Spotify’s Origins & Insights
How Spotify took off in the music streaming market
As a teenager my music library was one of my most prized possessions. I spent countless hours finding songs online, downloading mp3s, looking up album art, making playlists, and debating who was hot with my friends. I even kept an external hard drive with all my songs just in case something happened to my computer. By the time Spotify came out, I was so locked into my iTunes library that I didn’t want to bother with it. But when my then-girlfriend started sending me links to her Spotify playlists, I had to give it a try. I slowly started copying my playlists into Spotify to share with her, and within a few months I was a regular.
Spotify was founded in 2006 by Swedish entrepreneurs Daniel Ek and Martin Lorentzon. They were each decorated founders in their own right; in fact Martin’s company TradeDoubler acquired Daniel’s company Advertigo just months before they started working on Spotify. Their plan with Spotify was to create a service that people would rather use than pirating music — no small task in the era of illegal file-sharing services like Napster, Kazaa, and Limewire. Why would people pay for albums when they could just download the songs they wanted for free? Daniel and Martin believed that the answer was convenience: if people could listen to every song they wanted without having to wait for downloads, they’d either listen to ads or pay a small subscription.
Problem 1 — Competing with piracy
It’s hard to understate the impact piracy had on the music industry. For decades, album sales were the best way for musicians and their representatives to make money. Fans had to buy albums to listen to the music they liked when they wanted, so artists who made good music could sell millions of copies relatively easily. Even if you only liked a couple of the songs on an album you had to buy the whole thing, which meant musicians could generate a meaningful income with a tiny catalog. But with peer-to-peer file-sharing services, fans started handpicking their favorite songs and downloading them without paying anything. As long as one fan bought an album and uploaded it to a file-sharing service, millions could listen to it for free anytime they wanted. Even though this was illegal in most countries under DRM laws, it was impossible to prevent fans from doing it. Every time the music industry nailed someone in court, more would spring up and take their place.
Against this backdrop, Daniel and Martin decided to create a listening experience so compelling that the average fan wouldn’t bother to steal music anymore. Their big vision was to eliminate the need to download music altogether. Spotify’s entire catalog would be available to anyone with an internet connection. As long as fans listened to ads or paid a subscription, they could listen to anything they wanted. Then Spotify would share its revenues with musicians and their representatives.
Problem 2 — Getting music rights
With their vision in place, Daniel and Martin started building. Unlike the free file-sharing services that preceded it, Spotify chose to sign licensing deals with major labels before they launched so they wouldn’t have to worry about getting sued. This proved to be their biggest hurdle in getting off the ground. After a series of meetings with music executives in the US, Daniel sensed that piracy had ravaged the industry enough that the labels would work with Spotify. He estimated a 6 month timeline to launch. But it would take nearly two and half years and some creative dealmaking to get the deals over the finish line.
Despite their dire conditions, the labels wanted major concessions to sign on. Among other things, Spotify had to:
Pay 1 year of licensing fees up front even if they went belly up
Pay 70% of total revenues in royalties to artists and labels
Prove the model in piracy-heavy EU markets before expanding elsewhere
Allow the labels to buy 20% of Spotify to expand out of the EU
Daniel and Martin decided to accept the costs and move forward. The music rights were too important to their model to quibble over fees and constraints.
Once it settled its deals, Spotify was ready to launch. Tactically, they needed to make money in every market to earn back the licensing fees they were paying, so they tried to get as many premium customers as they could as quickly as possible. Their playbook was to launch the premium version first, make the free version invite-only, and use influential tastemakers to drum up interest. Their invite program was especially effective: each free users got 5 invites and tastemakers got even more depending on how large their followings were.
Aside from the labels, Spotify also had to contend with the new king of music: Apple. Not only did Apple have a wildly successful music app and its own deals with the music industry, it also created devices that Spotify would have to use to reach American fans. Spotify’s weapon was its business model. Where Apple sold each song for 99¢ (later raised to $1.29), Spotify offered its entire catalog ad-free for a monthly subscription. Cost-conscious listeners who didn’t want to pay per song could just listen to ads using Spotify’s free offering. Those who didn’t want ads could pay $9.99/mo for unlimited access to Spotify Premium, which offered better value than Apple as long as they found 11 new songs per month.
Insight 1 — Don’t let big deals scare you
The first insight from Spotify’s success is about dealmaking. Startups are often scared to pursue deals with large companies because of the time it takes to negotiate them. Spotify went the other way and bet its entire existence on deals with major record labels. The deals took a year and half longer than expected and saddled them with major costs at the height of the Great Recession. Instead of abandoning their strategy and pivoting, they stayed at the negotiating table and trusted that the wait would be worth it. Their resilience in dealing with large companies earned them legal standing and validated their business all over the world.
Insight 2 — Solve hard technical problems
The second insight from Spotify is about technical innovation. Daniel and Martin set a goal that many thought to be technically impossible: instant access to millions of songs without download times. Even Apple didn’t bother to attempt what Spotify pulled off. They came up with an innovative method where they only downloaded the first fifteen seconds of a given song from the internet, then filled in the rest using peer-to-peer sharing with nearby Spotify users. By setting a high bar for their technology, Spotify differentiated itself from other music players of its time.
Insight 3 — Every competitor is beatable
The third insight from Spotify is about competition. Spotify launched in the US in 2011, a decade after Apple revolutionized music through the iPod. Few companies in the world have ever enjoyed the kind of brand equity in an industry that Apple had in music. Compared to Steve Jobs, Daniel and Martin were nobodies. Apple had devices, apps, an army of fawning press, and ownership of the App Store. Every iPhone had Apple’s native music player and music store pre-installed. But in the face of all of that, Spotify persisted and built the largest subscriber-base in the world. Startups often get discouraged when they see a larger competitor with a successful product, but Spotify showed that startups can compete even in the most unlikely circumstances. In the end, it was Apple that had to change its business model to accommodate the demand for Spotify — not the other way around.