The Daily: How Spotify has been able to flirt with profitability and how it plans to take on YouTube

On today’s podcast episode, we discuss what happened to Spotify’s subscriber growth after it raised prices, how it plans to take on YouTube, and what has led to the audio giant inching closer to profitability. Tune in to the discussion with Senior Director of Podcasts and host Marcus Johnson and Analyst Daniel Konstantinovic.

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Episode Transcript:

Marcus Johnson (00:00):

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Daniel Konstantinovic (00:29):

They are really pushing video on the platform right now, trying to get podcast creators to upload video recordings of shows. And the reason why there's this big video push, is because it's part of an anchor into the company's deeper push into advertising.

Marcus Johnson (00:50):

Hey, gang. It's Tuesday, November 19th. Daniel and listeners, welcome to the Behind the Numbers Daily: an EMARKETER podcast. I'm Marcus. Today I'm joined by one of our analysts, who writes for our marketing and advertising briefing. He is based in New York City. It's Daniel Konstantinovic.

Daniel Konstantinovic (01:07):

Hello. Happy to be here.

Marcus Johnson (01:08):

Hey, fella. Thanks for hanging out. Today's fact, do you know which animal has the strongest sense of smell?

Daniel Konstantinovic (01:17):

I want to go to a dog right away.

Marcus Johnson (01:20):

Yeah.

Daniel Konstantinovic (01:20):

Is that it?

Marcus Johnson (01:21):

No, it's not.

Daniel Konstantinovic (01:21):

I was hoping it would be something like-

Marcus Johnson (01:24):

A slug.

Daniel Konstantinovic (01:24):

Oh, okay.

Marcus Johnson (01:24):

A slug.

Daniel Konstantinovic (01:26):

Yeah, I don't know. Just something you wouldn't-

Marcus Johnson (01:28):

Unexpected, yeah. It's not but I would've gone to a dog as well, which is why I was nodding along. Elephants, often known for their great memories also have the strongest sense of smell. The African elephant in particular is considered to have the most advanced sense of smell, two and a half times better than dogs and five times stronger than a human. Cows actually have a stronger sense of smell than dogs, interestingly. In fact, the rat, the mouse and the horse all have more olfactory receptor genes, stronger sense of smell, than dogs. And Guinea pigs and rabbits have almost as many as dogs according to the University of Tokyo.

Daniel Konstantinovic (02:12):

Well, you know they say that smell is the sense most strongly associated with memories, that it produces the strongest recall. So maybe that's tied to elephants remembering everything somehow.

Marcus Johnson (02:27):

Yeah.

Daniel Konstantinovic (02:28):

I've smelled this before.

Marcus Johnson (02:29):

That is interesting. Can you imagine though the smell of freshly baked chocolate chip cookies? If your sense of smell was five times stronger than it is now.

Daniel Konstantinovic (02:39):

You'd be like, ugh, get it out.

Marcus Johnson (02:42):

No wonder Cookie Monster was a maniac. He probably just had a lot of olfactory receptor genes. That was his problem and you solved it.

Daniel Konstantinovic (02:50):

You can tell just by looking at that.

Marcus Johnson (02:53):

Anyway, today's real topic, how Spotify has been able to flirt with profitability.

(03:04):

All right, Danny, we're talking Spotify again. Let's check in on how they've been doing. How many people are using the service, how much money is it making, what are they up to with video? All that stuff. But let's start with the users. They now have 640 million monthly users, adding around 12 to 13 million in every quarter this year. We play slice of pie for the first question and you're going to create a pie chart for us as to the reasons, three max, why Spotify was able to grow subscribers. 11% in Q3, adding 12 million.

Daniel Konstantinovic (03:44):

Okay, so I broke this down into three sections.

Marcus Johnson (03:48):

Okay.

Daniel Konstantinovic (03:49):

This was a big year for music releases. There are a lot, and a big quarter for music releases as well. There were a lot of very popular albums from major artists that I think drew a lot of people to audio streaming services in general. A lot of albums that really penetrated the cultural zeitgeist. Like Brat this summer was a big one, great album. So give that a 20% share, like the fact that this was just a big cultural year for popular music probably plays a big role there. But a bigger factor is just that Spotify is such a hub for all-things audio. I mean the value of the service despite having two price increases in the last year or so, or a little over a year at this point, is still extremely good. And I think the fact that user growth, even though it was 12%, that is still pretty good for the quarter immediately after a price increase, or subscriber growth rather, excuse me.

Marcus Johnson (04:53):

Yeah, if you zoom out as well, 16%, they've increased its subscriber base. Spotify has over 16% over the last year and a half. And to your point, they've increased prices twice in that time. Spotify's standard plan now more expensive than Apple's and Amazon's, so it's pretty impressive.

Daniel Konstantinovic (05:11):

Yeah, I think it's just such a prominent and powerful brand that is almost like synonymous with contemporary music consumption, at least in the US and its other major markets.

Marcus Johnson (05:25):

Yeah.

Daniel Konstantinovic (05:25):

So the fact that it continues to see gains is not that surprising to me. I think that if someone is thinking of a music service, they kind of immediately go to Spotify more than they would go to a YouTube music or Apple Music or what have you. This is something that I feel like we point out every quarter, but still-

Marcus Johnson (05:25):

-It is.

Daniel Konstantinovic (05:45):

It does matter. Absolutely, yeah. And they have a big advantage as being one of the early players in the scene too. So I would give their convenience, the huge variety of content on offer from audiobooks to podcasts, I would give that a 60% of why it did so well this quarter, like the biggest of the pie. And then I would give 20% to growth in Europe and Latin America. It made significant gains this quarter in Latin America and in rest of world. These are sectors that the company has been pushing into pretty aggressively over the last year. Part of why it's been such an effort to grow there is because it's reaching a little bit of a point of saturation in the US, particularly with podcast listenership. We forecasted that some Latin American countries like Argentina were going to be the only countries with double-digit podcast listener growth this year. So the fact that they're making strides in these markets where there's a lot of room to grow, I think is a positive sign for them.

Marcus Johnson (06:49):

So as we mentioned, Danny, they have been able to grow subscribers even though they've increased prices twice over the last year and a half. However, recent growth does look more subdued than it has done in the past. Spotify added twice as many new subscribers last Q3 as it has done this Q3. And if you look at the additions last year, quarter on quarter on quarter on quarter it goes 26, 36, 23, 28. This year it's gone 13, 13, 12, and we'll see what happens in Q4. So it does seem like a noticeable step change there, but with price increases taking into consideration, maybe it's not too bad. The other thing is, Spotify may not be adding as many people at the same clip, but monthly churn rates are some of the lowest across the digital landscape, about 2% as of April according to Antenna. So once they get people into the ecosystem, basically no one is leaving.

Daniel Konstantinovic (07:41):

Yeah, it's a super sticky service and it's such a companion to any activity. I think that's part of how Spotify positions itself. It's something to listen to while driving, while working out, while doing errands, while working, etc. Like people I think who subscribe to the service just have it going a lot of the time. It's just kind of a constant presence.

Marcus Johnson (08:04):

Yeah, yeah. And because, to what you were saying before about their content library, because you can not just listen to music, you're listening to podcasts, you're listening to audiobooks, etc. The other thing is if you zoom right out, I mean we talked about them now reaching the 640 million user mark worldwide, monthly active users for Spotify, Sarah Fischer of Axios was pointing this out. I didn't really pay attention to it. Spotify has nearly two and a half times the number of subscribers that Netflix has worldwide, so it's a big number. Sometimes maybe we... Think about it in full context compared to some of the other large streaming services that we consider taking over the world, but it's two and a half times bigger than Netflix, which is no small achievement.

Daniel Konstantinovic (08:46):

Yeah, I think your point about subscription growth slowing compared to previous quarters is interesting because it's something that is not just happening to Spotify. I think that we're starting to see a ceiling on user growth for a lot of these big leading platforms and companies across sectors. I mean, Netflix is starting to see the end of a runway from its password sharing crackdown and they are going to stop reporting subscriber numbers in the following quarter. Meta this quarter also started to show signs that it could be hitting a ceiling for user growth, although that's a company that has billions of users. So it makes sense the growth has to stop somewhere because there are only so many people in the world.

Marcus Johnson (09:33):

Yeah.

Daniel Konstantinovic (09:34):

So I'm curious to see what investors think, like how stock markets react to the growth slowdowns and what these companies try and divert attention to, to account for slower growth, which is bound to happen eventually and maybe is one of the perils of putting a lot of stock, no pun intended, in the quarterly results.

Marcus Johnson (09:58):

Yeah. Well, let's talk about the stock for two seconds because if your users are starting to slow down, you need to make sure that you're making more and more money so you have higher average revenue per user, that's going to keep investors happy. And they appear to be, investors, very happy with Spotify's performance. The audio streaming giant stock, Danny, was up 14% in the days after it reported Q3 earnings. And if you zoom out, its stock price is up 155% year-to-date. That's double Netflix's year-to-date stock growth that's three times higher than Amazon's stock increase this year and four times higher than Alphabet's.

(10:36):

So investors seem to be pretty happy with Spotify, even though, as you pointed out, their user growth seems to be slowing down, Meta's, Netflix's, some other companies. And the part of the reason that the investors are still happy with the company, even though they're not adding as many subscribers as they have done in the past, is because Spotify made $4.2 billion in Q3. That's growth of 20% year-on-year. And so we'll play slice of pie again for this. What to you are the reasons, the pie chart of reasons, three max, why Spotify was able to grow revenue 20% in Q3?

Daniel Konstantinovic (11:09):

Okay, I did something, I don't know if cheeky is the right word-

Marcus Johnson (11:12):

-Probably.

Daniel Konstantinovic (11:13):

... Or maybe lazy is a better word.

Marcus Johnson (11:15):

Both.

Daniel Konstantinovic (11:15):

My share, my pie breakdown for revenues was exactly what their breakdown for revenues is. So I gave 88% of it to subscribers and 12% of it to advertising because subscribers make up the overwhelming majority of Spotify's revenues still. Advertising is ticking up and I think despite that small share, it's probably the most noteworthy stat to pay attention to here because like we said, subscription growth is starting to slow down a little bit and Spotify's putting a really heavy emphasis on advertising, they are really pushing video on the platform right now, trying to get podcast creators to upload video recordings of shows.

(12:00):

And the reason why there's this big video push is because it's part of an anchor into the company's deeper push into advertising. So something that happened in this past quarter was that Spotify launched a supply side platform for buying video ad space and it has a major ad industry partner in The Trade Desk, which runs one of the leading demand side or buy side platforms. So the idea here, I suppose is that video will become a meaningful part of Spotify's ad revenues, but also that advertisers are more accustomed to buying video ad inventory than audio ad inventory. And if Spotify can get new advertisers on board through video, something that's familiar to them, maybe those advertisers will be more likely to spend on audio elsewhere in the surface. So.

Marcus Johnson (12:51):

Yeah, video podcasts are doing really well on Spotify. Alex Heath, The Verge, was pointing out there are now 300,000 video podcasts, that's up from 250 in June. And also video consumption hours have grown faster than audio only consumption hours year-on-year according to the company. So video doing pretty well from them, but they're still working on video and that money they're going to get from video likely to trickle in later. I did note though that ad supported revenue, Danny, had slowed quite considerably. It's three times lower than it was in Q3 from a year ago. It's about 6% growth versus the 16 that it had last Q3, that 6% growth this year is much slower than the 21% growth from premium revenue as well. And that's in a vacuum. If you zoom out, it's not like the ad space hasn't had its struggles this year, but at the start of the year, Spotify grew 18% ad revenue in Q1, 13% in Q2 and then dropped to six in Q3.

Daniel Konstantinovic (13:48):

Yeah, that's a really interesting drop off.

Marcus Johnson (13:51):

I just thought it was interesting and something to note. There've been times where we've seen growth drop from... I mean, 2022, we saw it drop from Q2 to Q3 from 31 to 19. So we have seen drop-offs in the past, but something I think to keep an eye on. However, revenue growth, if you zoom right out, top line, premium plus the ad supported looks a lot healthier this year. That's now three consecutive quarters, Q1, Q2 and Q3 of this year with 20% growth each. That's compared to the 12% growth that they averaged in the first three quarters of last year. So overall Spotify, its revenue picture is very healthy.

Daniel Konstantinovic (14:28):

Yeah. And I think despite the ad revenue this quarter falling significantly from the previous two quarters this year, part of why you're seeing the stock go way up is because I think people are bullish of Spotify's advertising potential. Like we said, just get the overwhelming majority of revenues from subscriptions and there are a lot of levers that they can pull to increase ad revenues and average revenues per user.

Marcus Johnson (14:57):

Yeah. Another thing I wanted to point out in terms of the money they're making, gross margin is improving and Dan Gallagher of the Wall Street Journal was saying Spotify posted a gross margin of 31% in Q3 at nearly a four point above Wall Street's expectations. This matters because gross margin, as he points out, is particularly important for a music streamer that has had to pay forever over 70 cents for every dollar in revenue back to record labels. And so the fact that the gross margin is going up, it is impressive.

(15:24):

Spotify is on pace for its first full profitable year since it launched 18 years ago, in large part because they cut their employee numbers by nearly 30% from a peak of 10,000 at the end of 2022. But that's also I thought a very positive sign. So that's the money they're making, Danny, and the company has a lot of stuff in the works at the moment to try to continue to increase revenue and stickiness of the platform as well. They're working on AI playlists, they're trying to figure out what to do with audiobooks and continuing to invest in video initiatives. You've already talked a bit about video, but what else is Spotify doing in the video space to try to improve themselves there?

Daniel Konstantinovic (16:04):

The platform is going to start paying creators who get a lot of video engagement on the platform as a way to incentivize them to make even more and encourage that kind of consumption. So if you are a podcaster, there is a lot more reason to add that extra mode of consuming the show since you can get paid by the platform for doing it in the same way that someone on TikTok or YouTube or what have you can get paid by the platform.

Marcus Johnson (16:35):

Yeah. Let's end, Danny, with a grade for Spotify's Q3.

Daniel Konstantinovic (16:40):

I gave it a A minus. I'm actually going up from what I wrote down in my notes.

Marcus Johnson (16:45):

Oh.

Daniel Konstantinovic (16:46):

Yeah, because as we talk about it, I gave it a B plus initially, but I think I'll give it an A minus since it really is on track for a super strong year. They're saying that they're on track for a fully profitable 2024. It's just impressive that this company continues to grow and not really hit too many obvious pain points in the way that other big platforms like Netflix did when it posted its first subscriber loss, for example. Although perhaps something like that is coming in the future for Spotify, it's totally possible, but they continue to do really well with subscribers. I think they've really established a powerful brand that continues to help drive subscriptions, and there's a lot of room for it to grow in advertising, which I think bodes well for the future.

Marcus Johnson (17:35):

Yeah. I want to end with this, Danny, one thing to watch out for, I think is this delicate balance between Spotify and the record labels. And Jeff Wlodarczak of Pivotal research was saying as Spotify dramatically improves its EBITDA, free cash flow generation, it could act as a signal for the music labels slash artists to demand higher rates. He was saying that the risk is mitigated a bit by the labels need to keep Spotify strong as streaming now accounts for the vast bulk of revenue from record labels. But that's something to pay attention to is that Spotify, as it does better, record labels might be like, hang on a second, we want more as a result, but they can't take too much because they need Spotify at this point almost just as much.

Daniel Konstantinovic (18:19):

Yeah, it's an interesting dynamic. I mean, you've seen something kind of similar play out with some record labels and TikTok earlier this year. Universal Music Group and TikTok had a really big battle that was kind of redrawing the lines of power in the music industry and you would think that the record labels might have all the power because without the record labels, where's the music coming from? But the platforms and distributors really do have a lot of leverage because that's just the main way that people consume music these days.

Marcus Johnson (18:49):

Yeah.

Daniel Konstantinovic (18:49):

So that would be really interesting if artists or record labels kind of pushed back against Spotify in that way.

Marcus Johnson (18:57):

Yeah. We shall see. That's all we've got time for today's episode, though. Thank you so much to my guest. Thank you, Danny, for hanging out with me today.

Daniel Konstantinovic (19:05):

Yeah, thanks for having me.

Marcus Johnson (19:06):

Yes, sir. Thank you to Victoria who edits the show. And Stuart and Sophie, who are the rest of the podcast crew. Thanks to everyone for listening into Behind the Numbers Daily: an EMARKETER Podcast. Tomorrow you can hang out with Sarah Lebow on the Reimagining Retail Show. She'll be speaking with Paola Flores Marquez and Sky Canaves all about the shopping habits of high income consumers.