Fixing SoundCloud

SoundCloud is in dire straits. Some ideas to fix its broken business model.

I love SoundCloud. It’s a great service. As a music fan, I use it to dig for new, interesting music. As a podcaster, I pay not one but two subscriptions to host different podcasts. As a digital business consultant from Germany, I admire that Alex Ljung & Co managed to build an internationally relevant platform from Berlin. As soon as I put my analyst hat on, however, I can’t but look at the struggling company and wonder what could have been.

Last week, the news of massive cuts to SoundCloud’s staff went around. The New York Times reported:

On Thursday, SoundCloud announced that it was laying off 173 employees, about 40 percent of its work force. The company will also close its offices in London and San Francisco, concentrating its business in Berlin and New York. “By reducing our costs and continuing our revenue growth, we’re on our path to profitability and in control of SoundCloud’s independent future,” Alexander Ljung, the company’s chief executive and co-founder, wrote in a blog post. The cuts may have been a defensive move. A fresh wave of speculation has spread through the music industry that SoundCloud may be for sale — at a valuation far lower than the $1 billion it has sought in the past.

It’s yet another sign of the company’s struggle to find a working business model. To fully understand the situation, we need to take a step back and evaluate SoundCloud’s role in the digital music ecosystem.

As I have written about on several occasions, one of the most interesting and long-term promising positions in the music industry would be to be the new rights owner. The second best option would be to be at the center of an independent music ecosystem. The latter would mean to be a major distributor of music and a revenue generation tool for artists. This would mean to enable a world where artists, not labels, own the rights to their music — a classical cut-the-middleman scenario.

Today, the rights to most relevant music are property of the music labels. Since streaming services need to license the music in order to legally use it — and because the labels have the bargaining power — all streaming services struggle to become profitable. One way to change this would be to significantly reduce the percentage of streaming revenues that goes to the labels.

I wrote elsewhere:

Their [the streaming services] move would be to turn into a “label”: working with artists directly in order to own the music and its distribution — without the labels participating at all. Let’s call this doing the Netflix, as the famous video-streaming platform has done exactly that. Creating exclusive, even fully-owned content is great. Not only can you differentiate your service that way, but it also ends your dependence on licensors and is a much better business model in the long-run. However, streaming platforms have by and large shied away from attempting this. … We have seen singular incidences of artists trying the streaming-only path — e.g. Chance The Rapper or Frank Ocean — but no full-blown efforts by the platforms to own exclusive music. Note that the latter would go way further than the marketing practice of (temporarily) having exclusive streaming rights. And labels even despise that! Likely because they regard the practice as a door-opener for more radical approaches. So it’s obvious why streaming companies don’t force the issue: the labels would likely judge it as an attempted coup d’etat. Which no service would currently risk because catalogue! The labels only need to whisper the magic word and any service — barring suicidal tendencies — will stop thinking about it.

This describes the situation for subscription streaming services like Spotify, Apple Music or Deezer. SoundCloud, though, is a different service. Even though the company launched a subscription streaming service in March this year, it’s main use case and heritage is a different one. It was founded as a service that allowed artists, DJs and other creators to easily upload and share their works and to directly connect with fans.

As a result, SoundCloud has become the preferred service for many young, unsigned artists and indie labels. It was essential in breaking artists like Lorde, Chance the Rapper and it even has an entire up-and-coming genre named after it, SoundCloud Rap. The Ringer’s Micah Peters summarized SoundClouds unique position nicely the other day:

Music that was recorded in a makeshift closet booth and music that was likely recorded in some lustrous spaceship of a studio isn’t on par, but it’s at least on the same playing field. Which, accounting for featured tracks, is generally way more even than other streaming services with “exclusives” and less democratized user experiences. Apple Music is filtered through artist curation; Spotify’s playlists are guided by label interests. Compared to the two, SoundCloud is something of a free-for-all — everyone and anyone can hear and be heard.

That is to say, SoundCloud’s DNA is much more suited to establishing a parallel world to the music label system than any other service’s. It has basically been founded on that premise.

Issues

But there are two major issues. For one, even though most media attention goes to new music, the best business is old music. As I wrote in Winning the Future Of Music:

Labels are still having the upper hand right now. The catalogues are their leverage. Most established streaming services likely wouldn’t aggressively push building their own catalogue.² But even if they would, it wouldn’t help them short-term. Why? Because old music matters to users! According to figures compiled by MBW’s Tim Ingham, catalogue music¹ accounts for 62% of all US audio streams and 73.8% of video streams. Which, in a nutshell, means that most of the money in music isn’t made with new releases. As a result, signing artists wouldn’t be a quick-win. Building a money-making catalogue from scratch takes time and investment.

Regardless whether you sign artists or simply act as a platform for distribution and monetization: it’s going to take time until you have a good business. Most people’s musical preferences are shaped during their youth, but young people lack the financial resources to spend heavily on music (also, there simply is much more old than contemporary music). That’s bad news for a company that just had to cut over 40% of its team because of financial pressures.

Moreover, if you want to build a sustainable ecosystem for creators, artists need to earn money. While SoundCloud has proven capable of breaking artists — which is no small feat! — it hasn’t managed to create significant revenue for those same artists. Thus, once they leveraged SoundCloud to build a fan base, they rely on other revenue streams — often including a label contract.

Which brings me to my biggest criticism of SoundCloud: It never built a business model that is aligned with the service’s unique strength. The me-too, sub-par subscription service, including licenses from major labels, is flawed. Not only did it come too late, it also doesn’t monetize the company’s best asset — the music from independent artists. The time and money that went into building it would have been better invested otherwise.

The producer subscription revenue stream is fine for SoundCloud but costs the artists money and doesn’t make them any. Advertising fits the bill, at least in theory, but suffers from a shrinking number of active users (according to an estimation by MiDIA Research, SoundCloud now has around 70 million MAUs, down from 175 million in 2014).

In brief, the company has foregone the opportunity to provide artists with a viable alternative to the label model which is why most artists that became popular thanks to Soundcloud, past a certain point, have to look elsewhere for monetizing their newly found fame. That is disastrous.

Now What?

Cutting costs might be the right move in the current situation. Being acquired is most likely SoundCloud’s best option. While Ljung’s blog post about the job cuts emphasized that the decision allows the company to remain independent, the fact is that investors likely lost trust in SoundCloud’s ability to manifest its long-term potential a while ago. That was illustrated this year when SoundCloud couldn’t close a $100 million funding round and instead had to secure a $70 million credit line. This lack of investor believe, at this stage, is damning. It diminishes the company’s ability to innovate and invest. Its most pressing challenges are the lack of a fitting business model and the declining number of users — fixing both would require investments.

Given this difficult situation and the reduced room to maneuver, it will take radical measures — by SoundCloud or a potential buyer — to turn the situation around. I have some thoughts on this. They are all based on the core idea that SoundCloud needs to concentrate on independent artists and become the best available service catering to their needs.

Since the company isn’t public, the available information is limited, so regard the following as raw suggestions.

Going all-in on independent artists

Cancel the deals with the major labels (if possible) and stop using their music. Not even Spotify is profitable and it is the market leader in general interest subscription streaming. Getting rid of the major’s music will translate to much lower content costs (assuming that SoundCloud’s contracts are similar to the one’s of other streaming services and contain revenue guarantees). Try to get separate, cheaper deals with the majors for music used in DJ mixes. If that doesn’t work leave that playing field to Mixcloud. It would hurt because DJs are an important group of users that double as brand advocates. But they would arguably stay around if SoundCloud remains the best place to discover new music. Keep the indie label deals. In case they contain any revenue guarantees, try to get rid of them — even if it means to increase the percentage of revenue you share. You want to pay a lot of money to independent artists, but you want to do so relative to success. Increase the ad load in the free tier of SoundCloud (even at the cost of lowered CPMs). Lacking data, it’s hard to estimate how the lack of major music will impact the user figures, but it will presumably be felt (though I assume SoundCloud would cope better with it than any other streaming service). Increasing ad load, consequently, isn’t about more revenue but about converting users into the premium tier. Speaking of which… Sell a $3.50 (or so) ad-free subscription (somewhat like the current SoundCloud Go, except without any major music and thus at a presumably much lower cost of content). Revenue is transparently shared with all creators (artists who upload directly and indie labels). Share data willingly. Market the subscription to fans as the best option to support independent artists — affordable even to school kids. Limit the number of times free users can listen to individual songs per month (say 25 times). Don’t make the free tier ridiculously unfriendly to users but, given the low price point of the subscription, be more pushy. Build new tools that allow artists to tap into other revenue streams directly from SoundCloud — and keep a percentage of those transactions. Allow them to sell tracks, albums and merchandise a la Bandcamp. Test a Patreon-like artist-specific subscription option, so fans can support their favorite artist(s) with a monthly amount. Also, experiment with professional services like music licensing to brands, movies etc. Last but not least, go hard after the podcasting market. This is your future ad play. For further explanation, just read this Ben Thompson post but replace Apple with SoundCloud.

I’m still convinced that SoundCloud has a lot of potential. To this day, there isn’t a platform on the web that has sufficient scale and caters to the needs of independent artists — which critically doesn’t only include distribution but also monetization. Even though SoundCloud, alas, hasn’t delivered on that in practice, it is still comparably well positioned to become that service. It has a well-known brand and still a sizable user base of music enthusiasts.

The major question is, whether or not the service has the financial staying power to turn around. In that regard, an acquisition by a company with the necessary financial resources and a shared vision would certainly help — if that company exists. Either way, SoundCloud needs to renew its focus on its core strengths and build a business model that is aligned with that proposition. Hopefully, the misguided attempt to become a Spotify competitor doesn’t prove fatal. We are about to find out.

Please consider subscribing to my newsletter. It’s the most reliable way to follow my writing. It contains links to my recent pieces & some exclusive nuggets. I send it once a week. Here’s an example.