Will Spotify Pull a Netflix, Screw Over Consumers and Kill its IPO Dreams?

There has been a lot of love for Spotify this year. But you know what they say: if you love something, you have to set it free. I'm starting to wonder if this applies to entertainment services. I look at what happened to Netflix NFLX and cringe. This was the company that took down Blockbuster! It was the company that made being lazy fun; why get off your butt and go to a video rental store when you could simply wait three days for a DVD to arrive in the mail? Netflix was cheaper, more efficient, and quickly became the dominant force in video rentals. In the financial world, Netflix had become a sure thing. It was the company that couldn't lose. But once greed and stupidity entered the picture, consumers told CEO Reed Hastings where to stick it, and investors scattered. While some argue that the firm is twitching but not yet dead, the reality is that Netflix may never fully recover from its mistakes. Unfortunately for music lovers who appreciate the low-cost, all-you-can-eat digital streaming buffet known as Spotify, a Netflix-inspired strategy may be in the company's future. It's not that Spotify's execs are eager to imitate what is arguably the most hilarious stock decline of the year. Rather, Spotify is eager to take over. And when it does – when it believes it has achieved an appropriate level of success – the company won't respond by showing us a bit of gratitude. Spotify will respond by attempting to take advantage of a situation it thinks it controls. That's what Netflix did. Hastings actually believed that consumers would accept a price hike because he told us that the company was “offering our lowest prices ever.” He thought this not merely as a cocky CEO but as a corporate exec that believed that his company's product was too important for people to walk away from. He was wrong. Hastings may have also been using the logic that if Comcast CMCSA can do it, why can't Netflix? Comcast, however, has never raised its rates proudly and loudly; it does so on the sly with as little PR as possible. Then, one day when consumers get their bills, they discover what Comcast has done, pick up the phone, and complain. Those consumers often get a fee or two removed, but only after spending an hour or more on the phone. Comcast knows that there are inevitably some consumers who won't complain. It also knows that some consumers will walk away from the service, but it doesn't care because, unlike Netflix, Comcast has a true monopoly in some markets. To be clear, Comcast isn't impervious. But its protective barriers are much thicker than those of Netflix. Consequently, Netflix is the one that has lost more than 50% of its stock value – not Comcast. Netflix is the one who will struggle to turn a profit in 2012 – not Comcast. You might be wondering what this has to do with Spotify. Let's review a few facts:

• Just as Netflix offers unlimited streaming of movies on a multitude of devices, Spotify offers unlimited streaming of music on Android and iOS.
• Netflix became an investor favorite after experiencing rapid subscriber growth. Spotify's paid subscriber rate is also very impressive; in less than two months the service reached two million paid subscribers.
• After its first success story, Spotify responded not by rewarding consumers but by forcing new users to sign in with Facebook. Consumers did not respond favorably.

“That's minor!” you say. “Lots of companies are turning to Facebook sign-ins!” Of course they are. But the fact that Spotify ignored the complaints is a sign that the company thinks it is too big and too important to suffer. That might be true. But what will Spotify think when it has five million subscribers? What about when it reaches 10 million subscribers? That day is coming. While there are millions of people who love to pirate music, there are millions more who would happily pay $10 per month to have a cloud-based music library they can take wherever they go. Spotify is simple and quick. It has almost every artist people care about. And you don't need a hard drive to store any of the music, which makes it the perfect service for the iPhone. All in all, Spotify is a can't-lose company. But wait…so was Netflix. Netflix had everything people wanted. Everything in the eyes of its subscribers, at least; I, however, was not persuaded by its lackluster streaming video lineup. But I don't matter. Netflix's millions of subscribers matter. The same can be said for Spotify. Unfortunately, it is unlikely that these subscribers matter to Spotify. All Spotify cares about is its newfound cash cow, the millions (billion!?) of dollars it will make in the future, and the potential to one day go public. ACTION ITEMS: Bullish: Those who believe that Netflix will recover and that Spotify will learn from Netflix's mistakes (instead of imitating them) may want to consider the following trades:

1. Well, for starters, how about Netflix? The stock is a potential steal at less than $80. If the company gets its act together, investors who buy now could be delighted by the results.
2. If services like Netflix and Spotify prevail, data will continue to become a more valuable commodity, increasing the importance of and the reliance on Comcast, AT&T T, Verizon VZ, Sprint S, and other broadband and mobile Internet providers.

Bearish: If you don't believe that Netflix will prevail, and if you think that Spotify is doomed to make the same (or worse) mistakes, you may want to consider this alternate position:

1. Apple AAPL is already the digital leader in music sales. iCloud will enhance that leadership. Over the next couple of years, Apple could also become a prominent player in streaming entertainment.

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