Spotify, Consumers and Businesses (#19a)

Spotify is poised to take over the majority of music sales someday.  Here’s why.

Know your target.  Spotify does; it chose casual listeners over what I would call “hardcore listeners”.  You know the type: they hang out at record stores, buy concert tickets, merchandise, and equipment for both listening and playing.  They might be the most valuable piece of the market, but to fight for them would bring the combined wrath of the big 3 record labels, Sony, Apple, Beats, and probably the Catholic Church for good measure.  Instead Spotify chose to be music for the rest of us.

This is an important piece of Spotify's winning strategy because the company is what you would call a disruptor.  Almost all disruptive business models involve 1. a new technology or capability to undercut the big players and 2. focusing on the least attractive customers.  By targeting those who rarely buy music, Spotify received minimal retaliation from the record labels, iTunes, and CD sellers while building up sales, users, scale and experience.  Remember that Spotify was completely free on desktop from day 1, a strategy Rhapsody and (legal) Napster never dared.  By the time the incumbents felt threatened, they were behind the streaming wave.

But wait, doesn’t Spotify have plenty of company in the casual music listener space?  Pandora is the original streaming radio and has an impressive library.  An array of playlist apps like Songza and user-submitted music apps like Soundcloud are still free.  Youtube Music Key is only a few months old, but promises to harness the world’s greatest content creation platform for an ads-free, online and offline music experience that, combined with the existing Google Music service, will be tough competition for Spotify.  

Still, the green streaming machine has staked out its position as cheap relative to owning music, but more premium than its peers.  While all streaming services may have a superior product to CDs, Spotify leapfrogged its peers with simplicity, focus, and overall user experience.  The features, such as the ability to see what music your Facebook friends like, add value without muddling the experience. I converted to the cult of Spotify a year ago, and it took a lot to finally overcome my routine of organizing a hard drive full of music and transferring it between devices as space allows.  I was paying nothing and now I'm paying something, but the experience is immeasurably better.  I love the extra benefits of using a service, such as my “Year in Review”, which gave me pretty graphs about what and when I listen, and recommendations with a level of depth and quality Pandora never reached.  

 
While the features are well-executed, the key to Spotify is what’s not there:  it’s a controlled environment without copyright infringement, reposts and unclear labels (looking at you, Soundcloud and Youtube).  There is no needless integration with other services (Google Music) or video and banner ads (Groovesharks, Songza) to ruin the interface.  There are no links to merchandise or to see artists on tour (last.fm), because hardcore listeners are not the target.  Granted, new features do come gradually and will continue to be welcome (I would love to see integration with Facebook chat so that you could tune people into what you’re hearing), but they are done at a pace users can learn and appreciate.   If you’re seeing the parallels to Apple, you’re not the only one.

Spotify’s focused, holistic strategy has yielded a ridiculous conversation rate – 25% of its 50 million listeners pay $10/month for premium, while only 3.5% of Pandora’s 70 million active users pay $5/month for an ad-free product.  This is money in the bank moving forward, as consumers rarely cancel subscriptions they don’t use, let alone ones they tried out for free and use often.

Spotify is threading the needle, balancing a quality product, attractive prices, and also a lack of the image problems that tend to plague tech companies on the rise.  OK, there’s one controversy, surrounding Spotify’s payment of its artists.  Click here for a shorter Part 2, where I examine Spotify’s relationship with the musicians that make up its huge library.

Update 3/2015 - Kendrick Lamar broke the single-day record for streams of his new album, which reignited the debate over Spotify's royalties. Considering Kendrick made $1 million in one day, and streaming revenue officially passsed record sales, I feel good expressing continued faith in Spotify's business model, for both the company and the artists.

Walter White's Empire, As a Business: Would You Buy Shares of MethCo? (#7)

[While this is not a discussion of Breaking Bad's plot, there are some spoilers.  So, if you haven't gotten into the most critically-acclaimed show on TV yet, consider bookmarking this and firing up Netflix right now.]

In season 4, Walter White tells Skyler that he is pivotal to a business "large enough to be listed on the NASDAQ", and this got me thinking: is this true?  Also, how would Walt's meth operation fare as an business investment?  How does it compare to other industries?  Numbers and costs are mentioned throughout the show, and all one has to do is write them down to get a basic picture of a fictionalized MethCo (METH), with Walt, Mike, and Jesse as CEO, CFO, and COO respectively.  This was not hard for me to do, mostly because Breaking Bad is the best show on TV.

So, without further ado:

In season 5 Walt and Jesse cook "nearly" 50 pounds of meth (let's say 45), which brings them $1,379,560 in gross profit, or their revenue minus the cost of the raw materials.  The time period over which this money was made is not told explicitly, but we will assume this was one week for reasons explained later.  So, all the numbers given for a week will be multiplied by 48 (assuming 4 weeks vacation pay.  Cooking is hard work) to show yearly amounts.

Mike takes a big chunk of the income for expenses only required due to the illegality of the business (legal meth would eliminate these costs, but also drive down the price with competition, taxes and regulations); the biggest piece was nearly 25% in "legacy costs", or paying off the families of the 9 men in jail from the last operation.  Walt's anger in paying for this was in one sense justified; the last operation was a separate business and shouldn't appear on their balance sheet unless there was a kind of chapter 11 bankruptcy that made this operation a successor to the last one.  However, (SPOILER) since Walt killed Gus, and is the reason this operation failed and the men imprisoned, we'll just call this a necessary business expense.

** Mike informs Walter that methlymine, their most important and difficult-to-legally-obtain ingredient, will become an ongoing expense even though the first shipment was free.  The cost (and effect on the business) is not brought up, but I can figure this out.  1 gallon, according to the infinite wisdom of the internet, could make 74 pounds of meth, so MethCo would need ~30 gallons of methylamine to last a year making 45 pounds a week.  With 1000 gallons of methylamine going for ~$15M on the black market (as evidenced by the proposed sale in season 5's "Buyout"), this would set the 3 not-so-amigos back a half a million, easily a million after the cost of safely obtaining and moving it.

So, MethCo would earn $18.5 million on sales in the 70 millions.  Walt's right that he can support a NASDAQ-sized enterprise, but MethCo is hardly Apple.  His business's sales would rank below thousands of publicly traded companies, among such heavy hitters as StealthGas, Inc (74M in gross profits) and PetsMed Express (77M in gross profits).  The business's income is a little better, around the 40th percentile of NASDAQ-listed companies, but there are CEOs of much larger companies that manage to not become egomaniacs.  Regarding margins, Walt's 20% (higher if he can scale production to send to, say, the Czech Republic) is more impressive, similar to mature cash cows like IBM, Google, and the company to which Walt compares his product: Coca-cola (21% PM in 2012).

Walt's high sense of self-worth stems in part from the fact that he is not only the primary decision maker in his empire, but also the 1/3 (and later primary) owner.  Working at Google is no reason to do doughnuts in a parking lot and then sell your car for $50, but owning a third of Google probably would be.

Investors would not pay that much for a piece of Walt's drug empire.  It is far riskier, has more dangerous management, and is less likely to be around in a year than virtually any publicly-traded company, but is performing better than only half of them, depending on what metric you use.   

But as Walt has himself confirmed, money is not the primary motivation for his cooking meth.  The industry in which Walt has involved himself is perfect to satisfy a dormant over-sized ego.  There is little competition and even less competent and intelligent competition, intimidation is the currency of all interactions, and staying above the law relies on detachment from others and a cold, single-minded focus on expansion. Walt provokes conflict with Mike in the scene I discussed not because he needs more money, but because he must preserve his feeling as the ultimate decision maker, and the smartest man in the room.  He's in the empire business.

Is my view of the empire unjustified? Is my math awful?  I'd appreciate your thoughts!