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I have a sort of love/hate relationship with Digital Music News. I’m really pleased somebody is trying to do it, but they keep posting stuff that makes me angry.

They do these little bullet-point roundups of what’s going on, often linking to original sources. That’s really useful.

They also do analysis, and it’s often really stupid.

Two themes keep cropping up:

1) Somebody in a suit says something stupid, and they treat it like it’s important

2) Some third-hand speck of data surfaces, and they construct around it an absurdly speculative narrative

The two surface together quite prominently in this story from last year, in which Lyor Cohen is quoted saying that vinyl will outlast CDs at about the same time as the news came out that vinyl sales had gone up and CD sales had gone down.

Let me explain why this is daft.

It makes me want to get a t-shirt that says “There’s no way of knowing. Why the hell are we even talking about this?”

That was a year ago. So what am I whining about now?

Well. Yesterday, they published a story entitled “I took one look at this graph and suddenly lost hope for streaming music” and it contains some even odder fun with statistics.

The graph in question looks like this:

 

(Original source here)

So Pandora and Spotify have got to the point where they’ve convinced customers to give them about a quarter of a billion dollars a year, but neither are profitable, and their losses have got bigger.

Now, if you had no idea how companies work, you might think this was because Pandora and Spotify were not able to work.

The relationship it’s easiest to see in this graph is that, particularly for Spotify, bigger sales means bigger losses. It’s like they can never win.

Except that’s not the important relationship, which is why people running companies don’t often look at graphs like this.

Companies are rarely profitable from the outset. A few are, and they fund their own growth while turning a profit for their shareholders. This is how my company works, because I didn’t have any expensive set-up costs, and my only marketing expense was some admittedly horrifyingly expensive business cards.

Generally, you need to spend some money to get the company to the point where it turns a profit. This is called “investment”. Digital Music News knows about investment: they keep publishing updates on how it’s up or down. They can count it, but they don’t seem to know what it’s for.

If you wanted to look at a graph that told you how you were doing in a company’s early phases of growth, you’d want to isolate the setup costs from the running costs to see if what you were doing was sustainable.

From the outside, that’s difficult, but if all you have is revenue and profit to go on, you can do something far more useful than looking at the graph above. You can look at the ratio between revenue and profit/loss. This is the profit margin and it will tell you if the company is heading towards profitability. You want it to be above zero.

Put like this, the situation seems to be getting better, rather than worse.

Of course, either of these companies might know exactly where they could shave off $20m-$50m in costs and make themselves profitable tomorrow, and they might be sensibly investing in further growth before they sit back and let the cash roll in. Alternatively, they might be as close to profitable as they’ll ever be.

We just don’t know, and there’s no point in talking about it.

Daft analysis like this isn’t just pointless, though. It’s misleading because it sells the lie that the answer will come if you stare at the runes for long enough.

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  1. niels #
    September 7, 2012

    good point(s), again.

  2. September 8, 2012

    “Why this is daft” is going in my top 10 graphs of all time. A list that I have just this minute invented.

  3. September 10, 2012

    As a scientist I am horrified by the extrapolation in the first graph above. Have these people ever heard of Data Analysis and what you can and cannot do with a set of data points? Good grief…

    • September 10, 2012

      Haha.

      I don’t think I’ve really done justice to the stupidity of it. My graph doesn’t show how volatile these variables have been in the past: they’ve never moved anywhere in a straight line for long.

      • September 10, 2012

        You are absolutely right, they couldn’t possibly move in a straight line from now to 2025. One should consider that in 13 years it’s likely that some new technology will be invented, or some new way of distributing content, or some new youngsters trend (hipsters going back to tapes anyone?), or changes in royalties legislation regarding a particular support etc.
        Should one these graphs present a linear trend over so many years then it would be the subject of a few academic papers and some PhD thesis because it would be one of those freak events that happens once in a thousand or more years.

  4. September 10, 2012

    One is a prime number. Two is a prime number. This, all numbers are prime.

    That said, the scale of your Pandora graph obfuscates local negative trends for the company. Volatility, as you say. Q2 FY2013 loss was 3x Q2 FY2012. Financial statements disclose Pandora negative cash flow from operations in the first six months of FY2013. Finally, Pandora incurring costs of sales (royalty payments) at roughly double the percentage of revenue presented in IPO prospectus.

    • September 13, 2012

      None of this is relevant to the point I make above, which is that these graphs do not contain anything like enough data to adequately assess the health of these companies or their prospects, good or bad.

Trackbacks & Pingbacks

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