THE SPOTIFY IPO & AGGREGATION THEORY
I'm a huge Ben Thompson fan and his Aggregation Theory framework that describes how value has shifted away from companies that control the distribution of scarce resources to those that control demand for abundant ones.
From Stratechery: "Aggregation Theory describes how platforms (i.e. aggregators) come to dominate the industries in which they compete in a systematic and predictable way."
What makes companies Aggregators? They have three key characteristics:
- Aggregators have a direct relationship with the user. This means customers pay the company directly.
- Thanks to the Internet, aggregators have zero marginal costs for serving an incremental user.
- Customer acquisition costs decrease over time because aggregators play in the digital world. The Internet means there is an abundance of supply and users value discovery and curation. Aggregators leverage discovery to deliver a superior service.
Unfortunately for Spotify, there is one major roadblock standing between the company and Aggregation. Record Labels.
Record labels present a unique challenge since the music industry has historically operated as an Oligopoly. Spotify gives the majority of every dollar in revenue that it generates to the record labels thanks to this pesky concept called wholesale transfer pricing.
From 25iq: "Wholesale transfer pricing = the bargaining power of company A that supplies a unique product XYZ to Company B which may enable company A to take the profits of company B by increasing the wholesale price of XYZ."
For this reason, Spotify’s margins (currently 21%) are completely at the mercy of the record labels.
The good news for Spotify is that, thanks to its superior service (i.e. discovery), music streaming represents a growing slice of record label profits. Redburn, an equities research firm, estimates that in the first quarter of 2017 Spotify accounted for 17% of the $5 billon in revenues taken by record labels and last year total music revenues in the US grew to $8.7 billion, their highest level in a decade. According to the Recording Industry Association of America, streaming accounted for 65% of annual music revenue!
Spotify's F-1 reveals that 31% of listening now happens through playlists. This influence over user listening habits gives Spotify leverage and could allow it to sign new artists itself, effectively replacing the role of major record labels and solving its wholesale transfer pricing problem. If the company executes and becomes a (the?) dominant player in the music industry it would be a textbook example of Aggregation Theory.
My back of the napkin valuation for Spotify is the $16-25 billion range but the upside is significant. While success is far from certain, Spotify's ultimate appeal rest on its ability to achieve Aggregator status. I'll be watching closely.
Submitted April 02, 2018 at 08:47AM by kidkapital https://ift.tt/2pWCec2
