- You do not control your own destiny: I would never want to be in a business where someone else controls my destiny. Music is that industry. The labels will squeeze you for every penny of profit at one time or another. Even if you reach a decent deal with them now, say, for 3-5 years, if you are a success in that time frame, they will kick your butt in negotiations in round 2. They will squeeze ever bit of profit and then, while you are bigger in 3-5 years (revenue-wise), you will be once again at zero profits. In my view, that is not sustainable. Pandora’s filing highlights this perfectly. The company has been in existence since 2000 yet is still not profitable. I love the company’s service and credit to them and Tim Westergren (founder) for what they have been through and accomplished. Nevertheless, 11 years later and with significant revenue, they are not profitable and nothing in their future makes me believe they will be. The labels will squeeze every bit of profit from Pandora and others like it.
- Netflix envy: If you think Pandora or Spotify could be the next Netflix, watch out. The Netflix model (and their wildly successful stock) may make you salivate. Dont buy the hype. I personally predict a sharp drop in their stock price once they announce their new licensing deals with the movie/TV labels. If I had enough time to focus on investing seriously, I’d be shorting the stock hard. Starz made a huge mistake a few years ago (when they signed a generous deal with Netflix) but it and it’s co-labels won’t do the same again. Netflix is either going to pay dearly for that content (i.e. no profits) or will do without the content. Without the content, people have fewer reasons to buy from Netflix and will look to alternative methods of consuming that content. Switching costs in Netflix or Spotify’s business are essentially ZERO! People can and will leave (unless you build a community, which Spotify is trying to do and Netflix has failed to do but even then, this might not save you – see Myspace music).
- Market is huge – isn’t that important?. Investors love big markets and the music industry is certainly that. However, check out any chart for the industry’s finances (revenue or profit). Down down down no matter the format. People don’t want to pay for music anymore. Sure, a service like Spotify sounds enticing but Napster (the legitimate version), and the millions of other competitors out there (including, even, Pandora) have not exactly taken off in terms of profit or revenue. Instead, they have gone out of business or slowly eked by. Sadly, people are used to free music. A small % of Pandora’s audience purchases their paid version. From what I have read of Spotify, it is the same in Europe. Paying customers are small. Mobile may change that equation but not by much. How long until we see a Kazaa for mobile? People love music but paying for it is a challenge (although I would stipulate that is because the prices are out whack with what the market will bear).
- Revenue from music purchases. If you are an investor and believe that revenue from music purchases will enhance your bottom-line, you are making a dangerous assumption. Assume this money will go away. Conversion from a free song to owning a song is low to start with and, I believe, will shrink with time. Owning music is passe (or will be in time as model’s like Spotify take hold and people realize owning music makes no sense…it is always available via the cloud).
Finally, to end where I started – in the music business, you never control your own destiny. The music labels do and they are old, dinosaur behemoths. Unless you, as an investor, are into that sort of thing, I would never get into bed with them. Dinosaurs don’t change. They go extinct.