Spotify, connected cars, and open banking – Platforms or glorified distributors?

Gaining power in concentrated markets

What do Spotify, the connected vehicle data market, open banking APIs, and trade finance blockchain projects have in common?

All of these involve markets where power is concentrated among a few producers.

• A handful of music labels own 70% of the music industry’s licensing rights.
• A handful of vehicle manufacturers dominate the connected vehicle data industry in most vehicle segments.

Intermediaries who step in to organize such markets may claim to be platforms but they usually end up just acting as glorified distributors.

Even in the financial services industry in some countries, a handful of banks provision most of the financial services. Banking-as-a-service (BAAS) ‘platforms’ end up merely acting as glorified distributors. We see this play out in the connected home market, traditional energy markets, healthcare markets, and many others.

In such markets, power accrues not to the so-called ‘platform’ intermediary but to the producers.

How exactly do you play in such markets to shift power back to yourself as an intermediary?

How do you move from being a glorified distributor to setting up a core platform position?

Let’s dig in!

Spotify: Platform or glorified distributor?

Spotify today accounts for more than a quarter of global recorded music revenues. In contrast, the iTunes Music Store accounted for less than 10% of total revenues in the pre-streaming years.

Despite its dominant market position (by numbers) it has a weak position in the music value chain.

The recorded music value chain skews in favour of the owners of music copyright and license – the record labels.

Here’s what that concentration looks like: The three major music labels control nearly 70% of global recorded music revenues and account for more than 80% of all the music streamed by users.

This concentration upstream essentially shifts power away from the intermediary.

In contrast, Spotify’s technology is primarily aimed at simplifying consumption through streaming.

Spotify – by most accounts – is merely a glorified distributor in the music value chain.

How does Spotify wrest power back?

Gaining power in concentrated markets

The dominant narrative in the platform economy is that power accrues to the point of aggregation i.e. the platform.

This is true, but only in markets where supply is highly fragmented. The more fragmented the supply, the lower its negotiating power, and the greater value created for consumers through aggregation.

However in markets with concentrated supply, power skews towards the producers and/or owners of supply.

In these markets, intermediaries are mere distributors. Consumers don’t incur significant search costs and hence no real value is created through aggregation.

In such markets, there are two ways that the intermediary can wrest power back towards itself:

1. The intermediary can develop horizontal power by rebundling inputs from suppliers into proprietary new bundles
2. The intermediary can leverage data about the end users, an advantage it has over producers, to backward integrate into production.

Building vertical power

Building vertical power is a more obvious approach so let’s get that out of the way first. Netflix is a great example of a company that’s followed the second strategy of building vertical power.

Working in a market dominated by a few large production houses, Netflix developed a data advantage, first through its DVD rental business and then through streaming itself.

As I explain in Why offline retailers fail at online marketplaces, access to demand-side data is a critical source of advantage for any intermediary. Even Netflix’s DVD rental business could better manage inventory because of its superior access to demand-side data:

The one thing that Blockbuster could never compete with was the integration of demand-side queuing data (users would add movies that they wanted to watch next into a queue) with a national-scale logistics system. All this queueing data aggregated at a national scale informed Netflix on upcoming demand for DVDs across the country.

Blockbuster could only serve users based on DVD inventory available at a local store. This resulted in:

1) low availability of some titles ( local demand > local supply), and

2) low utilization of other titles (local supply > local demand).

Netflix, on the other hand, could move DVDs to different parts of the US based on where users were queueing those titles. This resulted in higher availability while also having fewer titles idle at any point.

Netflix had already built a treasure-trove of data through its DVD rental business alone. With streaming, it was able to push this several notches further looking at which segments of which movies were skipped, rewatched etc to develop fine-grained profiles of customer viewing habits.

This data advantage allows Netflix to drastically improve returns on innovation

Building horizontal power

This bring us back to Spotify.

To gain power back from labels, Spotify has been pursuing both horizontal and vertical strategies.

The vertical strategies are best seen in its moves into podcasting where it can control the entire value chain (paying Joe Rogan and other huge sums to acquire their content).

But Spotify provides an even better example of developing horizontal power through rebundling.

As I explained in Finding the product in your platform:

Playlists are central to Spotify’s strategy within the music ecosystem.

Songs, which were traditionally bundled into albums, were unbundled by the internet and then went through three phases of

1. free distribution through file-sharing services like Kazaa and Napster,
2. pay-per-tune distribution through iTunes, and
3. fixed-fee unlimited catalog distribution through Spotify.

This unbundled song distribution changed for the first time with Spotify’s playlists.

Playlists provide the locus of rebundling where songs – unbundled from albums and artists – are rebundled into theme-based playlists.

Spotify’s playlists are critical to developing horizontal power in the music value chain.

With greater power comes greater monetization. And rebundling is central to pursuing monetization.

Monetizing music

Here’s an open secret:

The only players who make money with music are the labels.

And Taylor Swift!

That’s about it. No one else makes money with music. Not the artists, not the retailers, not the streaming platforms.

In fact, everyone else makes money by commoditizing music and creating gatekeeping power.

iTunes created a business model around unbundling the album. But iTunes monetization was never about making money with music, it was more about creating a high-priced consumer electronics product with low-priced complements (unbundled songs), a strategy it has successfully ported to the iPhone App Store as well.

Apple commoditized music to make a music-playing device valuable. A Sony walkman playing an album ‘bundle’ can never capture profits the way an iPod playing the unbundled album can. Apple’s strategy has never been to accrue value to the music or app market but to commoditize those markets and accrue value to its consumer products.

Unlike other content markets, where platforms monetize through their gatekeeping power, controlling access to consumers, Spotify has no gatekeeping power. The labels control the point of gatekeeping.

Spotify has known this all along. As a glorified distributor, it can at best gain distributor margins. Traditional pipeline-world distributor margins are nothing to get excited about, even at global scale.

And that’s where Spotify’s playlists help to create gatekeeping power where none exist.

Spotify leverages playlists as both a distribution chokepoint for artists and as advertising real estate for brands.

Migrating value with playlists

Playlists serve as a new locus for negotiating power within Spotify’s ecosystem.

Spotify exercises curation control – both editorially and algorithmically – to decide which songs and artists are included in its playlists.

Spotify also pushes playlists as the primary mechanism through which users consume music. By pushing playlist-based consumption Spotify inserts itself into a new position in the value chain. Songs and artists which are featured on playlists end up getting far greater exposure.

Without playlists, Spotify has very limited gatekeeping power. It is merely a distributor with a search function.

Playlists change that power equation.

Technically, anyone can create a playlist. But technical rights don’t necessarily translate to market access.

Spotify-created playlists invariably have far greater distribution power than user-generated or label-owned playlists. Almost all the top most followed playlists on Spotify are neither user-generated nor label-owned. They are Spotify-created playlists.

Artists looking to be featured on top playlists are hostage to Spotify’s curatorial power through its playlists.

Spotify also actively demotes third-party-created playlists and features its own. All these moves are afforded by the central curatorial power of playlists.

Channelling music consumption through playlists has a lot of the power dynamic that radio did, where consumers would listen to whatever the Radio Jockeys decided to play, except that instead of RJs taste-making on a local radio network, you now have a single dominant RJ at global scale.

Research at the NBER shows that getting featured on the right playlists is critical to artist discovery (and hence streams and earnings) on Spotify.

The research highlights that adding a track to the “Viva Latino!” playlist could generate between US$303,047 and US$424,265 in added revenue per track. The closer the track was featured to the top of the playlist, the greater the impact on revenues.

Spotify’s screen real estate determines winners and losers in the music industry.