This is why Spotify’s Losses doesn’t Matter. (atleast now)

How does spotify make money

Spotify earns revenue through its premium subscribers (~90% of total revenue) and ad revenue from freemium users (~10% of total revenue). The company has experienced revenue increasing at a compound annual growth rate of +44.40% from 2013-2019 and has been bolstering its cash balance to maintain its dominant market position with continued investment. During the same period revenue grew by +29% from EU€ 5.259B to EU€ 6.764B, highlighting the performance of Spotify’s subscriber funnel incentivizing users to become premium users by offering a best-in-class music streaming platform.

There,s bad news though. Spotify’s losses continue to surge at an alarming rate.

Since the creation of the company in 2006, Spotify has reported negative profits for the shareholders. Much of this, as Spotify claims are mainly due to the high costs they pay to record labels for the licenses of music. In the second quarter of 2020 alone, the net loss attributable to Spotify was 356 million euros, or 1.91 euros per share, compared with 76 million or 42 euro cents a year earlier.

There’s no doubt that Spotify’s super optimized subscriber funnel provides an advertisement laden freemium service that converts listeners to premium accounts. That too, at a rate of ~45.76%. Spotify earns the majority of its revenue from premium subscribers, which has a direct correlation to the total number of monthly active users. From Q4 2018-Q4 2019 alone, Spotify’s Monthly active users (MAUs) grew by +30.92% from 207 million – 271 million while premium subscribers grew +29.17% from 96 million – 124 million. As we reach the third quarter of 2020, Spotify has close to 300 Million Monthly listeners.

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It’s  not just Spotify. Growth in mature music markets has been slowing.

From 2018-2019, the Global Music Market revenue grew by a mere +9.7%, driven by Latin America, which had the largest year-on-year growth, and Asia which is rapidly becoming a significant consumer. Spotify is already available in 79 countries and is well-positioned to benefit from the economic tailwinds appearing globally within these markets.

From 2018-2019 Latin America contributed 20% of Spotify’s MAUs, an increase of 34% from the previous year, while the Rest of the World (excluding Europe and North America which have 40% and 30% MAUs respectively) made up 10%.

Spotify,s freemium Model

Spotify follows a freemium business model, and its main revenue stream comes from subscriptions to its premium account. Interestingly, during its launch, it was possible to use the free features, however, the free account was available just through a personal invitation only, so that the company could manage the growth of its service.

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Users can choose to use the application for free, however in that case several limitations and inconveniences are present. Free users cannot scroll through or skip the ads, can listen to music just in a shuffle mode, do not have the option of listening to music offline, and have a limit of 5 skips of songs.

Spotify’s Premium Model

Due to increased competition from Apple Music and Amazon, Spotify has been forced to become more aggressive with their offers to sway users away from the competition. Spotify’s strategy includes adding a Premium Family plan for US$ 14.99/month which allows up to 6 premium accounts, single-user premium accounts cost US$ 9.99/month, and student premium accounts are US$ 4.99/month, all premium options offer one month free.

To bolster its premium subscribers, Spotify has partnered with several companies including Spark and AT&T to be included in a bundle. As a result of these package deals, Spotify has seen a reduction in average revenue per user from USD$ 6.29 in 2017 to US$ 5.57 in 2019.

It has to be noted that the benefits of family and student plans often outweigh the short-term loss to average revenues per user. As for Spotify, Lifetime revenue per user should increase as family plans have low cancellation rates and students will be reluctant to change providers once they graduate.

In some of the countries, such as Sweden, Finland, the Netherlands, UK, France, Norway, etc. users can buy and download Spotify tracks for approximately 1 euro from their partner 7digital.

Spotify’s advertising model

There are seven main types of ads available on Spotify: audio-, display-, billboard- ads, homepage takeovers, branded playlists, lightbox, and advertiser pages. Ads run for a maximum of 30 seconds and are streamed in-between the songs (Spotify, 2014). Spotify has to pay off royalties to the copyright holders for the streaming music. Approximately 70% of total revenues are paid out as royalties.

Despite all of this, the future remains bright for Spotify.

How did Spotify start?

Spotify is a music streaming application that provides access to music content from different record labels, such as Sony, Universal, Warner Music Group, etc. Spotify was developed in 2006, in Stockholm, Sweden, and launched at the end of 2008. The company was founded by Daniel Ek and Martin Lorentzon. At the moment, Spotify has two headquarters: Spotify Ltd which operates as the parent company is headquartered in London, and Spotify AB which is in charge of research and development is headquartered in Stockholm. The application gives the opportunity to browse and search the music by artist, album, genre, playlist, etc.

But will Spotify be Profitable?

The Answer is Yes. Spotify has been developing its machine learning algorithms to offer a unique music streaming service available. The company prides itself on personalization and careful curation of playlists that predict what each user wants to listen to, expanding individuals’ music library with new songs and artists they would never have found otherwise. This feature is not only beneficial to users, but also to artists who give themselves a greater chance of being discovered amongst the crowd of artists vying for clicks.

A new era of Personalization

Personalization represents Spotify’s biggest differential to its competitors. When users log in daily they discover their ‘Daily Mix,’ playlists that group together several artists they frequently listen to with new artists they may like based on genre.

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Users also receive “Uniquely Yours” offers playlists “On Repeat – Songs you can’t get enough of right now” and “Repeat Rewind – Past songs that you couldn’t get enough of.” Users appreciate this; it’s useful without being invasive and contributes to reductions in electing to use another music streaming service.

A world-class subscription Funnel

Spotify has a world-class subscription Funnel.The primary source of revenue for Spotify’s business model is premium subscribers who currently make up 90% of revenue. The ability to convert free users to premium is a task that Spotify is performing better than its peers. In Q4 2019, premium subscribers grew YoY by +30.92%.

Spotify converts users tremendously well achieving a 45.76% conversion rate in Q4 2019, compared to other models that offer a free service, Dropbox has a 4% conversion rate while Google Drive has a 0.5% conversion rate.

Here are the main attributes to Spotify,s well-developed funnel.

  1. Reducing sign-up time with Facebook integration making it simple to create an account; o Machine learning playlist curation explicitly tailored to the user with a high degree of accuracy. Free account users are not in control of the music you’re able to listen to. Even if you create playlists, they’re only available on shuffle with a limited number of skips. You can only shuffle and skip so many times before you decide enough is enough; it is time to go premium!
  2. Spotify understands the benefit of music to enhance moods and situations. Spotify offers descriptive ‘mood’ categories that range from chill to partying and even perfect songs for road trips, finding the perfect soundtrack to make special moments better is a unique selling point offered by Spotify.
  3. When you create playlists, the user is essentially ‘investing’ in Spotify. This investment is more important than a monetary investment, spending time carefully designing playlists for yourself that is not transferrable to any other platform locks users down not wanting to lose their memories.
  4. Going premium allows you to download songs for offline listening, Spotify offers a 30-day free trial to let new users try this feature. By the end of the thirty days, users see the immense value they’ve created for themselves and do not want to lose all of their work. A lot of free-trial sites are easy to maneuver around by merely creating a new email, to do this with Spotify would take hours already invested in finding music all over again.
  5. Offering third-party integration with companies including Nike, Bose, Facebook, and even Apple. By enabling usage through a range of devices, Spotify enhances its brand by making its service as available as possible in the competitive marketplace.
  6. A free user journey is carefully designed by Spotify to both subtly and obviously promote the benefit of going premium with calls-to-action (CTA). Several features free users may want to access are discovered to be blocked engraining the necessity of going premium.

Podcasts offer a path to profitability.

The market for podcasts is rapidly expanding. Until recently, podcasts grouped into genres ready for listeners to find easily have been scarce. A 2019 PwC report projects that revenues in the podcast industry will top US$ 1 billion in 2021.

Spotify has been employing an aggressive strategy to own a significant portion of the market in podcasts with acquisitions of Gimlet Media & Anchor (US$ 340M), Parcast (US$ 55M) and the number one sports entertainment podcast company, Bill Simmons’ The Ringer (US$ 200M). Spotify’s music algorithms and platform are easily transferrable to podcasts, developing a model to enable listeners to discover and listen to podcasts that have a lucrative appeal.

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This model is working, Spotify are currently the podcast leader in over 20 markets globally. Podcast listeners are more engaged, retain, and convert to premium at a higher rate, meaning developing this segment of their user base is crucial to long-term profitability goals. By diversifying to podcasts, Spotify is becoming the number one audio company for not only music but streaming audio as a whole.

Spotify is taking a long-term view, dedicated to capital expenditure to maintain the uniqueness of the service and proactively seizing new opportunities to make it difficult for the competition to keep up. The current business model has limitations. Licensing deals with music companies are expensive and erode their profitability; podcasts represent an opportunity to own the sector by acquiring production companies and developing a vertically integrated model that will help drive profitability.

The Competition

Spotify operates in a competitive market, however, manages to hold its leadership position. Some of the competitors are Pandora, Tidal, iHeart Radio, Deezer, SoundCloud, and Apple Music. Pandora is an application very similar to Spotify, which features extensive online radio stations.

Similar to Spotify, Pandora operates under a “freemium” business model. Compared to most other music streaming applications, users can purchase the premium version of the Pandora application for $4.99. Its music library consists of approximately 1 million songs. Another competitor – iHeart Radio focuses on offering online radio streaming, but also allows to stream music based on a search. iHeart Radio is available solely for free, however, users have limitations of 15 skips per day, and 6 skips per radio during an hour.

The Criticism

There is a lot of criticism related to Spotify, mainly because Spotify fails to compensate the artists fairly for using their discography, which motivated some of the artists to opt-out of Spotify. A lot of critics point out that Spotify’s “free” aspect is unsustainable and that the company should do something about its business model. In 2011, Projekt Records label stated that Spotify is a service that does not respect and reward artists’ efforts accordingly, adding that their label would never be a part of this concept.

Also, the introduction of Spotify forced sales in some regions to decrease dramatically, which affect even more artists’ incomes. In 2014, Vulfpeck – an American funk band, funded a concert tour using Spotify royalties received for their album Sleepify, which was a fully silent album. The band promoted their album by encouraging the users to stream the album while they were sleeping, to receive higher royalty payments from Spotify!

In about a month, the album was pulled off Spotify, however, the band already managed to raise $20,000 in royalties.

There is also a positive side to the increased usage of Spotify, and namely “Spotify’s impact on piracy”. In 2013, as a reply to the criticisms against the exploitation of artists, Spotify stated that people pirate way less, once they have a free and legal alternative. This could be proven by real-life examples, as music piracy decreased considerably in the following countries: Sweden, Denmark, USA, Norway, the Netherlands, and the UK. As an example, the numbers related to music piracy in Norway were presented, and in 2008 the country had about 1.2 billion pirated songs, whereas in 2012 it decreased to about 210 million songs.

Spotify will never stop growing

Spotify has been making global headlines since launching in 2008 when they disrupted the music industry in a way nobody saw coming. Spotify has taken a long-term approach to take advantage of the reappearing economic tailwinds in the audio industry, with the continued development of their service it is not surprising that the company has experienced sustained growth in their user base.

Boasting a 45.76% conversion rate, Spotify is positioned to be the number one name in accessing audio online for years to come. The reality remains that Spotify occupies valuable real estate on people’s phones and that accordingly, we believe Spotify is an acquisition target and believe management understands this.

Let the Music Play.

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