Music industry’s future – Pandora’s going public and Spotify is raising funds…and why both are bad deals

For those who have missed the recent news, on Februarly 11, Pandora filed their S-1 papers (the documents the government requires you to file prior to going public).  They hope to raise ~$100M.  Here is an article from the NYTimes on their filing.  Rumor has it that Spotify, the big new European offering, is about to raise ~$100M from DST at a $1B valuation!  Of course, you have iTunes and Google music lurking the background plus a slew of competitors from Rdio to old stalwarts like Napster.
There are plenty of reasons to become excited about the music business (everyone likes and listens to music, right??!).  However, there are even more reasons why I would never, ever want to invest in the industry or to own stock in a company trying to build a business on the deadly ashes of the past.
  1. 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.
  2. 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).
  3. 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).
  4. 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.

 

What is an honest person to do?

What is an honest media consumer to do in the digital age? I want to pay for my music. I want to pay for the few shows that I want to watch (if I miss them on TV) and can’t find them on a streaming service.

I have two similar situations: 1. I got into Entourage this summer when I watched it on HBO. I really enjoyed it. I want to watch the previous seasons. 2. I want to buy the song “Not an Angel” by City Sleeps. My phone, which doubles as my MP3 player, can’t play DRM protected music (Sprint, a phone named “Muziq” should be able to play DRM protected music!).

I know this statement re-iterates what many have said before but what are the media companies doing? They should make it as easy as possible for me to legitimately find all these files in an easy to consume format. What do they think DRM is doing? Is it stopping people from sharing those files? Maybe those media execs should log into any file sharing service and find out. All DRM does is push honest people to one of two alternatives: a) don’t consume the media and forget about it, b) download it illegally. Neither option is a win for the media company or the artists.

Media company execs, please, for everyone’s sake, stop DRM and put all of your files in a place where one can find them and legally pay.

For those that want to continue reading, here are the details of my trials and tribulations to legally find my media.

1. Entourage: Buying the DVDs is impractical because I would watch the show once and never again (just my watching habits). Renting them from blockbuster is impractical because I wont watch 4-5 episodes in one week before I have to return the DVD. The cheapest netflix account ($5.95) might work but I watch TV so rarely and at such random times that I doubt I will get my money’s worth. So, like any person under a certain age, I searched online for a legitimate source of the file.

iTunes — not available.
HBO — not available.
Netflix download service — not obviously availabe (or available only for PCs)
Amazon Unbox service — not available.
AOL TV — not available.
HULU — not available.
Joost — not available.
P2P service — available.

Point made?

2. Not an Angel MP3 format: As stated above, this file is useless to me in any other format besides MP3. If I just want to listen to it, there are a number of services (such as Napster) that allow me to listen to it online. I don’t want it to just sit on my HD. Before I bought my Mac, I used Napster to download music. The only way I could change my files to MP3s to play on my phone, I had to burn them onto a CD. I did this but it was a hassle, file information was lost (and therefore didnt look correct on my phone), and is impractical to do when I only download one or two songs at a time but want those files on my phone immediately. Note to media execs — I have not shared or plan on sharing one song that I converted to MP3.

I searched online for a legitimate alternate source of the song:
Amazon MP3 — not available (I guess the artist/studio doesnt have a deal with Amazon).
Walmart MP3 — not available — only works with a PC.
Napster — available but protected with DRM.
iTunes — available but protected with DRM and even if it was not, it isn’t in a format that is usable by my phone.
Russian sites — available.
P2P service — available.

Point made?

note to any media execs who want to sue — i have decided on my first option above — not consume the media file and to forget about it. that is a loss for everyone.

Update: check out this great post from Don Dodge about Napster (here).