Spotify’s business model has been straightforward. Take music from the creators, let users have frictionless access to the content and generate revenue by either ads or premium subscriptions. The company delivers music in an appealing and user-friendly manner to the point that listeners agree to pay a premium for access every month. On the other side, Spotify pays royalties back to artists or labels every time a song is consumed. As the user base grows, Spotify generates revenue from advertisers which want to convey their marketing messages to an engaged audience.
Yesterday, the company announced their latest quarterly earnings and I found the report interesting. First, the number of subscribers. Both Premium Subscribers and Ad-supported MAUs increased.
There seems to be a seasonality in the subscriber acquisition. Subscriber acquisition seems to pick up more in Q2 and Q4 than in Q1 and Q3. The increase in premium subscribers in 2018 slows down, compared to the pace in 2017
Meanwhile, the Average Revenue Per User (ARPU) has been on decline.
With regard to revenue, it seems that the increase in subscriber count outweighs the decline in ARPU as revenue is on the rise
Both Premium and Ad-Supported revenues seem to be affected by seasonality. Ad-Supported revenue growth fluctuates more than Premium revenue growth. In 2018, revenue from ads grew faster than subscription-based revenue.
Gross Margin for both revenue streams went up with Ad-Supported gross margin growing at a faster clip in the last four quarters
In Q4 2018, Spotify became profitable for the first time. Free cash flow also reached the all-time high
Based on the numbers, it seems that everything is going in the right direction for Spotify. User base is expanding, revenue is going up, free cash flow is growing and the company becomes profitable for the first time. Even though ARPU has been declining, it’s understandable as many users were acquired on a discount. However, it’s necessary to maintain the network effect and grow the user base to attract advertisers.
As Spotify doesn’t own the majority of their content and it still has to pay a small royalty for content enjoyed by free users, Spotify faces two significant risks. First, it relies too much on the labels that can take their content elsewhere. Second, paying for content while generating zero revenue from free users might hurt the company’s margin. Hence, it needs original content. Already featuring original series with Amy Schumer and Guy Raz, the company now seems to switch its focus on another source of originals: podcasts.
During the earning call, Spotify announced the acquisitions of Gimlet Media and Anchor. The former is a podcast production company and the latter is a DIY tool that allows publishers to produce and broadcast original podcasts. In the call, CEO of Spotify mentioned that over time 20% of content on Spotify will be non-music and that several potential acquisitions which the company is considering in 2019 will all be related to podcasts.
The acquisitions and focus on podcasts make sense in terms of original content and monetization. Podcasts are gaining in popularity as a form of engaging content. Media outlets have podcasts. Companies have podcasts. Celebrities have podcasts. As an audio platform, Spotify certainly cannot afford to sit this one out. Having podcasts, in addition to music, makes Spotify more appealing. During the earning call, Daniel Elk, CEO of Spotify, hailed podcasts’ positive impact on the engagement of users on the platform. He indicated that podcasts could lure users who wouldn’t have signed up for Spotify. Plus, it’s definitely easier to have access to different content forms on one app than multiple apps. And what’s the better and faster way to be able to produce content than to acquire a proven production firm?
There is also the monetization piece. One revolutionary aspect of Spotify is to help obscure and less-known artists to get their creativity out to the world and get paid. The more their songs are listened through Spotify, especially the Discovery, the more dollars the artists receive. Spotify is in a position to do the same for podcast creators. According to a blog post by Anchor, nearly all podcast advertising concentrates in the top 1% of podcasts. The other 99% have to hope that their episodes are downloaded to the tunes of thousands to be able to attract advertisers. If Spotify can help podcasts generate revenue for their work in the same way as it has done for artists, Spotify can become the Spotify for podcasts and stand a higher chance of securing exclusives and originals in the future.
All in all, I think Spotify is going in the right direction. Securing key capabilities through acquisitions in a key area such as podcasts is crucial to future growth.