are happy to play for free. Don’t get me wrong: the free-to-play-model is great for players “play as much as you like, pay only if you want” – how can an offer be more consumer friendly than that? And the mobile games industry has made a lot of money from the free-to-play-model. The games industry adjusted and prospered. Except there was one side-effect.

In 2006, Chris Anderson wrote a very influential book about the digital economy called The Long Tail: Why the Future of Business Is Selling Less of More. The theory was that when cost for distribution and stock-keeping approaches zero, retailers can keep unlimited inventory. That has generally proven to be true, as the 1000 new games per month on Appstore show. But Anderson also said that there will be at least one customer for every offer. Ergo: with the long tail economics, there would be pluralism like never seen before. Now, that turned out to be wishful thinking. Around 25% of apps are never downloaded. On Spotify, around the same proportion of songs are never played (there is even a feature called “Forgotify” where you can “donate” a listen to an unplayed song!). The last part of the long tail turned out to be below the breaking point for demand. Unlimited supply did not create endless demand. Demand was still finite.

The free-to-play model for games turned out to be a big boys club. In order to cover costs with revenue from a small proportion of the players, the number of players must be significant. Huge. Millions of players. Yes, there were some spectacular outliers (looking at you Flappy Bird!), but the pattern is clear: in order to attract the large numbers of players needed to make money on free-to-play, the game needs a well-known brand and/or a strong marketing budget (called user acquisition in these parts). It was not for some kids to make a great game, put it out and hope it sells, instead it turns out it needs a very specialized business operation with data analysis, monetization strategies, interface design, A/B-user testing and so on. The expected democratization did not come, rather success gave more success in a feedback loop that pushes money toward the head of the long tail. Most of the 125 000 game apps don’t break even. The money lost comes from the developers themselves in most cases. In the old value chain, developers could get production budgets from publishers, but these days they turn to equity investors who often want safe revenue and a clear exit strategy. Yes, the Appstore is still vibrant with creativity and there is plenty of innovation in the business models on it. But the game developers don’t look to the Appstore so much anymore, instead it’s the PC game platform Steam that gets most attention. It has managed to maintain the premium model and new publishers have arrived to support the developers with marketing, production budgets, advice and admin. The value chain has a funny way of reappearing.

The dream of cutting out the intermediary did come true, but it did not bring the expected freedom. Instead, it brought evermore powerful intermediaries. If game developers used to complain about contract terms and publishers who don’t get the soul of the game they’re making, now they have faceless platforms. Uploading a game to the Appstore means ticking a box that you accept the terms. No negotiation. Appstore can pick the winners by promoting some games as recommendations, but the developer has little or no influence over those decisions. The middlemen were pushed out, then came back stronger. This is called re-intermediation.

Dear music industry, when you dream the dream of getting rid of the middlemen, take a page from the games industry. In other words: Be careful what you wish (it may come true)

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