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Spotify signs long term deal with Universal Music Group

UMG and Spotify have reached a licensing deal that clears the path for Spotify’s IPO.

5th Apr 2017

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After two years worth of negotiations, Universal Music Group (UMG) and Spotify have reached a long-term licensing deal that clears the path for Spotify’s long-anticipated IPO. The agreement, announced yesterday (4th April), sets royalties in a way that lets Spotify reduce its payments to the UMG if it hits certain revenue targets, and gives UMG’s artists the ability to make new albums available only via the service’s paid their for two weeks after release.

The deal comes at a time when streaming has become the music industry’s dominant business model. Streaming now accounts for 51% of U.S. recorded music revenue, according to the RIAA.

By securing a deal with UMG, Spotify has removed the biggest barrier to a Spotify IPO. UMG is the world’s largest music company, accounting for 36% of the recorded music market in Q1 2017 according to Nielsen Music, and without their co-operation Spotify would have been crippled by complex licensing issues. The company has been valued at $8.5 billion and is currently under a lot of pressure to either go public or face major penalties under the terms of a March 2016 debt deal, Billboard reported.

Major labels also have a stake in Spotify’s growth. They hold equity in the company and gain a significant amount of revenue fro the company. According to Sir Lucian Grainge, UMG’s Chairman and CEO, “The long-term success of Spotify, and others like it, is essential to the ecosystem’s enduring health.”

It’s taken a long time for the two parties to reach a deal. Analysts have stated that Spotify currently pays out 55-58% of its revenue to labels, which would significantly worsen the business model for potential investors. Moreover, certain artists including Taylor Swift and Adele have refused to make their new albums available on Spotify because they don’t want their music to be available on Spotify’s free tier.

Although the specific details of the deal are still pouring through, it looks that both sides are currently satisfied but that there’s also a lot of work ahead. Depending on what revenue targets it hits, Spotify will pay Universal an amount that would work out to be between 50% and 58% of its revenue. It’s all down to a process called “windowing”.

Mark Mulligan, an analyst at Midia Research, says “The two big bits are the windowing, which is obviously something the labels have been pushing for, for a long time, and the reduced rates in exchange for ambitious revenue targets. I think it's one of those rare deals where if Spotify meets its targets, then both sides can genuinely walk away saying that they got what they wanted.”

Spotify is also currently in negotiations with two other major labels, Warner Music Group and Sony Music Entertainment. Spotify would further improve their position in the IPO is they have another deal with at least one of the two labels. An industry insider said that Spotify is "trying to reduce the headline rate [from which royalties are calculated], and [is] looking for ways to make sure we don’t lose revenue. In a good deal, both sides would share in the upside and also shoulder the risk of the downside.”

As for the artists, it’s difficult to tell how big of a win this deal is. This is because not long ago, a fan who wanted to hear an album that was not available via Spotify’s free tier might have gone to buy a CD or pay to download it - which would have been marginally better for the artist. However both the CD and the paid download markets are vastly shrinking - so artists would have been damaged by that changing dynamic. However, restricting the new releases available on Spotify’s free tier could either encourage more fans to subscribe - which would help the artists - or push fans to go back to piracy, which would not!

All in all, the deal is a play against Spotify’s free tier. Lawyer Peter Paterno says “The labels hate the free tier” because it pays so much less than subscription revenue. With this deal, all parties are “trying to drive fans to subscribe."

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