The Spotify Play Read online

  “If you’re going to help me kill iTunes, we can keep talking,” Daniel said, according to one person who was close to the Myspace leadership at the time.

  “Otherwise, I’m not interested.”

  Wind of Change

  In 2010, Spotify’s burn rate was becoming a cause for concern. The company now had nearly 200 employees and around five million users, but no profits in sight. In June, the company moved out of its head office on Humlegårdsgatan and into a bigger space on Birger Jarlsgatan 6, next to Riche, a well-known, upscale bistro where bankers would rub elbows with entrepreneurs and creatives.

  Spotify also had offices in London and New York, where a small team had recently moved into a massive brick building on 8th Avenue in Chelsea. The New York team was led by Ken Parks, Spotify’s Chief Content Officer.

  Spotify’s costs kept swelling and the company was, once again, in need of funding. And, despite there having been no US launch, its valuation needed to increase substantially. It was the only way to ensure that the newly issued shares would not overly dilute the company’s investors and founders, threatening their continued control over the company.

  By the spring, Spotify’s funding had become such an urgent problem that Martin Lorentzon had to put the company’s new CFO to work earlier than expected.

  “I’d like a valuation of a billion dollars. That’s a nice, round figure,” he told Peter Sterky, who wasn’t due to start as finance chief until later in the year.

  By Swedish standards, the number was staggering. It would be another three years before the expression “unicorn” was coined to describe companies with billion-dollar valuations. At this point, Facebook and Twitter were among the few tech startups that had reached that level.

  Peter Sterky was used to Martin’s boundless ambition. They had worked together at Tradedoubler, which Peter had joined as one of the first hires. He knew that many investors would balk at the Spotify chairman’s aggressive asking price.

  But the new CFO found that there was one influential investor willing to pay that high a price: a Russian backed by Alisher Usmanov, an oligarch with ties to the Kremlin and the Chinese tech giant Tencent.

  And if that didn’t pan out, the Spotify founders had other options.

  Man in Black

  One cloudy day in October 2010, dozens of students and hordes of journalists squeezed into a packed lecture hall at the KTH Royal Institute of Technology. Daniel Ek was about to take the stage, but right now, the cameras were pointed at a six-foot-five man pacing back and forth in front of the podium.

  The man in the white collared shirt with the rolled-up sleeves was Microsoft’s energetic CEO, Steve Ballmer, whom Bill Gates had personally selected as his successor twelve years earlier.

  “The cloud drives advances that drive the cloud,” Microsoft’s CEO roared in a well-rehearsed routine about the software giant’s cloud services.

  Then he looked across the sea faces and welcomed a special guest.

  “Danyelek,” he exclaimed, compressing all the syllables into one loud burst of sound.

  The audience exploded in applause for the man who had employed countless KTH engineers and built one of Europe’s hottest startups. The Spotify CEO looked tanned and in good shape, dressed in a black shirt and suit jacket. Steve Ballmer shook Daniel’s hand and gave him a double back pat before yielding the stage.

  As the applause carried on, Daniel let an anxious gaze drift over the room. For an instant it looked as if he were going to start clapping, too, as if to honor Steve Ballmer, but instead, he brushed his hands against each other. Perhaps he didn’t want to appear to be clapping for himself. Finally, the auditorium settled down.

  “It’s great to be here, back in Sweden, which is always nice. I don’t get the chance to be back that often,” he said, in English, assuming the stance of a returning rock star. “As Steve said, I’m Daniel Ek, the CEO and founder of Spotify.”

  He used the opportunity to introduce a new partnership between Spotify and Microsoft, explaining how the service would be integrated into the Windows Phone. News of the collaboration would soon make headlines in a dozen Swedish media outlets.

  After he was done, Daniel stepped to the side and received four more slaps on the back from the towering Microsoft CEO.

  “I’ve heard a lot about Daniel through the years. It’s the first time we’ve met personally,” Steve Ballmer said. “We have a lot to talk about between us.”

  The exact contents of their conversation would remain a secret. But several people familiar with the discussions would recall that Microsoft was willing to invest in Spotify, or possibly buy the company outright. On one occasion, Daniel is said to have been offered a billion dollars for his company, the very valuation his CFO was trying to fetch in the capital markets.

  Daniel traveled to Microsoft’s head office in Redmond, outside Seattle, to meet Steve Ballmer again, several people would recall. Even Bill Gates, the Microsoft founder whom Daniel looked up to as a child, is said to have shown an interest. The idea was that Microsoft would integrate Spotify in its portable media player, Zune, whose own music software had failed to catch on.

  At the time, Microsoft was known for its deep pockets and willingness to make bold bets. A few years earlier, Ballmer had managed to talk his way into investing in Facebook. But the software behemoth was hardly seen as cutting edge when it came to building new consumer applications or products.

  Microsoft had missed the search-engine revolution, which had become Google’s domain, and Ballmer completely misjudged the potential of the iPhone when it launched in 2007.

  Microsoft would later purchase Skype, another Swedish innovation, and for years be criticized for stifling the company’s development.

  Daniel Ek took Steve Ballmer seriously, but he was never truly out to sell his company to Microsoft. Besides, he didn’t want Spotify to become just another play in a game of catch-up with Apple.

  It’s Not Right but It’s Okay

  Despite negotiating with tech giants, Daniel Ek’s core focus remained to stay independent, keep growing with the aid of venture capital, and launch in the US as soon as he could.

  His best bet was now Yuri Milner and his firm DST Global, with whom Spotify’s CFO, Peter Sterky, was negotiating. The Russian billionaire was best known as the founder of the internet company Mail.ru, which had recently gone public on the stock market in London.

  Since the financial crisis, DST, which stood for Digital Sky Technologies, had been making waves in Silicon Valley. In 2009, it famously spent $200 million buying 2 percent of Facebook’s shares, an investment that valued the company at $10 billion. Mark Zuckerberg had not been able to find any other investors willing to purchase shares at that price.

  “We have started to actively expand abroad,” Yuri Milner said of DST’s future plans in connection with the Facebook deal.

  A former physicist, Yuri Milner’s investment strategy was both simple and profound. He saw large swaths of the internet as underdeveloped territory and believed that the companies that dominated their specific verticals—be it e-commerce, social networking, or home rental—would emerge victorious.

  The scale of these companies, he reasoned, would guarantee them considerably more revenue than their competitors, and they would eventually become extremely profitable. Milner, therefore, did not fear fast burn rates and high valuations.

  He had built internet companies himself, but as an investor he operated in the background, seldom claiming a board seat. It was with this attitude that he, by the end of 2010, was willing to invest $50 million in Spotify, tripling its valuation in the process.

  For Spotify, the DST money was necessary but controversial. One of the fund’s largest shareholders was the oligarch Alisher Usmanov, who would often praise the Russian president, Vladimir Putin. Another major shareholder was Tencent, an internet conglomerate dependent on the approval of the Chinese government.

  Spotify’s board re
alized that taking Russian money might cause problems. The directors would ask each other who the “ultimate backer” behind DST might be, well aware of the likely ties to the Russian government.

  Martin Lorentzon, who had always stood for freedom and open markets, found Putin’s authoritarian regime deplorable. Yet his ultimate goal was to make sure that Spotify had the cash it needed to break into the US market. Besides, Yuri Milner was an established, clever investor who was sure to prove himself useful. Toward the end of 2010, Spotify therefore signed a preliminary agreement with DST. The VC firms Accel and Kleiner Perkins, both based in Silicon Valley, were brought onboard as well.

  The valuation was high, but it came with strings attached. One condition was that Spotify’s board guarantee that discussions of an IPO be initiated by 2014 at the latest.

  The investors also placed three specific demands on the CEO: Daniel Ek needed to renew the music licenses in Europe; grow by partnering with Facebook; and secure the necessary music licenses for a US launch. The final point would become one of his most difficult challenges to date.

  “Schmuck Insurance”

  THROUGHOUT 2010, DANIEL EK AND his team would shuttle between the head offices of the three biggest labels in Midtown Manhattan. They were all based just south of Central Park.

  His goal was to sign with Universal and Sony, and then force the third-largest and most stubborn label, Warner, to fall in line. EMI, the smallest of the four, was basically a shoo-in, but the others were hard to convince.

  Alles neu

  Thomas Hesse, a worldly German with wavy, salt-and-pepper hair, oversaw Sony Music’s digital division. He and Daniel would have lunch at the Sony Club, a private dining room on the thirty-fifth floor of the Sony Building on Madison Avenue. Daniel would tell him about his years as a teenage entrepreneur in Rågsved and expound on how music could be shared in social networks like Facebook, as Hesse would recall.

  For the major labels, sales were still plummeting. Digital distribution had grown to almost 30 percent of global revenue, but that wasn’t enough to compensate for the decline in physical sales. Hesse, who was also responsible for Sony’s sales and distribution in the US, watched as CD revenues fell every month. Soon, music sales in the US would be exactly half of what they were in the golden year of 1999.

  “We can return the industry to growth,” Daniel would say during their encounters.

  Hesse felt sympathetic toward the Swede. In Europe, Spotify’s model was clearly working. Beyond that, he was impressed that Ek had the backing of Sean Parker, whom Hesse would also meet with on occasion.

  The Napster co-founder claimed that Spotify was needed to counterbalance Apple’s dominance over the music industry. Gradually, Hesse began to feel that it would be reasonable to let Spotify into the US.

  But he needed to be certain. In the balance was Sony Music’s CD business and its long-standing, fruitful relationship with Apple. Hesse knew Steve Jobs personally. He had negotiated the iTunes deal with the Apple CEO in 2003, before the merger between Sony and BMG. Now, Steve Jobs was expressing skepticism about Spotify.

  “I don’t understand why you would want to give your music away for free,” Jobs told Hesse, the German would recall.

  The words weighed heavily on the label executive’s shoulders. After all, iTunes stood for the lion’s share of Sony’s digital sales in the US. And criticism of Spotify’s free tier was not without merit. At this point, the vast majority of the company’s users were still on the ad-funded side.

  Daniel made a decent argument, showing how Spotify was converting free users to paying users, particularly in Sweden. But the equation was complicated, even to a former McKinsey management consultant like Hesse. It was far from a given that what worked over fast broadband connections in Sweden would be a success in the US. He wondered how Spotify’s free tier might impact Sony Music’s long-term revenue per customer, and its CD sales as a whole.

  Usually, Hesse would let the numbers do the talking, but this one was tricky. Perhaps it would come down to the concessions Spotify were willing to make.

  Fame

  “What do you do about the iPod monopoly? That’s the interesting question,” Sean Parker said, riled up by his new favorite subject.

  It was October 2010, and Daniel Ek’s most outspoken board member was taking part in a panel discussion in New Orleans, sporting a beige vest, striped tie, and gray silk scarf.

  The movie The Social Network had just premiered, raising Sean’s public profile. He was famous for Justin Timberlake’s portrayal of him as the suave mentor to Mark Zuckerberg. But on stage, Sean was more interested in talking about Apple than about the movie. He stated that the iPod now had an 85 percent market share and that Apple’s closed ecosystem was shutting out every streaming provider in the US.

  “They can’t move content on the iPod,” he said.

  A few days after the debate, The Daily Beast senior correspondent Peter Lauria published a commentary describing a “war” between Sean Parker and Steve Jobs ahead of Spotify’s US launch.

  “With Spotify, I want to finish what I started with Napster,” Sean is quoted saying in the article, which also states that the only man who can stop him is the CEO of Apple.

  The piece would echo many of Sean’s own arguments. It praised iTunes for its “elegant design” but lambasted the service for selling music that could “only be played on PCs or devices manufactured by Apple.”

  According to the article, the music industry had made a “devil’s bargain” with Steve Jobs, only to turn around and stifle alternative services by demanding upfront payments so large that their business models would be doomed. The list of startups to “flame out or fail to gain traction” was long, the article stated, listing Lala.com, Qtrax, Spiral Frog, Imeem, iLike, Project Playlist, Grooveshark, Rhapsody, and Napster as examples.

  Lauria argued that Spotify could break the cycle, with seven million users in Europe—a figure that now included around half a million paying subscribers. But its launch in the United States had been blocked twice because of delays in signing deals with the major record labels, Lauria wrote, before delivering a final zinger: “A major cause of the delays has been Jobs himself, who is known for frequent calls to industry executives arguing that Spotify will cause them even more business pain.”

  To the reader, it was unclear where exactly the information about Jobs’s behavior had come from.

  Killing in the Name

  Behind the scenes, the previous month had been a dramatic one for Spotify. In September 2010, Warner Music threatened to pull its entire catalogue if Spotify didn’t kill its free service, according to one source involved in the process.

  The threat is said to have been delivered by Warner CEO Edgar Bronfman Jr., an imposing business magnate in his mid-fifties, who had become something of a nemesis for Spotify’s negotiating team. Bronfman made the statement in a conference room at Warner Music’s headquarters by Rockefeller Center, with Daniel Ek and his lead negotiator, Ken Parks, in attendance. Bronfman was backed up by his head of digital strategy, Michael Nash, along with several other lieutenants.

  Visibly agitated, Bronfman repeated that he would not renew the European licenses if the free tier wasn’t scrapped, or at least severely limited. Daniel hid his emotions during the meeting but is said to have been taken aback by the display.

  “He hated the idea of asking permission from anyone, for anything,” as one source would describe Daniel.

  In an interview, Bronfman would deny ever asking Spotify to scrap its free tier, but he did admit to being one of the free service’s staunchest critics. His goal, he said, was to put a time limit on the free service instead of letting listeners use Spotify for free indefinitely.

  “It’s unreasonable for us to continue to subsidize a free tier forever, and we’re not going to do it,” Edgar Bronfman Jr. recalled telling Daniel.

  To the Spotify team, that demand was tantamount to killing its business
model, reducing their product to yet another subscription service with a free trial period. The whole point of the free tier was that it had no time limit. That’s what made Spotify better than piracy.

  It had only been two years since Spotify launched as a commercial service. While amounting to tens of millions of dollars a year, its payouts to the industry were still modest, especially compared to Apple’s. It wasn’t unthinkable that one of the major labels would suddenly object on a matter of principle. Yet the Spotify executives regrouped after the meeting and quickly regained their composure.

  An outer time limit on the free service was unthinkable not just to Daniel, but to his whole negotiating team. They felt that such a fundamental revamp would be tantamount to killing the company. The question was if Bronfman really had a strong enough hand, or if he was bluffing.

  Spotify’s two-year renewals in Europe had already been cleared with Sony and Universal. If Warner pulled out, they would risk looking like the only label unwilling to bet on a promising digital service whose payouts to the industry were growing. Besides, Warner’s owners were rumored to be negotiating a sale of the entire company, a process during which turbulence would be unwelcome. Sure, Bronfman hated Spotify’s free service with a passion—all the record labels did—but if he was truly ready to pull the plug, why did he seem so flustered about it? It seemed clear to the Spotify team that Warner’s chief executive was bluffing.

  What followed was a month-long game of poker. Daniel met with Edgar Bronfman in London, while Ken Parks worked his magic in New York. Petra Hansson, Niklas Ivarsson, and Spotify’s new CFO, Peter Sterky, were also involved.

  Finally, they worked out a deal that let Bronfman back down without losing face. The terms lowered Spotify’s costs of running the free tier, and let the company keep more of its revenues from paid subscribers. Warner’s catalogue would continue to be available on Spotify in Europe. The license was renewed for another two years.