Why is Netflix Making Money When Spotify and Other Services Can’t?

Why is Netflix Earning Money When Spotify Can't?
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Why is Netflix Earning Money When Spotify Can't?
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Image by Jeremy Schultz (CC by 2.0)

Why is Netflix making money when Spotify isn’t yet profitable?

It’s a frustrating experience when you open up Netflix and can’t find the movie you’re looking to watch. It’s even more frustrating when you realize that the movie you’re searching for is in the Top 250 of IMDB.

Two years ago, a Reddit user, clayton_frisbie, decided to do his own independent analysis.  Clayton found that Netflix had only 49 films of IMDB’s Top 250, a paltry 19.6%.  Films in this list include classics like The Godfather, Pulp Fiction, and The Lord of The Rings, among others, all missing from Netflix.

Streaming Observer, however, decided to update Reddit’s list.  Two years after the original list was published, they found even worse numbers.  According to writer Andrew Dodson, that number had dropped to 31 movies, or an even worse 12%.  The gaps include favorites like Good Will Hunting, Back to the Future, and Forrest Gump, among others.

You can check out Streaming Observer’s site for the full list.

Here at Digital Music News, we don’t tend to cover movies, but it’s certainly tied to music in many ways.  And in light of Netflix’s sinking IMDB list, we started asking ourselves this question.

Why is Netflix doing so much better than streaming services like Spotify, which have ‘everything’?

Recently, Netflix poured $120 million into the production of The Get Down. Their 2013 political hit House of Cards cost the company $60 million to make. The latter investment was well worth it, as the show went on to earn Kevin Spacey and Robin Wright Golden Globe wins and lots of new subscribers.  It’s still unclear, however, if the money invested for The Get Down was money well-invested.

In answering this question, I found two main reasons as to why Netflix is successful whereas top music streaming giant Spotify, and similar companies, are floundering.

  1. Netflix Actually Earns Money

In its Q2 2016 earnings release, Netflix disappointed investors earlier this year by failing to add 2 million subscribers. They only added 1.52 million net additions, a number that by no means is nothing to laugh at. The news actually pushed shares down 15%. However, here’s the key difference between Netflix and Spotify: It actually made money. The company was able to generate a total of $2.1 billion across all of its businesses, up from $1.64 billion a year ago. These numbers come from Amigobull.

However, things weren’t so good for Spotify last year. This is due to one main reason: the music business definitely doesn’t work like the movie industry. Spotify was able to earn close to $2 billion in revenue, up from 2014. However, its losses also increased to $206 million. The reason why? Royalties.

Royalties are the very reason why similar companies are floundering.  Despite strong subscription numbers, Tidal posted huge losses earlier this year.  Royalty payments affected Deezer so much that they had to postpone their own public offering last year. They cited the reason as being “market conditions.”

One key difference, as noted above, is that movie studios actively look for distribution companies.  The music industry, however, actively looks for high royalty payments.  This may be the reason behind Spotify and YouTube’s poor artist payouts.  According to Fortune,

Of every dollar that Spotify brings in the door in revenues, about 85 cents goes right back out the door again in the form of payments to the music industry.”

Netflix takes a different approach to licensing payments. Whereas Spotify is forced into deals with the Big 3, Netflix actively renegotiates their licensing deals. They also set a fixed fee for during a set time period. According to Investopedia,

The licensing agreement can be renegotiated after the set time period ends, or Netflix could drop the show from its library if viewer interest is not high enough to warrant the cost…Netflix uses consumer data mining to determine which content viewers pay to see and relies heavily on this information to determine the total cost of each licensing agreement.

Analyzing Netflix’s real numbers once again, their total revenue isn’t as impressive. They only earned $40.76 million in net income, up $14.42 million from the same quarter last year. Netflix has to hand over a lot of their revenue to overhead, distribution, and operating expenses.

Over at Spotify, they don’t seem to be worried about not making revenue yet. In 2015, Daniel Ek was quoted as saying,

We’re only at the beginning of something really exciting. There is a profound change happening in music.

  1. Netflix Earns More Money, Not From Original Content, But From Users

One reason why Netflix has to pull titles from its service may be that they just don’t have the capital to pay the licensing costs.  Mic.com calls it “selective bill paying.”  Back in 2015, Netflix raised $1.5 billion in debt to fund its original programming.  Spotify has yet to invest in a similar deal for original content.  Even its top music streaming service rival, Apple Music, is trying to gain more subscribers through timed exclusive albums and songs.

Yan Bian Boey, former senior UI engineer over at Netflix, gives us a glimpse into how Netflix earns money from its original content.

Netflix does not make money directly from its original series. Indirectly, as Netflix builds up a stable of highly visible and must-watch shows, thus attracting more and more people to sign up for a monthly fee, Netflix will make more money as a result.

An important point to note is that Netflix does not need every show it makes to be well-liked by everyone. As long as you like enough shows to keep paying a monthly fee, that will be considered a success.

Spotify is devoid of a similar service, which may actually boost its numbers in the long-run. With Amazon’s entry into the music streaming market, this may even be more important in the coming future.

Amazon is currently stepping into an already crowded market with a very strong advantage over Spotify: they’ve had years to establish their user base. Amazon first focused on electronic commerce and then through solid cloud computing. According to Fortune, the company currently counts with 63 million Prime members. These 63 million members will enjoy a discounted monthly price for the music streaming service if they choose to sign-up.

In the music industry, there’s been a big question Spotify has been unable to answer: When will they make money? However, in the face of the previously named factors, the only real question that needs answering, ahead of their rumored IPO offering, seems to be:

How does Spotify actually plan to make money?

13 Responses

  1. capt. obvious

    the simple answer is that Netflix doesn’t have the same breadth of catalogue, and as a result lower licence costs. Not to say that movie licences are completely different to music ones.
    Your own article states that Netflix only has a handful of the IMDB top 250 movies, yet Spotify features pretty much every album produced in the last 30-40 years.

    • Daniel Adrian Sanchez

      Great reply. Of course, and you present a wonderful counterpoint against Netflix. But my question would be, if Spotify or another streaming music service did the same, would they be as successful as Netflix has been (despite its relatively low net profit margins)?

      • Me

        Amazon Prime music deployed a version of this strategy by focusing on back catalog music.

  2. Anon

    There are multiple factors in play that are not mentioned in the article for the differences between netflix and spotify. movie and television content is much different than music content and is consumed much differently. it takes a commitment to watch an entire program (or illegally download for that matter). and to add to that, people are used to paying for this content, whether it be movie theaters, cable, rentals, ppv, etc… there is a precedent of monetization in this industry. music content is completely different. sure people used to buy CDs, but music was absolutely free on the radio. when music went digital, napster was there to provide another free option. unfortunately, this seemed to set a precedent of non-monetization as music moved into the digital space.

    another consideration, which is a very recent phenomenon in the music industry, is windowing for movies. while music is nearly always all or none (except in rare cases), movie studios have made their titles available for limited times through different channels, and this is totally acceptable and expected. studios can use windowing the extract the most value from their products through the various channels available to them (including netflix). clearly the music industry is still working on how to best fit windowing into their business model.

    having said that, one of the strategies that i believe spotify is working on to pull in new subscribers is to add original content. it probably won’t be house of cards style dramatic tv shows, but if they can offer something no one else can and make it available only on their premium tier, people may just be willing to fork over the monthly fees. pandora is doing the same with the questlove program and i’m certain apple is on this road to especially considering their recent purchase of carpool karaoke.

    • IYI Bashar

      The music industry has a difficult time windowing because of federal compulsory licenses. Something they have no control over.

    • doktor audio

      Hey that comment was actually the far more interesting read. the article above didn’t even answer its own headline.

    • Michigan Lou

      If music subscription services are forced to accept licensing windows, they’ll lose me. People will go back to accumulating their own libraries through whatever means they feel is easiest. When you go to listen to a track, you want to pull it up and click play. Sifting through multiple sites isn’t an option. It’s not the same commitment, as you say, that sitting down and watching a show or movie is. That being said, trying to find the site to stream a movie or show is also a broken process due to the licensing issue. Roku search is the only device I’ve found that attempts to fix that, but it omits iTunes, and on my first attempt searching yesterday I easily found holes in it’s database. The first Italian director I tried to pull up was missing and several of his most recent films weren’t available anywhere.

    • Tinkerer

      I agree, movie and television content is much different than music content and is consumed much differently, however the percentage of revenues allocated to content costs is about the same for Netflix and Spotify, so it’s not only a royalties issue.

      The music industry charges Spotify the same percentage they charge to physical retailers; Walmart, Target, etc. If you can’t make a profit without the burdens of retailers you have a faulty business model. Spotify losses 600 K and Pandora losses almost a million dollars per day. Marinate that for a second.

      So why Netflix makes money and Spotify hemorrhages it is down to the combination of broadband costs, highly concentrated demand (77% of the demand of streamers is concentrated in 0,13% of the titles) and user behavior; music repetition is key as a hit is played hundreds of time per user in a three month period. Royalty is a factor, but Spotify won’t make any money until they charge a base price of $ 17,99.

  3. Anonymous

    Netflix also makes a lot of money from huge markets outside the U.S. where the service costs 30 times more (i.e. customers get approx 1/30 of the programmes for the same price).

    • Mauro

      You’re partially right
      In Brazil for example Netflix costs us$6 monthly less than US
      Netflix Brazil catalog has 95 of the iMBD films
      Apple Music charges for individual subscriptions 4.99 half than US the same for Spotify

  4. ZacX8

    I dont have a lot of money and i only buy things i like. When i want to watch pulp fiction I load up my copy. when i want to take a chance on an action movie i load netflix.

  5. Brit

    The main reason Netflix makes money over music streaming services is that Netflix can control its content costs. Its a simple as that

    Content is purchased on a buy out with no further royalties nor financial commitments. You invest once.

    Music on the other hand, the more people listen the more the service has to pay in terms of rights and publishing

    NetFlix therefore has scale and controlled costs. Music services do not.