Spotify does taxes

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This post is cross-posted from my joint newsletter with Ranjan Roy, The Margins. Please check it out, and consider subscribing.


Is my profit margin your tax? If you have to pay to me to merely exist in the marketplace, it can feel the same. Yet, taxes are unique, because generally you have to pay them to not do business, but also live freely, not in a jail cell. You just cannot opt out of paying them. If you are a talented (or a crafty) individual, and you can try going to Dubai or Singapore to minimize some of your personal taxes. And if you are a firm, there are many options available on the menu. But taxes as a whole remain as a fact of life for most people, and most companies.

Yet, taxes and profit margins are not the same. If a certain firm has a monopoly on some raw material you need, and you have to pay that firm exorbitant prices, it can feel a bit unfair. But that’s not the same thing as having a single supplier for your business. Lots of firms operate with having a single supplier, buyer, or a single way to reach their customers. It’s generally not a pleasant place to be, but it happens. What else can you do?

I guess you could complain as loudly a possible.

Spotify made waves recently by filing a complaint with the European Commission about Apple’s unfair practices, arguing that the Apple Tax it has to pay is stifling competition and is a big problem for the industry as a whole. The Swedish firm even built a custom website called Time To Play Fair (dot com, what a great domain name!). The ominous phrase “Apple Tax”, appears multiple times throughout the website, the videos and in the CEO Daniel Ek’s remarks, reminding everyone what is at stake.

Timing is certainly convenient. With the backlash against big tech firms in full force both in the EU and US, Spotify is fanning the flames. And Spotify counting the former Microsoft legal counsel, Horacia Gutierrez, in its ranks, you can see this is not just a press bamboozle for the company; it’s an existential issue. If you are going to take on a firm that has the cash reserves of a small European country’s GDP on an international battleground, you probably want someone whose firm was almost divided in half by US Department of Justice on your side.

Apple responded with its own fiery press release a couple days later, and did not pull its punches. It stops barely short of calling Spotify a bad faith actor in the music business but also doesn’t address the streaming giant’s legitimate points about how Apple is seemingly extending its dominant position to other markets. The main thrust of Apple’s argument seems to be that Spotify is in a dire position where it can’t afford to be in the Apple ecosystem, and now wants a free ride. Is that so?

Spotify’s gripes with Apple are numerous, and some of them definitely feel less grounded in reality than others. For me, the most interesting part is Spotify’s argument that Apple is stifling competition by not allowing other payment options other than Apple’s payment system for handling subscriptions. This Apple system doesn’t come cheap. Apple takes a 30% of all sales for the first year, and reduces to 15% the second year. The list of rules don’t stop there. The requirements are so strict, Spotify argues, not only they are not allowed to link people to a simple web page where Spotify can start billing people directly, they aren’t even allowed tell people such an option exists.

Let’s go back to the competition issue. It’s hard to disentangle whether Apple is a monopolist, and it defines on what the relevant market is. Market definition is a notoriously thorny question, and not one I can answer. Legal scholars such as Sally Hubbard argue as such. But we can limit our discussion to a single question: Can Spotify exist as a business without being in the Apple ecosystem?

The short answer seems to be no. We’ll ignore desktop clients for now, and focus on mobile. In the US, Apple has around 50% of smartphone market share. The number is around 25% for EU. It would be tough to make the case that Spotify could drop those users. Even Apple has an app for Apple Music in the Google Play store. Sure, it’s a remnant of its Beats acquisition, but it’s still there, and updated. That has to count for something.

In its response to Spotify, Apple also argues that most of Spotify’s users are ad-supported. That is true. But the main driver of Spotify’s revenues is the premium tier. Revenues from premium subscribers were around €1,320 million in the last quarter, dwarfing the €175 million revenues from the ad-supported tier. The same tier also has lower margins than the premium, especially in less mature markets for Spotify.

Moreover, there’s also the deeper question of why Spotify needs to have as many users as possible. As Spotify sits in between end-users and record companies, its future is dependent on the whim of its suppliers, as Ben Thompson of Stratechery smartly explains (Subscription required). And in order to have leverage over them, it needs to command as much demand as possible. Even the smallest loss of market share hurts Spotify’s negotiation position, which is already quite complicated. In fact, Apple seems to agree when it says “Spotify wouldn’t be the business they are today without the App Store ecosystem[.]”.

This mad quest to earn market share is obviously less of a problem for Apple. While Spotify has to make costly arrangements with mobile operators, and other smartphone manufacturers like Samsung to have its app pre-installed, or run expensive campaigns with Google, Apple’s Music app comes pre-installed on every iPhone. Apple even runs campaigns over push notifications, which is not allowed for other companies.

And there’s the more fundamental question of user experience. In order to comply with Apple’s rules, firms cannot even mention other payment options in their apps. Imagine trying to become a Netflix customer, on your iPad. There’s simply no way. You have to know, or somehow find out, that you can sign up online. Surely, new users having to make a phone call is not the experience Apple wants on its platform.

Apple’s argument is that Apple payment infrastructure is a more user-friendly, secure, and allows for an integrated experience. That might be true. For example, an in-app browser where users can subscribe also comes with its security risks, where a nefarious app might log the credit card information on the side. And Apple might very well argue that users being able to manage their Apple-mediated subscriptions in one place is a better user experience.

Yet, for any non-digital goods, Apple still allows third-party payment options. As bits and atoms (sorry!) merge more and more, the line will be harder to draw. Uber might be a physical service, but what about an Uber gift card? There’ll many more of these lines to draw in the future.

As the owner of its platform, the decision is for Apple to make, but the tingling sense of capriciousness between digital and physical undermines Apple’s “every firm should play by the same rules” rhetoric. People know that makers of big enough apps, like yours truly, have special levers available to them. In its press release, Apple is quick to point out Spotify leaves out Apple’s cut lowers from 30% to 15% after a year. But the same Apple fails to mention how Netflix was able to negotiate a special, instant 15% rate. Even that wasn’t enough to keep Netflix on its platform anyway.

Reading Apple’s response to Spotify, it’s hard at first to not sympathize with the company. I’ve invested, financially and personally, into the Apple ecosystem for more than 15 years and have convinced many people to do the same. I was even a paid customer of Apple’s overly expensive online services like MobileMe, and greatly benefited from them. Services, for better or worse, are Apple’s future.

Therein lies the rub. As Apple leans more heavily into the services revenue, the Cupertino firm will have more of these kinds of decisions. What works for the short term for the health and growth of a platform can be different than what needs to be done for the long-term sustainability, as many platforms are painfully figuring out now. It can also be hard for a company like Apple, where decisions are made in multi-year-long hardware cycles, to adjust itself to changing conditions fast.

The company has already shown signs of maturity, for example, when it changed course about its free trials on Apple Music, following Taylor Swift’s protest. If Apple wants to entice more businesses to its platforms and grow the pie, it should offer more than just access to its billions of users. Building an ecosystem requires long term thinking, and judging the interests of many different stakeholders, including the platform itself.

The best advice for Apple can still be derived from its core principles: do the right thing for the user. If Apple believes that its payment infrastructure is the best in business, it should let it flourish and compete in the marketplace. If makers of physical goods can be trusted with digital payments, the same rights can be extended to digital subscribers too. If Apple finds itself unable charge its double-digit markups, or developers flock to other options, that would only force Apple to either lower its prices or make its services even better to encourage app makers to switch to it. That would be true competition, making things better and cheaper for everyone.