Why SoundCloud Could Be Worth More Than Spotify

SoundCloud recently announced it struck a long-awaited licensing deal with Universal Music, whose hit roster includes Kanye West, Adele and Taylor Swift. This latest deal provides SoundCloud with 50 percent coverage among the “Big Four” — Warner Brothers also has a deal with SoundCloud; Sony BMG and Sony/ATV are still holding out.

The Universal deal, in addition to SoundCloud’s latest round of funding, is a strong indicator that the Berlin-based music-content platform is a serious competitive threat to Spotify.

The YouTube of audio

While SoundCloud usually gets much less media buzz than Spotify, you wouldn’t know it based on their numbers. First, while both SoundCloud and Spotify have large user bases, Spotify has only 75 million active users compared to SoundCloud’s more than 175 million monthly listeners.

For a booster many record companies and artists buy Soundcloud plays for some extra early visibility and the algorithm can often pick up demand for a potential larger audience before it reaches more music fans to give it an extra boost.

They also purchase SoundCloud reposts to enhance the boosting, so why does SoundCloud have twice as many registered users? Spotify is more of a paid service for streaming music. The total number of users matters less to Spotify than how many of them are willing to pay. In contrast, SoundCloud is less focused on monetization (for now) and can afford to provide free content in the name of growth.

Second, SoundCloud has much better unit economics than Spotify. Why? SoundCloud’s producers, the users uploading content, are there to build a following and are not as focused on monetization. The agreement with Universal simply wards off any potential lawsuits over copyright infringement. In contrast, Spotify pays out 80 percent of its revenue to content license holders.

As this stat suggests, the Spotify and SoundCloud business models are radically different.

SoundCloud has a platform business model where its content is created by its network of users, not acquired through licensing deals. For SoundCloud, the more audio producers that join the network, the more listeners will want to join. This increase in users, in turn, incentivizes more creatives to post their music or podcasts on SoundCloud, and the network effects continue to build from there.

“Once you find an artist you like on SoundCloud, you can … get lost in a rabbit hole of music awesomeness.”

In contrast, Spotify is primarily a reseller of music inventory owned by record labels and publishers. It’s simply a distributor for the latest releases, sort of like a Walmart for music streaming. Most of the songs on Spotify you could find on Apple Music, Pandora or another streaming service. As a result, Spotify lacks the network effects that SoundCloud enjoys.

Consider the difference between YouTube and Netflix. The distinction is the same here, but with music rather than video content. Given Netflix’s relative success, you might think this is a favorable comparison for Spotify, but it isn’t. YouTube is valued at $85 billion, or two times the value of Netflix. And you only need to understand one number to know why: Netflix will spend more on content in 2016 than any of CBS, Viacom, Time Warner or Fox. Like Spotify, the vast majority of what Netflix earns goes to license owners.

Could SoundCloud be the YouTube of music and Spotify its Netflix?

If you dig deeper, this analogy makes a lot of sense. Just like Netflix, creatives don’t build their own following on Spotify. Instead, they get famous on SoundCloud, just as the best users do on YouTube.

Fetty Wap started as a SoundCloud sensation before dominating the billboard charts. DJ titans Diplo and Skrillex each built their presence and notoriety by remixing already famous songs on SoundCloud and using their following as a jumping off point to produce original music. This also helps explain why SoundCloud has a much better relationship with its creatives than Spotify seems to.

Additionally, finding new songs and podcasts is an important part of the listening experience. But on Spotify, most of the music is content you can find elsewhere. The majority of Spotify’s content comes from major record labels and is freely available on other streaming services, like Apple Music or Pandora. But if you want to find the latest hot tracks outside of the mainstream, you’ll only find them on SoundCloud.

SoundCloud is increasingly becoming a place where users can discover unique content, such as music news and new artists. Users can follow each other, which allows you to find music based on another user’s musical taste and preferences. The platform provides a simple like-and-repost feature, which exposes troves and troves of activity that enables discovery by other users. Once you find an artist you like on SoundCloud, you can then see which songs that artist likes and get lost in a rabbit hole of music awesomeness.

This kind of musical serendipity is very specific to SoundCloud because of the platform’s unique content. This unique content gives SoundCloud network effects that improve everyday as more and more new artists (who aren’t ready for Spotify) and content producers upload their content. While the inventory on Spotify is finite and expensive, SoundCloud has the potential for YouTube-like hyper growth.

As long as the platform continues to attract talented new artists and content producers, its future is very bright. Spotify, on the other hand, may struggle to stay profitable. Like Netflix before it, Spotify faces a continual fight with rights owners over its streaming revenue. At the same time, other popular streaming services will provide constant competition. If I had to bet on one of the two companies today, I’d pick the “YouTube of Audio.”