NFTs, disruptive vs. sustaining innovation, music
Making the argument that this is more about Record Labels than DSPs.
This piece opens with a fairly simple question...
What if Spotify started doing NFTs tomorrow? Why hasn’t it?
Arguably one of the largest threats to new platforms innovating with NFTs is defensibility against “Web2” platforms moving in from a stronger base of operations. It is, after all, often a key part of their messaging “one NFT sold through us is worth XXm streams”.
Spotify has a userbase of nearly 400 million users and over 8 million artists. It has integration with ticketing and selling merch. It has licensing deals and distribution agreements in place with the market.
If Spotify wanted to take the Music NFT space, it could probably do so overnight and expand the market many times over.
But it hasn’t yet. Why?
Presumably time is a factor. The NFT boom over the past 12 months has happened relatively quickly versus the timescale that Spotify works to; it has been in operation for 16 years and has multi-year agreements in place with its suppliers. Spotify is a big company, and big companies set strategic goals in years rather than weeks.
Linked to relative timeframe is the necessity to react. Right now the leading NFT marketplaces can count the number of active collectors on their platforms in the hundreds. Spotify launching an NFT marketplace within its platform would likely increase this by orders of magnitude, but it is a business risk that it arguably doesn’t need to make yet. At least until product-market fit is further proven out.
Legal and regulatory risk is also likely a factor, especially with regards to the issue of Securities. Spotify is a public company, with a duty to its shareholders. NFTs as an emergent business model involve significant unresolved risk. In a related, but separate area of web3 development, we can look to Meta’s recent unwinding of Diem as an example where acting too soon can resolve poorly.
From the outside looking in, a watch-and-see attitude to NFTs seems to make sense for Spotify, for now.
However, historically, this position has sometimes invited risk around displacement if held for too long. Furthermore, while Spotify may not be publicly experimenting with NFTs, it is logical that other DSPs are being proactive in exploring this new model as a differentiator. Tidal, recently acquired by Jack Dorsey’s Square, for example, has a deep crypto ethos embedded in its new management.
This said, disruption is a process rather than a specific point in time. Even if the current major DSPs do ignore then adopt NFTs over time, let’s think about what that could mean in terms of market make-up of the future music industry. And whether NFTs represent “disruptive” or “sustaining” innovation within that.
Disruptive innovation can be relatively tightly defined across two areas of focus:
Low end disruption - targeting the long tail within an established ecosystem with an offer that is cheaper than currently available, but good enough for their needs.
New market disruption - creating a totally new market, with new customers.
The classic route to disruption is for a new entrant to serve part of the market cheaper than incumbents, usually targeting smaller customers that aren’t the most valuable. Once that position has been established the disruptor will leverage up to more valuable customers while maintaining the strategic advantage that they have built a foothold around.
Alternatively, the disruptor will create an entirely new market and usually a new business model within it. Once established this provides a foundation for moving into serving the higher value customer base across this new paradigm.
Fundamental to disruption theory is that incumbents won’t, or can’t, respond to the disruptor’s moves before the new model has started to grow into the high value section of the market. At that point, the incumbent is forced to either meet the disruptor’s offer or to cede further ground while maintaining their previously proven business model.
The other side of the coin to disruptive innovation is “sustaining innovation”, defined by HBR as follows:
Disruption theory differentiates disruptive innovations from what are called “sustaining innovations.” The latter make good products better in the eyes of an incumbent’s existing customers: the fifth blade in a razor, the clearer TV picture, better mobile phone reception. These improvements can be incremental advances or major breakthroughs, but they all enable firms to sell more products to their most profitable customers.
Disruptive innovations, on the other hand, are initially considered inferior by most of an incumbent’s customers. Typically, customers are not willing to switch to the new offering merely because it is less expensive. Instead, they wait until its quality rises enough to satisfy them. Once that’s happened, they adopt the new product and happily accept its lower price. (This is how disruption drives prices down in a market.)
Why is disruption important?
Mature markets operate within a stable equilibrium. External forces can generate a reaction in the system, but the aggregation of power on both sides means that it will recover relatively quickly. A well designed passenger plane will self-right itself from a gust of wind.
The music industries are an extremely good example of this dynamic through a combination of high head-long tail distribution of value on the supply side of the industry (artists, their work, and representatives), and aggregated customers through platforms (demand side).
Sustaining innovation results in further centralisation of power in a stable equilibrium. Upsetting that balance of power requires a change in the fundamentals of the game. Which happened in recent memory in the music industry with the launch of streaming.
However, only one side of the balance really got disrupted; the demand side. Despite streaming turning the industry on its head from a utility and value perspective, now the dust has settled, it’s largely the same market make-up with regards to who the dominant players are supplying music to the medium that consumers use. Despite Spotify turning the industry into a very different thing to what it was before, with significant impact for creators, it still has to do the same deals with the same rightsholders, if anything further cementing their position in the market.
One can argue that lowering barriers to access the music industry, cheaper recording and release processes, have helped to disrupt the supply-side of the equation over the years. Recent years have seen an increasing independent sector from an ownership basis, but aggressive aggregation of the pipes for distribution by the majors, resulting in an overall picture that is relatively unchanged. Rather than industry defining disruption, it falls more in the category of gust to self-righting of a stable equilibrium.
So, could NFTs lay the ground for the next round of disruptive innovation?
Arguably in the context of larger artists, especially those well served by the music industry ecosystem, NFTs look something more like sustaining than disrupting innovation. They have an established fanbase that is paying money into the system, and they are extracting a satisfactory reward. NFTs represent an additional revenue line, alongside t-shirts, gig tickets, and membership clubs. It is an additive, not substitutive business model.
For smaller artists, however, things are different. I’ve written in the past about the grim future facing new entrants to the music industry. The royalty game is increasingly stacked against them and their incentives are poorly aligned with dominant market participants.
And so, in this regard, NFTs could provide the foundation for a low-end foothold. Should new and smaller artists decide that NFTs represent a better option than the traditional route to monetising their music then there is the potential for supply-side disruption in the market. This may pose some interesting questions to rightsholders; labels and publishers; in the future.
The rightsholder business is built upon the relatively simple concept of investment in an artist’s work, or career, in exchange for a share (sometimes very large share) of reward once the artist is successful. The success rate of artists is low, and as with other risky investments the 5-10% of “good” ones off-set the ones that don’t work out.
However, that pay-out is largely related to royalties generated through streaming. And the equation underpinning streaming royalties for artists outside of the top end of market-share is increasingly looking unfavourable. Ergo, the incentives to invest in unproven creators is decreasing for rightsholders. There may be an opportunity for other mechanisms to fund, monetise, and promote art to come to the fore.
The demand side of the industry is trickier to make a case for though. The last 15 years has already seen wide scale disruption of how consumers engage with music, as widely documented by many pieces looking into the impact of the internet and streaming. Can NFTs pave the way for an equal or better experience for consumers, at a lower price?
In their current guise, NFTs are primarily targeted at the highest spending consumers; “collectors”, “superfans”. Which, taking the previously mentioned definitions of disruptive vs. sustaining innovation seems to place them firmly in the latter camp. The majority of rhetoric around NFTs, especially in music, is that they offer an opportunity for fans that would have spent more on an artist in a pre-internet industry to do so. They are a mechanism to better monetise the demand curve.
To validate our assessment that NFTs represent sustaining innovation for the demand-side of the music we can look at the other form that disruptive innovation can take, the creation of a new market. On this axis it too feels like NFTs aren’t disruptive innovation due to failing the key requirement of the creation of new customers. Put simply, current implementation of NFTs is targeted at pre-existing fans, not bringing in new ones.
However, there is an important second-order effect that may end up leading to disruption within the DSP controlled environment. Should enough creators decide to forgo the traditional industry contract of investment for rights, then we could find a situation where an increasing amount of content available to streaming services does not require a licence or royalty payouts. If scaled, this could fundamentally change the finances and restrictions underpinning streaming and open the door for innovation in what it is to be a future music (or “audio”) platform.
Forcing an innovators dilemma onto rightsholders.
Should the above hold true then what is the strategy to take as a potential disruptor? Where are the best areas to target your narrative and development?
I’ve argued above that the most likely route towards disruption innovation through NFTs is through gaining a low-end foothold in the supply-side of the industry. To disrupt the traditional investment-for-rights model by bringing capital and support to the table through different means.
Rather than Spotify and paltry royalty payments, it is the very structure of rights assignment and control that should be in an emerging disruptor’s crosshairs. Success will be measured by impact on the default method of how an emerging creator sets up and runs their business.
With this said, it’s important to understand Securities requirements, attempts at democratising investment in music in the past, and what the key drivers will be to increase demand for this new model.
However things play out, it’s unlikely that the DSPs will be blindsided by NFTs. But the labels might be; if this thing works it could fundamentally change the balance of control for creators. Rightsholders will be well placed to react and work with the emergent model, but should that happen then disruption will already be under-way. Disruption is, after all, a process.