Bargaining power of customers: Streaming is not like food or other necessities, it is a consumer discretionary product, and as such customers have more bargaining power in deciding to accept or not a given subscription price.Threat of substitutes: There are a few substitutes to streaming, including buying the songs on iTunes, or even a physical medium.
Further complicating things, the new entrants are mostly diversifying from another market and they can leverage existing expertise, cash flow, and brand identity, for example YouTube ( GOOG) ( GOOGL). That is why companies like Apple ( AAPL) found it relatively easy to launch their own streaming services. The technology to build a streaming app is not particularly that advanced, what is really needed is some capital and to sign licensing arrangements with the main labels.
The reason we say the market is not buying Spotify's narrative is that if the market believed this had a decent chance of happening, shares would be trading significantly higher today. In particular we are referring to the target they have given themselves to reach $100 billion in revenue, with 40% gross margins, and 20% operating margins, over the next decade. Interestingly, shares are not meaningfully higher than they were on June 8th of this year, when Spotify held its investor event and shared some jaw dropping targets. This year has been tough on the shares, which have lost more than 50% of their value. Spotify itself appears to have come to that conclusion, and we believe that is the reason behind its enormous resource allocation to initiatives like podcasts, audio-books, and other non-music efforts.
There are several reasons for that, but the most important one is that its suppliers, companies like Warner Music Group ( WMG ) and Universal Music Group ( OTCPK:UNVGY ) are currently in a position to extract most of the value created by the streaming industry, and until this changes it is unlikely that Spotify can become significantly profitable. We find Spotify the product terrific, but the business not that attractive. It is easy to confuse a great product for a great business, and we think that is what is happening with many investors and Spotify ( NYSE: SPOT ). Travel the world to capture moments and beautiful photos.
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