Strategies for Spotify

Just recently we’ve taken a look at some strategies Beats could take to steal the throne from Spotify, and to a lesser extent, the other music streaming services (Rdio, Deezer, Rhapsody, etc). Since we don’t discriminate on music services here, we will be doing the same strategy recommendation piece for Spotify. Spotify will not just sit idle when the Beats redesign goes live, and it will presumably retaliate through its own strategies. I don’t know, of course, but I would speculate that Beats is one of the major topics that gets discussed during management meetings at Spotify HQ. If it isn’t, Spotify is doing themselves a huge disservice, by shutting their eyes from impending competitive pressures. 

Before we get into the strategies section, let’s take a brief glimpse at the data. Currently, Spotify is the largest on-demand streaming service, with 60M users, of which 15M are paying subscribers (20% pay-to-free ratio). By my calculations, Spotify has been growing users at a rate of 3.75% per month. This percentage was calculated by taking the user-growth numbers Spotify has provided every few months. It is impossible to say with certainty if this is a high or low rate of growth, since none of the competing music services provide enough data to compare them to each other. If you want to read the technical details of my calculations, this post from November is your destination. Otherwise, we can continue to the meat and potatoes of this analysis. 

Strategies for Spotify

#1 Partnerships with music social networks

In my strategies for Beats piece, one of the strategies I recommended was exclusives. Beats could pay labels $X amount in royalties in exchange for being the exclusive streaming provider for an artists newest album (I advised the period to be a month to lock users into Beats). Spotify doesn’t have billions in cash like Apple does, which is why the exclusives strategy is not feasible. Instead, Spotify should partner with music social networks, specifically The Hype Machine and SoundCloud. 

Spotify is great for major artists who are signed with music labels. In my experience, it’s very rare that I can’t find an artist I like on Spotify. Kendrick Lamar’s latest album, To Pimp A Butterfly, was ready to stream the day it was released. Barring few exceptions (I’m looking at you, Taylor Swift), popular artists always have their music available on Spotify. The same can’t be said about many indie artists and song remixes, which are often found on sites like Hypem and SoundCloud. Spotify should partner with these indie music social networks, and structure the deal in a mutually beneficial way. Spotify would gain many users who previously listened to indie music on Hypem/SoundCloud. In return, Spotify would pay Hypem/SoundCloud for the access to their data and music. To be fair, this deal would benefit Spotify much more than the indie social networks, but so goes the nature of business. Hypem is run lean, so it’s probably profitable. What it needs is more users, which Spotify can provide. SoundCloud, by all acounts, is losing money, despite have millions of registered users. Getting paid by Spotify could help them become profitable. Ideally, Spotify could purchase either Hypem or SoundCloud, but it is doubtful they have the cash for it.

These partnerships would also be a powerful competitive advantage to retaliate against the personalized playlists Beats offers. Unless Beats makes its own partnership with Hypem/SoundCloud (doubtful), Spotify would be the only streaming service to offer the type of indie music that’s only available on these music aggregators. 

#2 Audiobooks

The music streaming business is a loss-leader. It is an offering that adds value to existing customers in order to keep them attached to your ecosystem. That’s what Google is doing with Google Music, Microsoft with Xbox Music, and now Apple with Beats. I can’t say with certainty since the data is unavailable, but I have strong suspicions that the above companies are actually losing money on operating their music streaming offerings. We know as a fact that Spotify is posting net losses, and will probably continue to do so in the foreseeable future. The tech giants can afford to lose money on streaming in order to strengthen their ecosystem, but Spotify and the other streaming services can’t. Even if Spotify does manage to operate at extreme efficiencies of scale and achieve profitability (big if), that income won’t be enough for a company of that size, especially if Spotify has plans to go public. What then, could Spotify do to become profitable? 

Spotify has an incredible engineering culture, and the service experiences almost no downtime. Compared to competitors, Spotify streams songs the fastest: I’ve been using Spotify for the past two years and I have never experienced any stream-related problems. I can’t say the same for Beats/Rdio (I’ve not used the other streaming services). Spotify also has well designed apps, which are only getter better (early on, Spotify was not well designed, but lately I have been very impressed with the UX). These strengths can be used to enter a new market: audiobooks. 

Essentially, Spotify will be diversifying its income streams by entering into a new market for audiobooks. While we again encounter the problem of a lack of data, this time on audiobook profitability, the nature of the business implies positive profit margins (unlike music streaming, a book won’t be bought twice). Spotify won’t be starting from the ground-up here, as their infrastructure is already set up, so it is likely that they can enter the audiobook business at a lower cost than music streaming through economies of scale and leverage. 

In fact, there are already some audiobooks available on Spotify, but from what I found they mostly include public domain books (Pride and Prejudice, The Art of War, Romeo and Juliet). The Spotify app, however, is currently optimized for music listening rather than audiobooks, so listening to multi-hour audio streams is an obstreperous affair. Similar to how Facebook broke its main app into a web of focused applications (Facebook classic, messenger, groups, etc), Spotify should make a separate app specifically designed for audiobook listening. If that is seen as a big risk, I would advise to start with an app that provides only free, public domain books, since they’re already hosted on Spotify servers. If there is indeed demand for audiobooks, slowly add books from other publishers to eventually compete with Audible and iTunes. 

#3 Podcasts

Podcasts are another vertical Spotify could enter, especially if they partner with SoundCloud. SoundCloud, by the way, already hosts thousands of podcasts, and makes the process easy for both creators and listeners. Despite SoundCloud’s podcast features, there is still no comprehensive platform (monetization, hosting, dedicated apps, portal, listener data) for podcasts, despite many years of existence. What’s more in their favor is that podcast popularity is increasing, as internet connectivity and better apps make them simpler to find and consume. The good news for Spotify is that it doesn’t look like Apple has plans to host the podcasts - instead, iTunes is merely a portal to find them. 

Even if the SoundCloud partnership is not possible, Spotify already has the expertise to host and make them available to listeners. Not a podcast per-say, but spoken-word comedy shows are already available on Spotify. All it needs to add now is a dedicated app, a better way to find podcasts, and most importantly, the ability to host them. Podcast creators (especially indie ones) would be willing to pay for the service, and it would serve as another outlet to help creators find new listeners. 

Coda

Spotify should do its absolute best to become the go-to audio destination on desktop, mobile, and wearable devices. Competition in music streaming is already fierce and will only get more competitive when the rebranded Beats enters the market. Worse, the music streaming business is currently unprofitable. Huge companies can afford to subsidize their music offerings as an additional value-add for their ecosystem, but Spotify can’t. Spotify can try to turn the industry on its head and attempt to become profitable, but it will be swimming upstream against the Niagara Falls. That is why it should be leveraging its existing infrastructure and competitive strengths to enter the other audio markets, audiobooks and podcasts. The partnerships with SoundCloud and Hypem (especially SoundCloud) would not only boost the value of its music streaming service, but also help them enter the market for podcasts. Spotify already has data about its users. Now imagine if they could provide this data to podcast creators, which in turn can sell tailored ad spots to advertisers. Being a music streaming provider is not enough for Spotify to turn into a profitable business. Platforms make profitable businesses, and Spotify should try to become a comprehensive audio platform: music, audiobooks, and podcasts (The Spotify MAP). 

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If you have anything to add, or just want to share your meandering thoughts about what we covered, please comment below! I’m also active on Twitter, so don’t hesitate to reach me at @lsukernik.

Spotify's Temporary Growth Spurt

Spotify released their latest subscriber numbers yesterday, announcing they have 15 million paying subscribers (up from 12.5 million in November), and 60 million total users (up from 50 million). 

I have updated all of my Spotify models, and below is my latest chart showing user growth.

While month over month growth rates seem to have increased (temporarily), the new subscriber data is likely an outlier. By outlier, I mean these rates shouldn't be used to make stable projections of future Spotify growth. Let me explain why. 

In December, the company held a promotion that let users sign up for a three-month Spotify Premium subscription for $0.99, instead of paying $9.99 per month. Great deal, right?

Right. But how many of those users who signed up for this promotion will actually stay with the service after the three months are up? My guess is 15-25% (25% is the current paying-to-free user ratio, and 15% is the more realistic rate, since users who signed up for this promotion are less likely to keep the subscription active). 

In addition, December is the holiday month, so it's very likely Spotify gift cards and subscriptions were gifted by friends and family. This further inflated the latest Spotify figures. 

It's never a good sign when companies inflate their numbers to proclaim better than expected results, but you will be hard-pressed to find companies that abstain from this practice. Especially in the world of startups. Fortunately for us, Spotify's number-inflation was easy to spot (sorry, I had to). Unfortunately for Spotify, it was caught.

Some Spotify Charts

Sometimes it’s helpful to turn data into another medium. It is easy to get lost in the numbers, so I often find it helpful to view the information from a distance. Charts are great for that. I am still working on my Spotify analysis, but here are some preliminary findings. I will show the chart first, followed by my thoughts.

• As I have previously calculated, Spotify’s monthly growth is around 3.738%. We don’t have enough data to tell if this is a rapid rate, since no data is available from competitors. That’s why we can only compare Spotify with itself, at least for now. Paying subscribers are growing at nearly the same rate as active subscribers, which use the service for free. I would have predicted that free users would be growing much faster than paying subscribers, but the data seems to show this isn’t the case. Currently, roughly 25% of users pay for Spotify. This seems a little too good to be true, but I assume Spotify would like to convert even more users into paying subscribers. 

• Revenues and Cost of Revenues are an extremely basic measure of profitability. In fact, these two data points sum only to give us Gross Profit. That said, they are arguably the most important indicators of growth and scale. Revenue tells us growth, while Cost of Revenue implies scale. Spotify shifted from a negative Gross Profit in 2010 to a positive one in 2011 and on. In short, this means that Spotify is making more money than it costs to power the service (without taking into account R&D and SG&A). Many startups have higher Cost of Revenues than actual Revenues, implying that they are not operating at scale. Spotify is still not profitable since the company isn’t posting Net Profit’s, but it appears to be running efficiently, as far as most startups go. 

• 91% of Spotify’s revenue comes from subscriptions, while a measly 9% comes from advertising. This is a paltry amount, considering that 75% of users are free users. It makes you wonder how little Spotify pays out to artists for every play a free user makes. No wonder many musicians are hesitant to put their music on Spotify - it barely pays. 

I often like to gauge a company’s future success by a simple question. Would I invest in it? Currently, Spotify is unprofitable, but if they can spread their costs over an increasing amount of paying users, it’s very likely that Spotify can turn into a profitable business. 

How Fast Has Spotify Been Growing?

If you've been reading this blog lately, you will notice my interest with Spotify. It's a relatively young company, and not much data is available online about it. For the past week, I have been trying to figure out the growth rate of paying Spotify subscribers, which I have finally calculated. It has been difficult mainly because Spotify doesn't announce growth numbers every month. Fortunately, I found data online to have enough numbers to work with. Below is a table I have created listing the date and and paying subscribers that Spotify has publicly announced. I calculated the number of days and the growth percentage between the dates, and then multiplied them by 30 (number of days per month). This gives us the a very rough growth rate of paying subscribers per month, which we can use to predict future subscribers. 

As you can see, the growth rate per month (from now on just growth rate, since it's shorter to type) varies from a high of 18% in November 2011 to a low of 4% in November 2014. These numbers are deceiving, as they calculate the growth between two unequally distant periods, divided by the days between those periods. Some months may have had higher rates of growth due to well-placed advertisements, entering new markets, or just fortunate word of mouth. What these calculated growth rates did was give us a ballpark figure, since no other data was available online. So now I knew the approximate rate of growth, and now I needed to check if I was on the right track. I did just that. I had the data Spotify announced in March 2013, as well as the number of subscribers in May and November 2014. If my rate of growth from March 2013 was correct, I would be able to multiply the paying subscribers by the growth rate and come up with the actual data Spotify announced. 

The first growth rate I tried was the one from May 2014, or 4.69% per month. If this was the correct rate, I could calculate 10,000 paying subscribers for March 2014 and 12,500 in November 2014. Here is what the 4.69% growth rate got me.

10,400 users in March and a whopping 15,000 in November - Spotify wishes! This told me that my calculated 4.69% rate was too high, and I had to adjust it down. Next, I tried the most recent rate from November 2014, which was 4.08%. Again, here's the calculation.

9,695 users in March, and 13,350 in November. Again, I knew I was off. The rate per month was actually higher leading up to March, and much lower from March to November. My goal wasn't to calculate the growth for each month (that is impossible, since I don't have enough data to work with), but rather, it was to calculate the approximate growth rate per month between the periods of March 2013 and November 2014. Since 4.08% was too high, I knew I had to adjust it further. I kept adjusting the rate until I came up with 3.738%. That is the average growth rate that the Spotify paying subscriber count kept growing at every month. Again, it's worth reiterating that this is an approximate rate, and some months grew much faster than others. As you can see below, my calculations almost perfectly matched the data provided by Spotify for March and November 2014. For March, I got 10,030, when the actual number was 10,000 (Spotify likely rounded this number, so my calculation may be perfectly precise). And for November, my calculation was precisely right - 12,500 - just what Spotify announced. 

This rate of 3.738% is useful for many reasons. Foremost, it will allow me to predict subscriber counts in the future with a reasonable accuracy. With that, I can finally begin to put a value on Spotify as a whole. This analysis was mostly numerical. With the calculated data, I'll be able to dig into the real meat of the story, which is how Spotify can grow, strategies to do so, the operations underlying those strategies. 

How is Spotify Growing so Rapidly?

As I'm working on a deeper financial analysis of Spotify, I started pondering how Spotify plans to grow and differentiate itself from the other music streaming services. Based on their latest actions, it appears they are partnering with complementors (which are services that increase the value of Spotify), developing good cross-platform apps, and aggressively pricing and marketing their service.

Partnering with Complementors

There is very little platform lock-in with music streaming services. Anyone can sign up for Beats Music, use it for a few months, and then switch to Spotify. While the playlists you make on one service don't transfer to the one you switch to, it's not an issue for most users. People just want to stream particular artists and songs on demand, which all of the streaming services easily provide. Spotify is well aware of this issue, so its been smart to partner with complementors like Facebook and Uber (in addition to many more). For example, the partnership with Facebook allows you to log into your Spotify account and easily find what all of your Facebook friends are listening to. With this feature, you're able to find curated music choices from the people who matter the most in your life.

In addition to Facebook, Spotify also partnered with Uber last week, further increasing their supply of complementors. This latest partnership allows you to play all of your songs while in an Uber car. The goal here is to further increase the value-add of Spotify, as compared to their competitors.

Spotify also makes available a third-party API that allows application developers to tap into the Spotify music collection. Apps like Djay use this API to add extra features on top of the already existing Spotify service. The effect is to further lock-in users, by providing them with more value. This, of course, comes at a lower cost to Spotify, since they don't have to develop these third-party applications - they only have to build the API.

Cross-Platform Apps

This strategy needs very little explanation. Spotify wants to reach as many users as possible, so it builds applications on as many platforms as it can. It has apps on all of the major platforms (iOS, Android, Windows Phone, Mac OS X, Windows), including the web. If somebody wants to try it, Spotify made sure its service will be available anywhere.

Aggressive Pricing and Marketing

The price for music streaming services is an established $9.99 per month on all the major services. Spotify also offers family and student plans, however. The family plan is $10/month for the first family member, and is discounted to $5/month for additional members. This isn't a novel feature, but not all of the music services offer a family discount. Again, Spotify wants to appeal to as many users as possible.

There is also a student plan that goes for 50% off, or $4.99/month. The aim here is presumably to indoctrinate students, who will eventually graduate and switch to the full price plan. Students are also much more likely to download their music illegally, and having them pay discounted rates is much better than having them pay nothing. Lastly, Spotify must know how vital word of mouth is for younger audiences, which essentially provides free marketing.

It's no wonder why Spotify has been growing faster than their competition - they've been engaging in beneficial partnerships, providing access to all the major platforms, and pricing themselves aggressively. This doesn't mean that they will succeed in the long term, though, it just means they're currently doing well. Perhaps Taylor Swift was foolish to pull her music off Spotify after all?