Chit Chat Stocks - The State of the Music Industry With Sleepwell Capital

Episode Date: June 1, 2023

The music industry is a complex landscape with diverse revenue streams, including streaming, live performances, and licensing, but faces ongoing challenges such as digital distribution, piracy, and fair compensation in the streaming era. Listen as Brett and Ryan ask questions about the industry, various business models, and market competition. Enjoy the show! ***************************** Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney  Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Interested to see more of Sleepwell Capital's work? Check out their Twitter here: https://twitter.com/SleepwellCap?s=20 Contact us: [e-mail] Timestamps Music Industry | (2:51) Song vs. Composition | (17:18) Music Streaming | (58:19) 2 corrections from the show: 1) The recorded music industry is approximately 3 times the size of the publishing side, not 4 times. And 2) The new Warner Music Group CEO is the former chief business officer of Youtube. Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. This is our Thursday deep dive episode where we interview an analyst to discuss either a single stock or an industry overall. And today we have on the show Sleepwell Capital. He's been on the show before. He's a longtime friend and he is kind of maybe I would say our foremost expert on audio and music industry in general. And today we hit specifically all things music. We did not talk podcasting. I think we're maybe saving that for another discussion, but this is just really all things music, including streaming rights, relationships between the labels and the streaming organizations, the potential for AI. We kind of touched on that at the end and really just where we think the industry as a whole,

the music industry can go from here. However, before we get into it, I do want to mention Sleepwell asked us to throw an extra disclosure on this. Just know that the opinions expressed by Sleepwell are not investment advice. The author and associates or Sleepwell and associates actively invest in securities. They may have long or short positions in any companies or industries discussed, which are subject to change at any time without notice. There's a disclosure. Keep that in mind. Without further ado, here's our interview with Sleepwell Capital. Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat

Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or recommendation. Now, please enjoy this episode. all right welcome in today we are joined by long time friend of the show multi-time guests i'm not sure how many times at this point but i know you've been on a couple so third time yeah okay it's uh it's sleep well capital if you're on twitter you may know him as kind of audio music experts uh we've also had him on to discuss other other companies as well so feel free to look at

those in the catalog, but we're talking music today. So pretty much all things music. I know some people are going to want us to ask about AI, but we're saving that till the end. I think the best place to start is to kind of lay the foundation because everyone has their own experiences with music, but maybe they don't know how the actual industry works. So could you go through the current state of the market, where we're at, where we were at prior to streaming and then we'll we'll kind of talk probably more about the streaming royalties in a second yeah sure no and and thanks again for for having me i think it it had been over a year um by now but um yeah excited to be back so yeah i think it's it's pretty helpful

to to set the context and and actually go back um maybe to the 90s to kind of know where where we were coming from. I think music is a particularly interesting industry to study and understand because essentially it went from a pretty good but unpredictable business to then being almost demolished by the internet and piracy to now basically thriving again with growing and recurring revenue. So I don't think there's that many industries that in 30 years went through three different phases. So just anyone who's interested in business and business history, I think is very much worth understanding what happened, right? So in the 90s, I mean, obviously everyone that grew up during the 90s knows this very well, but CDs were the main form

of consumption, right? They represented 90 plus percent of the industry revenues. Back then, the labels were, you know, very, very powerful companies. They basically controlled music production. They own the studios, the equipment. So if you wanted to record something, you had to work with them. They control the manufacturing of the CDs and the distribution, you know, they have the relationship with the retailers. So, you know, back then, the independent market, as we know today, was basically non-existent. But they also became arguably pretty complacent, They were used to this model of sort of a one-off purchase. And in some ways, this model was dependent on the artist coming up with basically two songs known as singles that were pretty catchy and could be sold commercially and bundling that with another eight songs to complete a record. But most consumers were paying for a CD because of those two songs that they had heard on the radio or on MTV or whatever.

So the consumer experience wasn't ideal, right? You had to spend a decent amount of money to get access to all this music, right? So the internet came along in the late 90s with quickly getting wide adoption. And very soon we saw piracy coming through and basically destroying the industry because you had the option to buy a CD or you had the option to go listen to thousands of songs online, basically for free, just by downloading them. So, the labels were pretty much caught flat-footed through that time, and they took very long to react. Eventually, in the mid-2000s, iTunes came by and signed a deal to start selling songs on their stripped-down version, so you could pay $0.99 for a song. That really didn't move the needle. There was a bit of a revenue stream during that time, but the industry revenues came coming down and kept coming down throughout that time. And it wasn't until the late 2000s, early 2010, when Spotify launched in Sweden, which interestingly, Sweden was very well known for piracy.

So they had much more piracy than many other countries, in large part because internet connection was incredibly fast. So the way that that happened was that Spotify had to come up with a model that could compete with piracy, right? So it was incredibly hard, but that also meant that the offering that they brought to the market had to be incredibly compelling. So originally, it was a free version, ad supported, but essentially, it became a lot more convenient for consumers to just listen to everything through one application. And eventually they found out people were actually willing to pay for this and remove the ads and have even more

convenience and no limitations. So fast forward 10 years, 10, 15 years later, it's basically a a thriving industry it's uh it's it's grown a lot over over the last over the last couple of couple of years in 2021 it finally surpassed the the peak that we had that we saw in 1999. um that's on a nominal level though and inflation adjusted we're we're still way below that that 99 Peak um but but I mean, just to put a little more context on where we are now, 2022 was 9% growth in the industry, again, driven by subscription. The recorded music industry is $26 billion. Two-thirds of that is coming from streaming.

And we basically have around 600 million music subscribers today globally, which is approximately 10% penetration. And, you know, obviously, developed markets are sort of getting closer to a more mature stage, but still growing just more slowly. And then emerging markets are growing very fast because it's much earlier in the adoption curve, right? All right. Yeah, that totally makes sense. And as you mentioned, streaming is two thirds of the industry and will probably hit maybe 80% of industry revenues within the next few years. So I think it's important for anyone interested in this market, how streaming royalties work. You wrote a nice little blog post, I believe two years ago, outlining the complications

with this, but where does the money flow? Because you have the platforms, you have the artists, you have some of the rights holders, and then you also have the labels as well, as I guess might be a little bit different in the mix there. So how does that work? Maybe from an example, or you probably have a better way to outline it than us. I can. Yeah, let's let's summarize it. And then anyone interested in kind of taking a deeper look, we can share that that piece on Substack. So streaming royalties 101. If, if we look at the, at the music industry, we're usually talking about two separate industries. One is recorded music, the other one is publishing. The reason why these two are separated is because every song has two separate copyrights okay so on the one hand you have the composition

which is basically the lyrics and the and the melody if you can think of it as you know as the music sheet with with with the notes and and whatnot um essentially that's comparable to like a script in if you think about filmmaking um so that is related to to the publishing industry On the other hand, you have the master recording, which is the actual file that comes out of the recording studio, right? The MP3 that goes and gets distributed to Spotify, Apple, Amazon, the radios, et cetera. That's what's referred to as the recorded music industry, okay? So those are the two separate pieces of IP that every specific song has attached to it, okay? Now, in terms of, you know, because there's a couple differences there, right?

Recorded music is around four times bigger than the publishing industry. This, you know, it's a little complex, but it has to do with sort of the incentives behind it and the risks involved in actually recording these songs because it's more capital-intensive versus just writing a song and sort of distributing it. So when you think about, for example, many people have read the headlines, which have been ongoing for a long time, about Taylor Swift, right? So the master is, in most cases, owned by the label, okay?

So what that means is the label will, when they sign an artist, they'll pay the artist in advance that is usually recoupable with the actual royalties that the master will generate. And it's basically an 80-20 deal where the label keeps 80% of the revenues and pays 20% to the artist. Right. So in Taylor Swift's case, she didn't own her masters and the masters were actually sold and changed hands a couple of times. And she was obviously incredibly mad about that. So interestingly enough, she decided to rerecord all of all of the albums where she didn't own the master.

Now, that's not normal, right? Like not not many artists can can actually afford afford to do that. But in most cases, when we're talking about the label negotiating a deal with Spotify or with TikTok or something like that, we're talking about the master. Okay, it's that part of the industry is most of the time private negotiations, right? And the publishing side is usually government regulated. um so there are there are certain laws uh usually you know there's in the u.s it's it's typically set by the copyright royalty board um but the the government will basically say uh how much it costs to license the publishing side of a of a song um so that again that's the composition um so if i to record uh a song from bob dylan where bob dylan is a songwriter um i can i can go ahead

and do that and and you know and put it in in youtube and or whatever um and then bob dylan's you know catalog will get paid for that right and that's again that's set by the by the government right and uh and i think the other distinction to to make here that may not be you know as as obvious is that in many cases the the master and the publishing um are two different people right um there's you know especially these days with like you know hip-hop r&b even even reggaeton um the the performer is is usually the one who's attached to the to the artist right so someone like you know bad bunny um he he will he will get the cut from the from the master but in most cases he would have worked with maybe three four or five other songwriters um on the song that will

get a cut from the publishing side if that makes sense so maybe to now take that in and you know put put an example of of how the money would flow um because again i think there's there's a lot of misconceptions here uh you know we've heard we've all heard people complaining artists, consumers, everyone that streaming doesn't pay enough, right? But there's a lot of nuance to that, right? So just to keep it simple, if you're paying $10 per month to Spotify, basically 67 cents, about two thirds is going to get paid out to the rights holders, right? So that's, rights holders is anyone that has some sort of IP ownership on that catalog, right? Within those 67 cents, approximately 52, so yeah, so 67 cents, 52 of those are going to the master, and then the other 15 is basically going to the publisher.

So again, you can see how those two are separated and why I was explaining that they're two different industries. In terms of how it gets decided who gets what, it's basically a pooling mechanism and it gets aggregated. So they take all the money that they received from the month of April, and if Harry Styles had 10% of all the streams, and they have $1,000 to distribute, then Harry Styles' catalog will get $100 paid out. And then the label will take a share and pay some to Harry Styles, and the publisher will do the same things. there's usually a lot more intermediaries in between, but that's, you know, kind of broad strokes how the money is flowing. So, you know, if you're an artist that has, that signed a deal and gets, you know, 20% of the royalties of the master and you're not writing your own songs and you're not, you know, you're not that big of an artist, then yeah, like people may be paying

$10 to Spotify, but you're not going to end up getting that much from that, if that makes sense. Is this a way to think of it that there's basically, there's the song and then there's the content? Is that kind of a way to kind of look at the two different rights, I guess? like are you saying content in terms of like lyrics like so i guess no yeah i mean that's fair i don't think the right way to refer to it is is as the content but i mean the technical term is the composition right if that makes sense okay and so on like for example to kind of put this in perspective of maybe the common music listener uh one really popular song that came out recently was uh like luke combs had an album and one of the popular songs was a cover it was called fast car

fast car was written by someone tracy chapman i want to say 30 years ago even though luke holmes probably is selling that uh that song maybe is listened to more on his composition um or on his audio recording a big chunk of that is getting paid out to tracy chapman or whoever owns the actual lyrics the actual composition side that's exactly right the master will will be paid out to you know i mean i actually just looked it up he's with sony So Sony will take the master and will pay to him whatever terms they agreed when he was signed to Sony, and then the publisher will take that share from that song and distribute that to whoever owns that. And that's that 15%. So the 15% goes to that person or whoever that rights holder is of the lyrics, whatever you want to call it. If you're thinking about the total monthly payment, yeah, it's approximately 15%.

But then in that case, that could get split up again. Publishers usually do a 50-50 deal. So the publisher will keep 15 and it'll pay around 7% of the total, right? So it ends up just cutting that in half. right to the estate of, of Tracy Chapman. I don't, I don't even know if she's still alive or not, but you, you get it. You, you, you get what I'm saying. Um, but yeah, that's, that's exactly, yeah, that's exactly how it works. And sometimes like, and we can talk about catalogs in, in a little bit, but, but sometimes these catalogs get sold and, and many in most

cases, when you read the headline that, you know, you know, Bob Dylan or Justin Bieber or whatever sold their catalog. In most cases, it's referring to the publishing catalog. So they'll sell the writer's share of the publishing, if that makes sense. Yeah, definitely makes sense. All right, we're going to get to industry dynamics, but maybe, do you have any lessons as an independent artist of how these platforms work or how the modern music industry works? I mean, what's good about it what do you think you know it helps with the industry participants mainly the artists and what do you think could be improved if anything yeah yeah for sure so i think it's probably helpful to to give a bit of background of of where i'm at now um so i'm an independent

artist it's a solo project it's relatively new i recorded it about a little less than two years ago and it's still in process to like i have four singles that are out and then on an album is going to be coming out later later this year um i think the the first lesson that i learned pretty quickly it's that it's a lot more work than i originally imagined uh a lot of people i think when you think of this like oh independent artists like you can you know sit in a room write songs record and and public like like that's not how it works at all right like especially if you want like you know like like decent quality uh song and and try and and try to to do the best you can for it to get to get heard right so you know recording it takes takes time i mean does

it you don't necessarily have to go to to a studio but if you if you do have a studio at home that still cost money you need you know you need you need a producer you need session musicians i mean i don't play drums uh right and i don't play bass so i i need i needed to find people that could do that for me um you need someone to to on the kind of the more technical sound recording aspect you need uh sometimes a mixing engineer you need someone to to mix the file to master the file and then after everything is sort of recorded and completed comes the second stage which it's i mean Arguably, it's a lot more work and a lot less fun because I think that's another interesting lesson that artists are not business people and they're not entrepreneurs. They just want to be in the

studio writing songs. So this second part is where most of the labels tend to add most of the value because you need a manager, you need the distribution, you need advertising, marketing, you're gonna do a promotional video you're gonna do you know you need artwork you need a bunch of photo shoots you need interviews with the radio and and blogs and what so it's it's a ton of ton a ton of work right and that's like to just have some sort of decent chance to to to to get heard right because the other thing is and and this is not a surprise to anyone i think is that it's incredibly competitive right i think the most recent stat we heard is is that there's a hundred thousand songs being uploaded to spotify per day right now and that sounds like it sounds a lot

like the podcast market too a lot of spot could be uh but but yeah and that's up from like 60 000 a year or two ago so it's it's it's rising you know it's rising incredibly fast now um in terms of you know when the song comes out and and and stuff i mean it's there's only so much you can do marketing-wise, especially if you're not getting support from the DSPs, so the digital service providers, that's how they're called, the music streaming companies, right? Because the best way to get heard these days are you either get into a playlist on Spotify or one of the big streaming streaming platforms um apple youtube amazon etc or you you go viral on tiktok like that's basically the the two avenues you have the radio doesn't make much much of a difference now i've i've

been featured on on radio stations in in latin america in the my song term spanish so but and it hasn't really moved the needle much right it used to be the radio 30 years ago but that's not the case anymore. And I think the other thing is, is for most, for most artists, there's only going to be like two or three platforms that really matter. Right. So those two to three platforms are probably going to make up, you know, 70, 80% of, of your, of your stream. So you're probably going to be spending a lot, um, a lot more of your, of your time and focus working on those platforms. If that, if that makes sense. And those are Spotify, Apple, Well, it changes a lot. Like Latin, Latin, Latin America is super skewed to Spotify. So I think

for me specifically, Spotify is probably like 70% or something like that. Uh, there was a point in time where I was featured in a playlist in Amazon. So Amazon was, was a bigger part. Um, that's not the case anymore, but now it's basically for me, it's basically Spotify, YouTube, and, um, actually Pandora has been pretty decent for me in terms of streams. And YouTube, I had a video which helped as well. And the marketing in YouTube is actually more efficient because you can actually market the video and advertise a video, if that makes sense. So that's another way to try to get found and try to get heard. So in your case, do you own the master recording then? Yeah. So that's a great point. I'm not signed to a label. So what I did is, and this is what all independent artists do,

is you pick what is called a distributor. So the distributor will typically take anywhere from 10 to 30% of a cut. So it's flipped basically. Instead of that 80-20 that is typical in the labels, this is the opposite. And I mean, people that follow the industry may have heard of some of these companies, but the most well-known ones are Believe, 1RPM, City Baby, DistroKid. Believe is actually public. So you can look at their financials and they're actually growing a um so yeah i'm working with with a distributor and they basically you know that you you never think about this but there's there's like a hundred two hundred different platforms where music gets distributed gets distributed to right so it it would be impossible for me to go out and

like upload individually to all of that and that's basically what a distributor does plus they try to help you with marketing and they have a relationship with all the DSPs. They've talked to someone at Spotify, someone at YouTube and try to push for your song, your new releases to get included in playlists, et cetera. So that's kind of what their role is, but I get most of the revenue. That makes sense. Makes sense. Let's move. I think we set the landscape for the industry quite well. Let's move to more, I guess, investing takeaways, I guess you could say. You mentioned that streaming is the lion's share of music revenue today. Where are we at in terms of market saturation with streaming? Maybe for starters, in North America and Europe,

I know those are probably some of the more mature markets. Do you think there's still room to grow for streaming in those areas yeah no i i do and i mean it's it's it's slowed and that's i mean it's not it's not surprising i mean there's a natural less curve to to all these markets as as the adoption takes place but if we look so the entire market right it's around 10 penetrated we can break that up into developed markets and and emerging markets the the more the more mature markets which are mostly developed as you as you said are about 30 penetrated right um one thing that is pretty instructive in terms of how markets like the us and and you know newer newer developed markets, if we want to call it that, that haven't been around as long. You can look at Scandinavia

because that's where Spotify started in 2008. So, I mean, we're talking 15 years now. And they also expanded to Denmark, Norway, Finland pretty early on. So those four countries are actually a pretty good data set to get an idea of how things can play out for the rest of Europe and the US. And they're basically approaching, if not already surpassed 60% streaming adoption. And this is paid streaming. We're talking paid streaming. They're still growing mid single digits. By that point, you're basically capturing the older cohorts that take a lot longer to stop listening to radio or buying CDs and they eventually decide to get a subscription. When they reached 40%, which is where the US is basically now, it was still growing 10% per year.

I think for Spotify specifically, the US is growing like 12% or most recently grew around 12%. Now, there's a lot of other developed markets that are 20%, 30% adoption. Actually, Japan is even lower than that. Japan is huge on physical sales. They still buy a ton of CDs and vinyl and whatnot. So that's one way to think about it in terms of how it could play out. So yeah, I think there's still some runway left on most of these markets. Another interesting parallel is we look at streaming video on the US, penetration is around 80%. I mean, I don't see any reason why it couldn't get there in the next, call it 10 years, right? I think people do want to listen to music and the experience of getting an ad every couple of minutes just absolutely sucks, right?

So it's just a matter of time, right? So yeah, that's where we are basically in developed markets. And we had this one later, but I think this is, it came to my mind. So I think it came to a lot of listeners' mind as well. When we're talking about these mature markets, people always bring up pricing power. They've been, Apple just recently went up from $10 to $11, which is still significantly trailing inflation. Spotify's standard service has been $10, I think, ever since launching in the United States. They won, yeah. And again, on an inflation-adjusted basis, it is way down.

This is turning into a bit of a leading question because I do think they have pricing power, but I would like to see your opinion on maybe how much pricing power these services have or whether, because I think the bare case for these streaming services is that they're owned by a lot of big tech companies and they don't really care about profits and it's just a race to a bottom to reduce churn across their entire ecosystem. Oh, I mean, go ahead. Just to ask a follow up to that. One, obviously, yeah. Do you think they have pricing power? Why do you think that? But also, why hasn't Spotify increased the price of their? No, that's very important.

And I'll get to that. So I think first, I was actually a believer of the fact that the big tech companies didn't care about music and sort of were like a lost leader, great way to capture new subscribers and whatnot for their bigger ecosystems. I was pretty surprised in the past year when we saw Apple, Amazon, and YouTube, the three of them raised prices, right? So I think I changed my mind a little bit on what I thought was their stance on that. And now I'm a little bit more in the camp that they've realized that they have the pricing power and that music doesn't necessarily need to be a loss-making business, right? I think it probably helps that we've seen a lot of changes in big tech in the past year or so and a lot more discipline in costs, etc. So that's the first part, right? And as you said, it wasn't material, right?

it was like a dollar or so i think actually youtube's was was pretty high it may have been like a couple dollars and which was like 15 or something but because when you when you put it in percentage terms like a dollar from from 10 to 11 it's still 10 right so so but but yeah so spotify has tested price increases in various in various markets and and they have said as well as the labels have said that there was basically no impact on churn and that's also applied to the other music services. The reason why there haven't been that much price increases is because it basically comes down to incentives. As the current label agreements stand with all the DSPs, every incremental dollar that they raise prices on, the labels are going to get close to 70% of

that, right? So if I'm Spotify or I'm any DSP, why would I raise prices to give most of those economics to somebody else when I own the consumer relationship, right? And I've built the platform and I've tried to keep churn low and engagement high, et cetera. So there's not really that much incentive for me to raise prices and if and they're still growing right so um again i mean if if you have high single digit growth at developed markets that's not that's also not a bad place to be right so i think what what we've seen and and we actually there was a pretty interesting development uh in warner music's uh earnings call in that was like two weeks ago So basically, Warner has a new CEO, which used to be the head of music at YouTube.

His name is Robert Kinsel. And it was the first time ever that I heard someone from the big labels talk about there being the need for a change in the label agreements in order to incentivize price increases on the DSP side, right? So his quote literally was, the current wholesale relationship has to change because today, it does not incentivize price increases. And what this tells me is that they've realized that with how things are now, they're not going to rush to raise prices. So my theory is that they're going to get better economics on the incremental dollar, therefore incentivizing

them to raise prices. And if you think about it, it's going to be a kind of a win-win situation, win win win because you know the the streaming platform is going to get more money at a better margin the label will still get more money and the artists will get more money obviously the the consumer is the one that quote unquote you know suffers but there i think you know part of the part of the thesis for the whole music industry here is is that it's it's the most undervalued form of of media content right it i mean per hour i think it costs something like you know 30 or half of what other comparable forms like video or video games cost so so theoretically there's there's a lot more that consumers could be paying uh for music now where

can that go i mean i think i think we'll see um i've seen and i think and this is like pretty common on twitter but you'll you'll see people polling like what happens like what would you do if i double your spotify subscription and you'll get all these you know varied results i think first of all like i wouldn't pay any if if if you know any sort of attention to that because polling is inherently bad like yeah for for example i one time polled if uh if a podcast had two advertisements would you listen to it and 60 roughly with this poll and 60 percent of people said i would stop listening to that show and there's no data that supports that so that's perfect example right so polling polling is is pretty bad like consumers don't know themselves

right and and there's like there's all and there's also like so many different ways that like spotify is not going to double or any dsp is going to double their price overnight but if it takes place over 10 years like like i'm pretty sure people would wouldn't go anywhere now that it's important to to talk about churn here as well because a lot of people also think that that these platforms have very high churn and again this is this this is there's a lot of nuance to this okay so if you looked at if you look at these markets where we're we're talking about where where the potential price increases would would would take place um churn is is between two to three percent which is pretty much comparable to netflix right um if if you look at

at cohorts of call it six to 12 month cohort so so consumers that have stayed for longer than that to adjust for for trial periods in markets like the us and the uk churn is below one percent okay so that's and that's not that's not like well known um i think spotify has basically talked about this once in their investor day and it was like that figure was kind of buried in there but But people still think that these services have like 6%, 7% churn, right? And that's just not the case. Now, when you look at the whole company, because you have markets like India and some places in Latin America where they offer weekly plans and sort of prepaid plans and things like that, that basically screws the whole formula up, right? Because you're sort of renewing weekly.

You can count somebody has churned four times where that's not necessarily what it means. So that's why they stopped reporting churn in the first place. But yeah, so the way to think about it is churn is low, engagement is high. Once they stick around and they build playlists and they become accustomed to a certain UX and whatnot, they're not going to go anywhere, right? I mean, at least we're not anywhere close to a price where they would consider going to an alternative, right? And I do think that if the incentives change, you'll see that even big tech is going to continue raising prices.

So it'll just be kind of the tide will rise and everyone in the industry will benefit. What other markets do you think are going to be big in terms of growth for streaming? You mentioned India. Is that kind of one of the biggest? Not yet. Yeah. I mean, the one that's actually been pretty surprising is China. China is now a top five market and growing fast. For the last 40 years, the top four markets have stayed the same. It's the US, UK, Germany, and Japan, I believe. Maybe not in that exact order, but everything else has been sort of meaningless and ignored for a very long time. But with streaming, now that you can

actually monetize globally. We're seeing a lot of markets, emerging markets like China that have been growing a ton. Penetration in China is 10% now, which is pretty high. I think India is like 1%. Again, paid subscription, right? Obviously, things like YouTube is huge in India, right? But I think India is clearly a pretty promising market. Indonesia seems to be doing pretty well as well um latam interestingly is is a market that that you know still has a lot of of of runway ahead of it uh but has also embraced embraced streaming um you know pretty pretty well um i'm not sure exactly what the penetration is is over there but it's i mean i'm i'm pretty sure it's it's probably higher than than china right and streaming entered entered latin america

a couple of years after the US. So they've been added for longer as well. So yeah, kind of in the medium term, those are probably the markets where most of the growth will be coming from. Some people talk about Africa as well. It's definitely growing fast, but it's also coming off of a really, really low base. So yeah, I mean, 10, 20 years from now, we will be hearing more about those markets. But I think that the bottom line here is there is so many different places where growth is coming from that that's just going to be a pretty good tailwind for the industry generally, even if obviously ARPU is lower, but it's just the amount of people that are going to end up paying for a subscription service is going to be multiples of what it is today. And that's kind of the most

important thing for now. Right. Yeah. If you get a billion people paying $2.50 a month, that can be meaningful for these businesses, at least those segments within at least some of the big tech companies. One follow-up on China, because I know we don't want to go too long here, but I think people may be interested. Is it like the other internet services around the globe

where they've kind of separated themselves out or do the big labels in Western markets, or I guess maybe Sony's from Japan, but the big three, do they have relationships with these companies or any streaming services within China? Like is Apple Music in China? because I know Spotify, for example, has a deal with Tencent Music where they don't go in that

market, but Tencent doesn't go in any other international markets from what I'm aware of. That's the, I think it's a kind of a handshake understanding, but they did exchange equity. They had an equity swap years ago where they each own 8% or something of each other. And that's kind of the understanding. So in China, you basically have Tencent Music and netties which has been growing nicely tensen had a quasi monopoly for a couple years because they actually had like exclusive deals with some of the labels but that that god got killed by the regulators so now you have netties kind of you know leveling the competition a little bit um the the labels have have been trying to get in there um inorganically so by by acquisition um

i'm i'm not as as familiar with with that market uh specifically but i know that they paid a lot of attention to it and there's things like you know that like jvs and things like that that they've tried to to to get to get into um because in in china and emerging markets generally local music is incredibly important and especially in places like india and and things like that like they don't they they very very seldom listen to like the global stars that we all that we all know right so it's incredibly important for for labels to get some exposure to that i think we'll talk about you know the labels more specifically in a little bit but but yeah they're that's one sort of issue that they're that they're trying to to to address just their exposure to to emerging

markets because they don't have a strong a foothold in those in those markets yeah let's Let's talk about the labels, because I think most of the discussion has kind of been from the lens of the streamers. On the label side, do you think that, I guess it's kind of a simple question, but do you think the big labels are good businesses? Why or why not? yeah no i think i i think i do um there is there is some caveat to that because when you think about the big labels and i think it's helpful here to to also just put put put the background in place there's there's three big labels that control roughly 70 percent of the of the of the market and that's universal music sony and warner in the in that order right um and when you think of of any of those three labels specifically you're really talking about two businesses right one is the the back catalog okay so the the back catalog is there's different you know people will

will define it in different ways but basically anything older than than three years um and when you think about especially the deep back catalog so music from you know the 60s the 70s the 80s and et cetera, where the labels basically own those master rights in perpetuity. I mean, that is still incredibly valuable, okay? So you're basically talking about a toll road. There's no operating expenses related to that. And I mean, the Beatles, for example, over 30 million listeners on Spotify, they're basically a top 100 artist.

um you know umg owns those those masters um and and i mean they're they're they're taking in a lot of money from that without any sort of associated expense if that if if that makes sense there's some royalty that's probably being paid out to you know the the probably paul mccarney probably getting some of that etc but um so that part of the business is is very is very valuable and it's it's benefiting a lot from the growth in in in streaming right there is theoretically some decay in terms of how long those those artists and and how like how long people will listen to those artists but i think that they own such a a vast you know um a vast catalog of different artists that they're they're probably protected enough that if one of them

you know kind of falls through and people stop listening to them you'll have something like a like a fleetwood mac event that we saw on tiktok a couple years ago where they blew up again and came back to the charts and and there's all all these things that they that they do as well like you have uh you know you had the biopic of queen uh you know streaming increased meaningfully after that that came out um sometimes they'll do reissues of of albums and like mix them again and put them in really high quality sound and put them back on. They did that with the Beatles recently. That sells for $200 if you want to buy the vinyl set. So there's all these low-hanging fruit things that they can do to keep that alive. And again, it's a really good business. And that

is pretty much impossible to disrupt. You can't replicate that. Now, turning to the more traditional role of the of the label right so that's known as as the frontline catalog right so this is what you would think of uh in terms of what a label does right so it's artist development it's it's helping them you know with form you know form their their image putting them in touch with with producers and songwriters and musicians to record a novel etc like that it that business is is is still a good business but it's it's not as good as it used to be it and there's there's a lot of moving pieces to that right so so the the first one is that what we were talking about the the competition which is kind of a it's kind of a double-edged sword because the fact that there

is so much competition means that the labels can also help artists differentiate themselves right but that the fact remains that that even if you sign to a label there's no guarantee that you're that you're going to make it so if if an artist wants to you know if they if if all they want to do is like be a global superstar they're most likely going to kind of sign to a label so the bent they have that benefit going for them but at the same time you have a lot of artists that grow organically by themselves being independent uh for a very long time and sometimes either stay independent, which means they're just competing with the labels, or if they do decide to go to a label, they're going to have a lot of leverage. And that's something

that's also changed a lot, especially in the last 10 years, right? There's this idea that we were talking about of a label offering an 80-20 deal in perpetuity and owning the master. That doesn't happen that often anymore. But yeah, with newer acts, if you're unproven and whatnot, the label will force their hand and they'll be able to extract that from you. But I mean, if you have a couple million TikTok followers and a couple hundred thousand listeners on Spotify, you can probably sign up a pretty decent deal with the labels and actually get your master's back in a couple of years. So yeah, I guess that's kind of one way to explain why I think it's a little bit tougher but again it's their businesses are these two businesses put together so um so all in

all you know they still have pretty good runway growth ahead of them i think and they're still you know they're still good businesses what are the growth avenues besides streaming because we hit on streaming it's gonna most likely grow at maybe 10 or so for the foreseeable future and that's great for them but there's you know there's more people listen to music in other ways is there any really material growth avenues that you think could benefit the labels? Yeah. So, I mean, social is a big one and a lot of people focused on TikTok right now. The labels have been pretty vocal in the fact that TikTok doesn't pay them enough. Facebook, so Meta has actually been uh trying it to to be sort of the the the good guy in that in in that part of the

market and and they've for a long time they've they've had deals in place with with all the labels and and something that's that's important to to differentiate here on the on on the deals with with platforms like like tiktok and and instagram for example is that those deals as opposed to to how the streaming deals are are structured are usually fixed payments and they're they're super short they're like um maybe 18 months or something like that and just keep getting keep getting renewed but but it's not it's not consumption based right and and i think the labels are trying to change that but it's but it's not it it you know it's not that that easy it's kind of a back and forth negotiation in terms of the labels arguing that music is you know

central to their to their consumer value proposition and they're coming back and saying we're a discovery tool like we shouldn't be paying you that much etc so it's it's complex uh but i think they can probably manage to to do something there and it's it's been growing pretty nicely right you have other things like like fitness with like you know having songs on the on the peloton like peloton will pay something to the labels to license that um you know video games uh as well things like roblox etc so these are these are some of the avenues that that that labels are are are trying to to better monetize ai is is becoming another one uh right now it's kind of a big you know it's kind of a big question mark in terms of how all of it will play out but

we did see umg signing a label uh signing sorry signing a deal with with an ai company that does like sleep music ai generated and and umg is actually going to work with them um i think we're going to talk a little more about ai later because that's a whole separate conversation but that's that's one of the that's that's some of the ways that they're trying to to monetize outside of of of streaming and as we know now that they're very focused when it comes to streaming they're very focused on those those price increases right now which i mean we'll see probably later this This year, it's how those agreements play out and what it means for the future of streaming. I guess it sounds like the pie, if you think of the music industry as a whole, is going to grow.

How it's sliced or who gets certain take rates, do you think that will change? In other words, do you think Spotify's maybe margins, but also their take could increase over time? Or do you think it'll stay kind of relatively similar to how it is today? I think there is a case to be made that now that price increases are very much on the table, Spotify is going to get an effective increase in take rate on that incremental dollar. But the base will probably stay the same. So it looks more positive for Spotify now going forward, but I don't think it's going to change drastically, if that makes sense. I do think that the way to think about the industry and the opportunity for all the players that are involved are what you were just suggesting, which is growing the entire pie. and something we haven't touched on that it's probably worth you know mentioning and discussing a little bit is is is the super fan opportunity that labels are also uh starting to to to mention

more and more right so this whole idea that had no matter like if i'm the biggest taylor fan ever and you don't and you don't like taylor swift we're both paying the exact same thing to listen to her right so that's there's an argument to be made that there's a lot more products and offerings that can be that should be distributed through these through these music streaming companies that could be offered and people would be willing to pay i mean we know that people like a tip right like a tip yeah so it could be tip jars i don't know if tip jars could would work but there's obviously a lot of testing would would be will be taking place around that but you know we've like we've seen how much people are spending on on like vinyls and things like

that and and how much they're paying for concerts so there's clearly a very very big demand for for for monetizing superfans but you could you could envision you know uh a scenario where um where Spotify or... And this is not specific to Spotify. This could be offered across all the DSPs, right? But if someone told me, I don't know, Death Cab for Cutie was offering extra special content for $10, and maybe that's a one-time payment, maybe it's a $5 subscription or whatever, I would subscribe to that. And I would probably do it for my top five artists, right? Or maybe you pay you know you pay a one-time fee and you listen to to the to the album three days become before it comes out with uh with the artist in a live or something like that like there's a ton of

things you could do to play around um and and just monetize that super fan in a much more effective way something that basically the labels were just not really embracing a couple of years ago we have seen the labels, their growth has slowed down these past couple of quarters. And there's some concern around that. And that's also why they've tried to push more the price increases. But that's not necessarily indicative on what's going on in the broader industry. As we said, they're losing share, especially in emerging markets, which are the fastest growing markets. So Spotify is still still growing pretty nicely but then the labels uh they sort of depend on on what releases they have on any quarter and uh again they're losing some share to the independent market as well as

market so it's a it's just different moving moving forces on the on the industry all right let's flip back to the streamer side of things i think what's interesting to talk about is you You know, the big companies, there hasn't really been a big new streamer in the last few years. But who, let's say, over the last three to four years has made better, let's say, I don't know, gained market share or made better inroads globally or in certain markets? If we look at the big ones like Spotify, Apple and Amazon. And then I also want to talk about, because I think this can be added into this response, is the nice Twitter comment we got about the multi-format risk, which in my mind, the biggest looming competitive threat to the other streamers would be YouTube and then potentially TikTok as well. sure so i i actually think you can you can count youtube as someone who's made incredible inroads on the subscription side right because youtube has always had a huge role in in the music industry

generally it's just been monetized via advertising for the for the most part but they you know google went through a couple of like mishaps originally they had like google google music or google play something like that and youtube read and eventually they figured they figured it out and now you're basically you basically have youtube premium which includes uh both ad free youtube as well as youtube music and that's kind of their more their most popular most popular product that the last figure they they reported was they had about 80 million subscribers which is pretty it's pretty incredible right i mean they've they've definitely taken taken share um so that's that's one that is is worth sort of keep paying um paying attention to but i think we're at a point now where

the market is is pretty much uh defined at least you know excluding china because of what we talked about but it's it's basically it's basically spotify apple uh amazon youtube and i mean youtube can probably overtake um one of one or both of those at some at some point um and then you have, you know, all these other subscale kind of regional players that I think, you know, my sense is that it's going to be really hard for those players to remain standalone. We've all seen how tough the business is, right? It's a very low gross margin business, especially compared to all the other tech. So it just naturally requires a lot of scale if you want to eventually have any sort of chance of being profitable because you need to try to get leverage on anything that's below the cost of goods line.

So it's just incredibly hard to do that for someone like a Deezer or even Tidal. I mean, we've seen some of the headlines around Tidal. SoundCloud. I mean, SoundCloud should, I think, would see a share to these other people as well. Yeah. So, you know, it's tough, right? And Deezer has actually exited a couple of markets. The other really interesting one that makes a lot of headlines is Rezzo, which is basically the TikTok music streaming company. There's been reports a number of times that they're going to launch global. We haven't seen anything about that yet. They only operate in three countries, as far as I know, and that's India, Indonesia, and Brazil. But interestingly enough, they did announce a couple of weeks ago that they're closing down their ad-supported tier, which was, I mean, to me, that says that, first, that they're super unprofitable on the ad-supported side.

And it just takes way too much money to subsidize that to get more subscription. But they're probably rethinking their strategy, right? Because I think launching globally is probably incredibly hard, even for a company that is backed by ByteDance. But it feels to me that if we look at this from kind of a capital returns framework, money seems to be exiting the market more than it's entering it. Like, it's basically impossible for someone to start a new streaming company at this point, right? I mean, unless you were someone like YouTube, which obviously had a huge, you know, start and good competitive advantages in their distribution.

But taking, you know, any other player and just coming in from scratch, again, we've seen how hard it's been for ByteDance and, you know, with their TikTok distribution. And it just, at least for now, we haven't seen anything that, that shows that they're gaining a lot of market share. Okay. Maybe last question. There was another one back there. Oh, multi, multi-format. Yeah, no, that's, that's worth quickly touching on.

I think, um, so yeah, it's, it's important to, to keep in mind and sort of be cognizant of the different ways that people listen to music, especially Gen Z, because that's what is going to drive most of the growth in the next 10 years or whatever. And if they're spending most of their time on TikTok and they just don't want to be listening to music and you get some sort of habit change in that sense,

I mean, I'd be concerned about that. i don't think there is data to support that like i think if you look at just the the amount of hours that people are are spend listening to to audio and and tick to you know consuming tiktok would actually count as you know social media or actually short-form video which counts as video so it's it it's not being um like it's not taking share from audio like audio is is still an incredibly big part of our consumption per day of any media. And I think it's going to stay that way, right? I think people discover music through TikTok and eventually just go and listen to it at whatever service they're subscribed to, right? That's kind of my base case.

Okay. How about AI? I know this is one where it's hard to have any concrete thoughts here, since it's so open-ended, but any thoughts in general on AI and how it might affect, I guess, the industry overall? Yeah. No, it's definitely a big question mark. I think there's a couple of ways to think about it. And there's also different parts that get affected by AI, if that makes sense. If you look back at history, I think something that is interesting and worth keeping in mind as all of this unfolds is that every time a new piece of technology came about and changed the way that music was made, the reaction of most people and especially like the established community and the artists

uh was typically like oh that's that's not real music like you're not you're not a real artist right and this happened with like autotune the first time we heard we heard autotune i don't know if you guys know the story of of t-pain but basically he started using autotune as an instrument and he got like he got everyone in like all the artists were like insulting him i I think Kanye got into a big fight with him and whatnot because he was cheating and stuff like that. And now, obviously, basically everyone uses Auto-Tune, right? It's like a standard industry practice, right? Same thing when production became digitized, right?

In the 90s, what we were talking about, you had to go to this studio that had probably millions of dollars of equipment. And now you can basically replicate all that in your computer and make, you know, produce a really good sounding song through everything, through your computer, right? And that, you know, that brought about electronic music. And again, a lot of people were saying that's not real music, but then you have, you know, artists like Tiesto and Avicii and David Guetta and all that. So my point is that I think the way that this will play out from a creative standpoint is that because everybody's going to have access to it, apparently, I think there's going to be really creative ways to use it. And the best artists will just find a way to differentiate themselves in terms of working in conjunction with AI, if that makes sense. It's not that they're going to press a button and put something out and it's going to blow up. No, I think they're going to use it as a tool, right? It's going to be like having another songwriter. It's going to be like having a great bass player next to you. And it's kind of what you can do with that, like your talents combined with the AI tool, the sum of the parts is going to be bigger if that makes sense. Now, the other question, obviously, is the legal aspect, right? And that's where I think there's an even bigger question mark, because the labels are arguing that they're protected, and that you shouldn't be training data with their music because it's copyrighted.

And then you have the wow moment for me, at least, and I think for many people was when all these Drake songs and The Weeknd songs started coming out that people were basically using AI, were copying their voice and kind of putting out a song as if it were being performed by Drake. And it sounded exactly like Drake. Now, I think for that specifically, there's a pretty strong argument that you're sort of impersonating him and there's this legal aspect known as name and likeness that is probably enforceable as well. And those songs got taken down. But I think the labels are probably better off working collaboratively with these platforms and finding a way to sort of license the songs to a lot of these platforms and trying to monetize them in some way. It's probably going to increase competition even more. I'm pretty sure about that. But yeah, I mean, it's definitely, it feels like one of those moments where we might be entering sort of the next phase of music and I'm sure we'll see, you know, we'll see a lot of changes.

So, you know, a big question mark remains. I think the DSPs like Spotify are probably more likely to benefit from it than be heard. I mean, related to all of this, you know, Spotify released their AI DJ. that's that's basically a large language model that came from their semantic acquisition and i mean if you haven't tried it i i encourage you to because it's it's pretty incredible the way that it talks to you and just like plays music for you it feels like literally like a personalized radio i'm i'm actually using it a lot in the in the car because i don't have to think about it i just press the button and then it and then it comes it comes up so yeah just i mean a lot of

question marks i mean it's it's definitely it's it's it i think it's exciting uh to kind of see where where all this this goes and probably probably could predict that it'll bring some volatility into some of these um into some of these companies in the near term as as we've seen um because yeah a lot of these are public now which is the other sort of interesting thing that's happened in the industry like five years ago or more there was there were no public companies. So I'm glad to see that music is sort of starting to get more and more attention as an industry these days. Okay. Well, I feel like we could go forever on the industry. So we got to call it at some point, but that is going to do it. Thank you as always for joining us. And we've got

to throw a disclosure on this real quick. I want to remind listeners that Brett and I are not financial advisors. Anything we say or discuss here on Chitchat Money is not formal advice. We're going to throw, I think we have an extra disclosure we'll throw in at the intro for Sleepwell as well, but basically do your own due diligence. This is not financial advice. Brett and I are actually general partners at Arch Capital, so clients may have positions and we do have a position at Spotify and maybe some of the other securities discussed in this podcast. So all that is to say, not financial advice. Thank you all for tuning in. Thank you again, Sleepwell, for joining us on the show and we'll see you all next time.

We'll see you next time.