The Partnership with Zefr Isn’t the Real Story
News broke today both on The Verge and TechCrunch that SoundCloud is looking to step up its drive towards revenue by signing a deal with Zefr. For those unfamiliar with Zefr, they’re the same partner who works with YouTube to track content and brands. Part of what makes Zefr so helpful to YouTube is that they are able to track media files as well as specific brands like Nike or Coke.
But that’s actually not the story here. The real story is buried deep in the TechCrunch article. Helpful though Zefr may be to and for SoundCloud, they can’t help with the larger problem that SC has created for itself. No, that has to do with the licensing quagmire that SC is increasingly encircling itself with. It goes like this.
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SoundCloud blew up as an independent-driven engine way before major label music was even a thought. It was the place for the singer/songwriter in his basement, or the newly formed doom metal band, to post their recordings and attempt fan acquisition. It was beloved by independents the world over because it was a free, easy way for them to distribute their material and make a name for themselves. That’s where SC started, but it’s not where they now find themselves.
Legal Problems That Were Never Solved
Of course SoundCloud’s rich environment of remixes and covers led to a legal quagmire that saw them losing material as complaints were brought against them from the original sources for copyright infringement. While Zefr does help specifically with this, it’s effectiely irrelevant, as independents will begin to migrate away from SC amidst a new major label focus anyway. I can imagine it was a major headache for SC as remixes and covers are particularly popular in certain genres of music. Thus began the drive away from remixes and towards “more mature” content. For those who care, this is basically code for major label content.
And thus, instead of solving the more challenging problem (the legalities associated with remixes and covers) SC rather decided to chase the major label route to better compete with services like Spotify and Rdio. (Again, as noted above, partnering with Zefr does help, but will essentially become irrelevant in the bigger picture). In doing this, they basically told their grassroots fanbase (you know, the people who gave them love and support (and traffic) before anyone else) that they didn’t need them anymore.
Rather than spend the few million dollars of their funding figuring out the legalities they were faced with (which probably couldn’t have amounted to more than ~5M), they made the choice to look towards the major label paradigm for music content. Frankly, the partnership with a company like Zefr which helps in the copyright arena may not be too little, but it is too late. Let’s examine how this worked out for them.
Buying Into a Broken Business Model
Back in November of 2014, SoundCloud signed a licensing deal with Warner Music Group (one of The Big Three) to bring onto SC’s platform the music which Warner controlled through itself and its subsidiary labels. My assumption was (is) that SC is looking towards the other two big labels (Universal and Sony) to sign similar deals, and step up to the same level as a service like Spotify. Here’s why that was a bad business decision:
1. A Bad Business Model
SoundCloud already had a dedicated userbase of independents who used it, without demanding licensing money upfront. To put this in perspective, the deal which SC signed with Warner most likely cost them ~45-50M for a 1-year contract. This means that they paid somewhere in the neighborhood of 50M to license music content from Warner for a year. This in turn means that they will most likely need to renegotiate sometime later this year; those licensing contracts are not static agreements. It also does not account for the royalties which they will need to pay on the backend. So, to recap, multi-million dollar expense on the front-end (which will need to be renegotiated eventually) and multi-million dollar expense on the backend.
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2. You Can Only Have One Priority #1
Business 101: You can only have one priority #1 in the morning. SC’s priority #1 used to be its independent artists/users. Now it’s not, and it can’t be. How do I know? Because Warner now holds the power in the relationship. In providing SC with major label content, they have eventually shifted the paradigm of SC’s focus from independents to Warner’s major label artists. This means that, eventually, independents will begin to understand that they are no longer the priority, and will migrate elsewhere. That’s not a guess, that’s fact. Look at the migration patterns:
The reality is that independent artists are loyal only insofar as they are the priority customer base. Why would they be loyal beyond that? They don’t have major label deals and massive radio play on FM radio to fall back on. And they’re not signed to a powerhouse like Warner or Universal. Which means they don’t need to settle for anything; they’re free to do whatever the hell they want.
3. You Should Never Depend on Anyone Else
SoundCloud has basically tied itself to the major label paradigm, which could cost it. It’s never a good business decision to tie your company’s future to the company structure and revenue of someone else. You should never be dependent on another company’s good fortune for your own upward trajectory. But in signing a deal with Warner, that’s effectively what SoundCloud did.
It goes like this: As the independents begin to see that SC has shifted its focus from their desires and needs to those of Warner’s major label artists, they will begin to look for other options. SoundCloud can’t really do anything about that because they’re now tied to Warner (and searching for deals with Universal and Sony). That means that as the independents begin to trickle out, they can’t market any sort of real campaign to woo them back; Warner wouldn’t let that happen. And if I was Warner, I wouldn’t either. Why would I? I want all the focus on my artists, not some independent artist who might be taking ears away from my stable of talent.
Once the independents start to trickle out to somewhere else, SoundCloud is essentially locked in to the major label paradigm. It will effectively need to renegotiate with Warner (and the others) because their major label content will become its lifeblood. If Warner decides not to renew their contract with SC (which they could do, since they have Spotify, Rdio, Deezer, etc. to fall back on), one could see the music-life sucked out of SC in a heartbeat. With no major label content, SC could become a shell of its former self, begging the independents to come back (which takes years, if it ever happens at all, just look at Purevolume and MySpace).
4. The Big Kicker
Now here’s the big kicker for SoundCloud: they have not yet been able to secure deals with Universal or Sony—only Warner. This means that they are effectively straddling two completely different music industries moving in opposite directions: the major label machine and the independent arena. Precarious though this may be, it’s not a secret. And the independents know it. Artists I’ve spoken to are already looking for more alternatives because they recognize that SC will soon become the same sort un-level playing-field as Spotify or Rdio, where they essentially stand no chance against the Taylor Swift’s and One Direction’s of the world.
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If I’m SoundCloud, I’m driving hard at those Universal and Sony deals because I can’t backup. If I try to, that will send a message to Warner that I’m not really invested in their business model, and since Warner essentially now holds the keys to my content, that could be a major mistake. But if I continue to pursue those deals with the other major labels (which I can pretty much guarantee is what SC will do) I will lose that attractive quality that made me popular among independents to begin with.
Except these aren’t really the thoughts going around in SoundCloud’s head; they already made their decision when they inked that deal with Warner last November.
SoundCloud’s Independent-Focused Days Are Over
The options for SoundCloud as I see them now are really only to double-down on the major label paradigm and business model. They need to out-Spotify Spotify; and that’s going to be very difficult. Rather than sitting pretty as king of the hill with the ever-growing base of independents, they made the decision to move towards the major label content arena.
Does this mean that they are destined for failure? Of course not; they may in fact find a way to play the major label game better than even Spotify or Rdio. That’s entirely a possibility. Really only time will tell if that is what becomes of SC’s new business trajectory.
But it does mean that SoundCloud will play less and less of a significant role in the independent sphere, possibly moving mostly out of it in the next few years. It makes no economic sense for them to stay, now that they are pursuing the major label route. They may host independent material, but the independents will never be their bread and butter again—those days are coming to an end.
Independents aren’t stupid; they go where the best opportunities are for them. They don’t stick around too long where they’re not wanted or cared for. I wouldn’t, not if I was free to do what I wanted. Which begs the question: where will they go next?