Welcome to Scaled and Failed! My name’s Amil Naik and I’m an aspiring VC and founder at The University of Texas at Austin. I write about startups that scaled and startups that failed to draw insights about the patterns of startup failure and how to avoid them. Everything is clearer in hindsight, so it’s worth looking back.
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TLDR
Today’s Topic: Music Streaming
Scaled: Spotify; Intense focus on the growth of its freemium product and conversion to subscriptions, investment in core technology features, and ripe market conditions led to success and IPO.
Failed: 8tracks; Focus on features like personal music upload that were past and present aligned rather than forward-looking, mounting costs without corresponding revenue gains, and competition from Spotify with its more developed product led to 8tracks’ failure.
Lessons Learned: When an industry is in flux and user behavior is changing, product-market fit needs to be dynamically understood, not a static image of what works right now. Develop your product with where users are going in mind, not just optimizing for current behaviors, to keep ahead of competitors. If some things aren’t scalable and you know that ahead of time, have a plan to transition away from them when you’ve hit serious growth.
Today’s Topic: Music Streaming
It’s hard to imagine the days before most music ever created was available at our fingertips online. Various streaming services, platforms, and websites have allowed us access to music from around the world and across history. I still remember spending a day loading up an early MP3 player with songs from LimeWire, and then slightly more recent days using YouTube for piracy of less mainstream music that wasn’t offered anywhere else yet. Few people have reason to rely on such methods anymore with how convenient it is to access any kind of music nowadays. Having earbuds in and a playlist on is a good way to avoid any unwanted social interactions and focus on one’s own thoughts, and we have many startups to thank for the gift of solitude.
The precursor to streaming’s rise to stardom began just before the turn of the century with a company called Napster, founded in 1999. Napster was a pirate’s den filled with a treasure trove of songs, all uploaded by users on a peer-to-peer file-sharing software. Suddenly, you could access songs anyone else using it had provided the MP3 file for. It was an extremely popular service as it circumvented the exorbitant costs of purchasing songs and gave access to obscure, niche music. Naturally, those who would get the money from such purchases were a tad irate about the piracy. Lawsuits from major record labels and several artists brought it down in 2001, but Napster had left a lasting imprint on the music landscape, and the winds of change were blowing. Several years later, the revenues from the music industry had fallen significantly; physical CDs weren’t selling as well, piracy was rampant, and the major record labels of the world had no clue how to fix things. The space was ripe for a major disruption.
In 2008, long after the ashes of Napster had cooled, 8tracks and Spotify saw their respective launches (though Spotify’s initial launch was only in Europe). Spotify is an on-demand music streaming service while 8tracks is about human playlist curation for users to enjoy music for any mood, drawing from both its own licensed music library and user file uploads. Both held immense promise and were ready to capitalize on market conditions, but Spotify has IPO’d while 8tracks has gone the way of Napster (though it has recently relaunched with Backbeat acquiring its assets and putting the service back up) as the music industry evolved further.
Scale: Spotify
Spotify’s success was the result of several key factors, chief among these the focus on product and growth. From the beginning, the founders had an intense focus on delivering an amazing user experience and product. Founder Daniel Ek has said:
We spent an insane amount of time focusing on latency when no one cared because we were hell bent on making it feel like you had all the world’s music on your hard drive. Obsessing over small details can sometimes make all the difference. That’s what I believe is the biggest misunderstanding about the minimum viable product concept. That is the V in the MVP.
They wanted Spotify to be an instant, high-quality listening experience that avoided the legal challenges of Napster. They also benefited from extensive beta testing in Sweden and a limited launch in Europe that allowed them to refine their product extensively before entering the US and other markets. This type of quality extended to its innovations as well; one of Spotify’s most well-received features, the Discover Weekly recommendations playlist, was developed after the acquisition of The Echo Nest. The acquisition of the “music intelligence” company has helped develop Spotify’s lauded recommendation algorithms. Additionally, expansion into podcasts to increase the variety of content available has made Spotify a platform to serve needs beyond music for users and pushed the product even further.
Spotify also maintained their freemium model despite pushback and constant criticism from artists and labels. Perhaps counterintuitively, they fleshed out and added premium features to the free tier of Spotify, such as mobile listening at the end of 2013. Decisions like this have led to massive user growth, and Spotify's focus on product and experience has generated incredible conversion rates (though not the 40% often cited) to the paid subscription service. While the company is not yet consistently profitable, it has had a successful IPO and remains the streaming juggernaut in the global market.
Despite all these things going for it, Spotify heavily relied on the dismal state of music industry revenues to rise to the top (and bringing music streaming along with it). Sales of CDs and MP3 files were extremely low, and so major record labels were willing to try new methods of making money. It would be difficult to cannibalize sales that had fallen so significantly in the golden age of music piracy, so why not? They got a hefty stake of Spotify’s equity initially to license their music and have taken in the bulk of Spotify’s revenues as royalties and fees, which is a significant part of why Spotify struggles with profitability. It remains to be seen how Spotify proceeds to increase its profit margin, but the horizon continues to look bright.
Fail: 8tracks
8tracks had great traction and was profitable once upon a time, even turning down an acquisition offer from Google in 2013. By the end of 2019, 8tracks was shutting down. At a basic level, 8tracks failed because it could not generate the revenue needed to cover the costs of royalties it had to pay out. This is a reductive take, as a myriad of factors, from competition to the basic business model, led to this outcome.
The issues regarding 8tracks’ mounting costs and business model were tightly tied together. 8tracks had an advantage while it remained smaller as it qualified to pay royalties as a percentage of revenue as a “Small Webcaster.” As the company grew in size, it eventually had to pay per-play rather than a percentage after 2013, significantly increasing costs as it scaled. Revenue did not follow suit, as advertising could not pay the bills, and subscriptions to the premium service did not rise to the levels needed. 8tracks’ business model advantage disappeared at scale, and it wasn’t prepared to raise revenue growth to match. This was further compounded by problems with changing user behaviors and competition.
8tracks was among the first social music platforms, allowing users to create mixes of at least 8 tracks from their personal library or the company’s, tag these mixes with different emotions and descriptors, share them with others, and follow other users and their mixes to stay up to date. Those are nearly all features of Spotify now, aren’t they? Exactly. A severe blow to 8tracks came when Spotify released its free service to mobile users at the end of 2013, with the beginning of 8tracks decline in users and streaming hours beginning after that release. 8tracks was no longer very differentiated even though its free service was available for mobile first, and Spotify had a lot of features going for it, like its great algorithmic recommendations, that 8tracks didn’t. All the things that made Spotify so great were pulling users away from 8tracks, making it difficult to grow revenue. Combined with the change to per-play royalties, 8tracks was in trouble.
In terms of product-market fit, 8tracks was tailored to a type of user behavior that was disappearing: downloading actual music files. Spotify was forward-looking from the start, focused solely on streaming, while 8tracks allowed users to upload their own tracks to playlists. This may have had some benefit in the early days, but music downloads have dropped off significantly in recent years in the US. As a result, this feature was no longer useful to many users. Spotify thus had a significant lead in streaming music it had licensed for the platform. Additionally, as algorithmic curation got better, the human element of playlist curation in 8tracks no longer had a significant edge over Spotify’s recommendations of music. Over time, user behaviors became more aligned with what Spotify was built for, and 8tracks simply became an inferior alternative to many. With Spotify outcompeting 8tracks in its value proposition and larger set of features as well as increasing costs without corresponding revenue gains, 8tracks had to shut down. Luckily for fans, BackBeat acquired 8tracks’ assets and has put the service back online with some limitations.
Lessons Learned
The most important lesson comes from the fact that 8tracks was a good business with traction earlier on. The acquisition interest from Google didn’t come out of nowhere; 8tracks was serving its users very well and growing. However, 8tracks and Spotify were both taking advantage of an industry and user behaviors in flux. 8tracks was optimized for user behavior that was prominent earlier and at the time, while Spotify was forward-looking towards streaming’s dominance and invested heavily in core technology features. This paid off longer-term as it maintained dominance over the market as 8tracks fell into obsolescence when it couldn’t compete. Product-market fit can’t be decided just when a business is started, but must be assessed over time. As the market changed, 8tracks did not. That’s not to say a company should pivot with every single new trend, but consumer behavior shifted enough to make 8tracks no longer a good option, and the company didn’t respond to this. Businesses need to remain dynamic and pivot when necessary or address the longer-term behaviors and needs from the start (as Spotify did). Addressing the long term from the start is riskier if predictions are incorrect, but gives a sizeable advantage if the dominos fall as expected.
Another important lesson focuses on 8tracks’ business model. It took advantage of the “Small Webcaster” designation to keep costs down initially, but this wouldn’t scale. Costs would rise significantly in the per-play royalty model, but there was no ramp-up of revenues to combat this. It was known from the start that growth would lead to a skyrocket in costs, but there wasn’t a plan to make revenues reach this level. “Do things that don’t scale” is pretty good advice for founders, but there needs to be a transition plan to something that does scale in the event that the change will make your business unviable.
Regardless of how things ended up, Spotify and 8tracks both played a role in changing how we access music today. I hate having to download MP3 files and use up my storage, and easy access to streaming just about anything has steered me away from my days of piracy. It will be interesting to see how streaming addresses the good Internet access needed to stream music in international markets, as actual downloads to devices remain prominent in other areas of the world.
More Reads and Info
Thanks for reading! Let me know in the comments if there are any music startups you think I should keep an eye on. If you found this interesting, consider sharing it with friends and subscribing if you haven’t already!
Cheers,
Amil