Streaming strikes the right note
The evolution of streaming services is contributing to renewed growth for record companies following a long period of decline.
The launch of the music file sharing service, Napster, in 1999, and Apple's iTunes two years later, triggered a long period of decline for the global music industry.
Earnings from recorded music fell from USD 27 billion in the peak year 1999 to less than USD 15 billion in 2014. The sharing of pirated material naturally put a dampener on the sales of licenced music and this remains a challenge in many parts of the world. iTunes – with its legal downloads – quickly evolved into an important distribution channel, but also contributed to unbundling, by diverting sales away from profitable albums over to lower value singles.
New music habits
Over recent years the evolution of streaming services has led to another change in music purchasing behaviour. Unlike the sale of CDs and mp3 files, where customers purchase ownership to specific songs, with streaming they buy access to large music libraries.
However, while the evolution of Napster and iTunes struck a false note in the industry, Spotify and other streaming services are striking a more harmonious tone. In 2015, there was a decent rise in the sale of recorded music for the first time since the 1990s. Although income from both physical sales and downloads continues to fall, the increase in the number of paying subscribers to streaming services was sufficient to compensate for the decline. This resulted in global sales growth of three percent relative to 2014.
The positive developments do not end there. In the first six months of this year, the number of paying subscribers doubled in the US, contributing to the strongest growth (+8 percent) in the music industry since the end of the 1990s. There is good reason to believe that in future years the rise in global internet and smart phone penetration, combined with more flexible subscription possibilities from streaming services, will help result in more paying users and higher income for the music industry.
Nevertheless, the evolution from physical sales via downloads to streaming services is not without risk for record companies. An extremely important question in the longer term is what role these music industry giants will play in a changed reality.
Universal, Sony and the other record companies have played a key role in cultivating new music stars. With their financial clout and substantial resources within global marketing and distribution, they are still an important contributor to artists' commercial success.
A changing reality
At the same time, both distribution and marketing have undergone significant changes. Today's artists are better positioned than ever before to directly reach a global public via services such as YouTube or Spotify. The marketing landscape is changing too, particularly with the ever more important role played by social media.
If record companies are to play a smaller – or different – role than they have done traditionally, then the power structure in future contract negotiations with well-known artists may be displaced. We are already seeing signs of change when it comes to the widely discussed contracts directly between Apple Music and some of the industry's greatest stars.
Salvation, at least in the medium term, comes from the record companies' large catalogues of recorded music. Songs from these catalogues – i.e. music that has been recorded more than around 18 months previously – makes up as much as 70 percent of the music streamed on Spotify and other services. Generally speaking the record companies have perpetual rights to this music, which thus provides a steady flow of future income.
In addition, the margins on income from streaming services are very attractive. Both the production and distribution costs are naturally a different order of magnitude than for the sales of physical products.
As investors we find it interesting to study sectors that undergo significant changes. In SKAGEN Kon-Tiki we are indirectly exposed to the music industry through our holding in French Bolloré. This company owns more than 20 percent of Vivendi, which in turn owns the world's largest record company, Universal Music Group.
We make sure to guard against forceful predictions in an industry that is characterised by rapid technological developments, but it appears that after a number of tough years, record companies are set to enjoy more melodious times.