The guest post is written by Niko Nyman, a Finnish consultant and a flash developer, with former careers in graphic design, web strategy, and music production. He has also co-written a book about social media called Yhteisöllinen media ja muuttuva markkinointi 2.0 (In Finnish). As a former professional musician Niko has a unique perspective to observe and comment on the current state of digital music industry, its latest darling Spotify and the challenges it faces against established players like Apple. You can find our previous post on Spotify here, where Daniel Ek, Spotify’s founder, discusses the rivalry with iTunes.

Spotify is growing strongly, and everybody seems to be talking about it. Spotify even made the news on Finnish national TV last week! It’s David Bowie’s music like water pouring down the internets, and if Mr. Bowie’s 2002 epiphany is to be believed, the aging 20th century music industry will exist no more after three years. Three years!

(See also music like water, as popularized by Gerd Leonhard.)

So what is the future of Spotify?

It is difficult to envision any other serious competitor for Spotify but Apple. I find it quite brave of the small Spotify to go against the big Apple in the music market — and they will go against each other, even if they do not yet compete directly. I’m not claiming to have any information on either company (I haven’t even done my research, really) so this is just speculation, mainly to entertain my tired brain after work.

Here are a couple of possible scenarios for what might lie in Spotify’s future:

Spotify might have been able to secure exclusive deals on music streaming with the major labels. This is quite a long shot, and if true, the sales team at Spotify should be crowned and bathed in honey and milk and saffron (does that combo actually work? anyone?). This would also imply that the cluelessness of the execs and licensing managers of the majors stretches far beyond the bounds of my imagination. On the other hand, they’ve been clueless before.

In the summer of 2001 I was in the middle of licensing my most successful musical work, Slusnik Luna’s single “Sun”. Everyone in the industry thought it was a good idea to maximize profit by splitting the copyright by territory. Basically the idea was, that instead of getting paid once for licensing the track to one record company for the whole world (or actually, for the “known universe and beyond”, as the contracts put it), it was better to sell the UK distribution license to one record company, GSA (Germany, Switzerland, Austria) to another company, Spain to a third, USA to a fourth company, and so on… And each company would pay a licensing fee; Individually not as big as if one company would have paid for the universal license, but in total the territorial licenses would add up to a bigger amount. Everyone thought that was the best deal for the artist.

May I remind you that this was the summer that the original Napster closed down, so it was not like MP3s or P2P networks were unknown at the time. But it never occurred to the record industry folks (and not in time for me either), that having the licensing rights distributed around the world based on physical territories would make it nearly impossible to sell the music online. That was, and to some extent still is, the reason why you cannot download everything on Emusic, why it took so long for iTunes to start selling outside the U.S., and why you have songs appearing and disappearing from Spotify.

So, in their quest for maximal short-term profit, the labels effectively cut off the possibility of online delivery (and related income) for a lot of artists. For years. In layman’s terms, pretty fucking stupid, considering this was done by people who should have an idea where their industry is going.

Which brings me back to the cluelessness of the record industry peeps and how that might have played a part in Spotify (possibly) getting an exclusive deal for music streaming. Like said, mad props to Spotify if they pulled that off.

An exclusive streaming license would put Spotify in a strong position, giving them a couple of years to grow their user base without worrying about direct competition. They could start building the Spotify ecosystem, experimenting with how to entwine streaming music in the social networks of users, or partnering with device manufacturers to create Spotified portable players, phones, and home stereos. All of this within a somewhat sheltered business environment.

But all things come to an end, and so do licensing deals.

If the above future scenario were true, I would be absolutely certain that Apple would not rest on their laurels and sit back, waiting for the streaming licenses to expire. No, they would be busy preparing their own offering, so when the licenses became available, Apple would be ready to roll.

The question then is, what would Spotify need to compete against a streaming service from Apple?

First, being the leader in the streaming music market wouldn’t be enough for Spotify. They would need to achieve such a critical mass during their period of exclusive streaming licenses, that they would succeed the popularity of the whole iTunes ecosystem. The iTunes ecosystem has a strong position not only because of the superb user experience and great marketing clout, but because of the “soft lock in” achieved by the combination of the iTunes software, the iTunes Store services, world’s largest mobile application marketplace, and of course the iPod devices. Considering these features of the environment Apple has created, it would be an unbelievable undertaking from a young company like Spotify to beat Apple in a few short years.

Should Spotify decide to compete by trying to create a more compelling ecosystem rather than trying to win by simply being more popular, it wouldn’t be much easier to find unique advantages for Spotify. With my current knowledge (and at this time in the evening) I can’t think of single way a possible Spotify ecosystem could provide significant value to its users. That said, months ago I didn’t see Facebook status updates providing significant value for users either, and turned out I was wrong. Without significant value for users, there would not be notable switching costs associated with users moving over to Apple’s offering. So if users were able to leave the ecosystem easily, the ecosystem wouldn’t be very valuable to Spotify, now would it?

Mobile being the Next Big Thing for the past few years (when will it really happen?), it’s again a market dominated by Apple. There are app stores for Android and S60 (kind of), but they are nothing compared to the success of the iPhone app store. Spotify has already demonstrated an iPhone app, but Apple can easily block that app from ever reaching the app store. For Apple it would actually be beneficial for S60 and other competitors to catch up just a little, so they would be better protected against someone, like Spotify, trying them for misusing a monopoly market position.

If Spotify is lacking exclusive streaming deals with labels, like it probably is, what prohibits Apple from wiping them out in a couple of months after Apple comes out with their own streaming offering? Just asking.

So, it looks like the only way for Spotify to thrive would be for Apple to not go into streaming. Why wouldn’t they?

I cannot think of many reasons. Maybe Apple, or their major label licensors, would fear that streaming would eat the iTunes download sales. Obviously majors are not against streaming, they have licensed their catalogues to Spotify after all. But if download sales are good on iTunes, why kill a milking cow?

If David is right, Apple has only three years to be a part of the future, where music flows like water. The streaming market will emerge, whether Apple goes into it or not, and eventually the streaming market will eat download sales, whether Apple offers streaming or not. Better get the streaming revenue as well as the downloads revenue, rather than let a competitor like Spotify take the market. How well Apple will maximize profit, is a question of timing really.

The investors of Spotify will most probably make huge profits eventually. But how well off Spotify the company will be in the music like water economy, I wouldn’t be too sure.