The Streaming Wars Continue, And SoundCloud Is In The Balance

It’s been a challenging year for SoundCloud. And its last quarter hasn’t made things any easier on the music-streaming startup.

Amidst a streaming war between Spotify, Apple Music, Pandora, and others, SoundCloud’s orange cloud is greying. Spotify passed on buying the company in December, it’s seen a patent dispute, a high-level shakeup, and multiple reports (here and here) have explored the possibility that it might run out of money by the year’s end.

The news has not been good for SoundCloud. (When contacted, SoundCloud declined to comment on its financial situation.)

So what comes next for the music company? The answer to that question is anchored on three points:

1. The economics of streaming for non-label players.
2. SoundCloud’s efforts to expand past its original, core user base.
3. Its efforts to stabilize allegedly difficult financials.

We’ll approach each topic respectively to get a handle on how it will impact SoundCloud.

Streaming 101

To understand SoundCloud’s current financial situation, we have to understand streaming economics.

Streaming companies license material from two main sources: major labels and independent artists. In SoundCloud’s context, it’s the first content source which matters. Major labels set the standard royalty rates which services like SoundCloud must pay for access to their critical libraries.

It is notoriously difficult to pin down what a private music streaming company is paying in royalties. For companies like Spotify and Soundcloud, royalty payouts can total in the neighborhood of 70-85 percent of a company’s revenue.

To that point, rates released in reference to Spotify over the last few years have been all over the map. In 2013, Spotify released (via Stereogum) its own accounting of its royalty payout structure, which detailed that ~30 percent of generated stream revenue stays with Spotify while the other roughly 70 percent went to labels, publishers, and others. There was no mention of any additional costs.

In August 2016, however, Music Business Worldwide calculated that ~84 percent of Spotify’s topline went out the door for “royalty distribution and other costs.” Again, those other costs were not defined. Music Business Worldwide then followed up on its first statement and calculation with the note that Spotify’s precise royalty payout is believed to be just under 70 percent.

In 2017 alone, TechCrunch reported that Spotify’s royalty payout was 70-72 percent, except when other factors—like catalog geography and free vs. paid streaming—could bump the royalty payout as high as 84 percent. All this was before Spotify’s new deal that supposedly lowered royalty payouts in exchange for windowing. The aforementioned “extenuating factors” are so important to acknowledge precisely because they affect so much of any music company’s catalog.

So is Spotify’s royalty payout less than 70 percent, 70 percent even, 70-72 percent, greater than 70 percent, or even up to the low 80s? No one really knows except Spotify and the labels. Even using Spotify as a bar for understanding SoundCloud’s royalties leaves us convoluted

Of course, streaming services have an interest in limiting their payout rates, but streaming companies don’t have much leverage due to an imbalance of power. If SoundCloud or Spotify don’t have a major label’s catalog, either one could immediately start to shed subscribers to competing services not locked into the same label fight. In music streaming, platform diversification only flows in one direction.

Shifting Priorities

The streaming cost matter puts SoundCloud’s recent strategies into context.

SoundCloud cut its teeth licensing content in the independent world, a much different paradigm than Spotify or Apple Music. Because it built its success on independent material, SoundCloud wasn’t beholden to the major label oligarchy for material.

Priorities shifted when SoundCloud changed direction and pursued major label content on top of its independent catalog.

It signed deals with every major label, leading to a new direction for the company. When pressed last year, SoundCloud responded with the stark “no comment” on how much equity it may have provided to labels for access to the respective catalogs. Additionally, most of the deals hinged on SoundCloud releasing an on-demand premium service to directly compete with Spotify and Apple.

By summer 2016, SoundCloud had evolved into another major label distribution platform. This effectively posed the conundrum of potentially alienating its initial userbase, which might not have been inclined to see another mainstream music service as necessary in the first place.

Compounding the mainstream content conundrum, SoundCloud’s new catalog was the same mainstream content that its direct competitors were distributing. Further, SoundCloud was now compelled to build a new product to directly compete with Spotify, putting it in a position where it held less power for the content it licensed while burning money at a ridiculous rate.

Challenging Financial Realities

All that sums to the company’s current financial situation.

In order to understand the company’s fiscal situation as it stands today, it behooves us to remind ourselves what we know about its past performance.

As I previously wrote, SoundCloud’s financials in December of last year were as follows:

Revenue tracking upward (source):

• 2010 – $1.8 million.
• 2012 – $9.6 million.
• 2014 – $19.6 million.

With losses ballooning (source):

• 2010 – $2.01 million.
• 2012 – $14.9 million.
• 2014 – $44.2 million.

Based on the new numbers, SoundCloud’s revenue saw a 10 percent increase from $19.6 million in 2014 to $22.5 million in 2015. Its losses, however, increased dramatically by 81 percent, from $44.2 million in 2014 to $54.6 million in 2015.

Debt and Irony

Most recently, SoundCloud raised an additional $70 million in debt funding. With this round of debt funding, it’s likely that SoundCloud is trying to follow Spotify’s example by doubling down on their growth numbers long enough to find an exit. The problem with this strategy is that SoundCloud is nowhere near as big as Spotify, perhaps lowering its M&A potential. While this strategy presents challenges for Spotify as well, the analogy ends right there, since SoundCloud’s debt is barely a pittance of Spotify’s $1 billion debt raise.

Spotify’s delayed IPO casts a shadow of doubt on its smaller rival as well. If the company most obviously in line to acquire it has its own challenges to contend with, it’s clear that its attention will be on its own IPO, rather than a bail-out acquisition of SoundCloud—even at a fire-sale price.

Unfortunately, the reality for SoundCloud is this: the company has extremely unwieldy financials, and its main competitor—the company most likely to acquire them—just delayed its own IPO in order to figure out its own financial situation

Uncertain Future

The faster that SoundCloud tries to shift to become more like Apple Music and Spotify, the more it runs the risk of highlighting it wasn’t trying to be like the standard streaming services at all.

Whether or not the summer will bring back the orange in our grey cloud remains to be seen.