How Spotify Makes Money: Premium Service and Ad-Supported Service

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Spotify Technology S.A. (SPOT) is a music-streaming subscription service legally domiciled in Luxembourg, but whose operational headquarters is located in Stockholm, Sweden, where the company was first launched. Its streaming services are monetized through both premium subscriptions and advertising, officially designated as its Premium Service segment and Ad-Supported Service segment, respectively.

Spotify offers its services globally with a presence in 79 countries and territories, and boasts 248 million monthly active users (MAUs) and 113 million Premium Subscribers as of September 30, 2019. Some of the company’s primary competitors include Apple Inc. (AAPL), Inc. (AMZN), and Google, whose parent company is Alphabet Inc. (GOOGL). Unlike these rivals, Spotify doesn’t have devices on which its music-streaming service is preloaded, putting the company at a significant competitive disadvantage.

Key Takeaways

  • Spotify provides music-streaming services.
  • The biggest share of Spotify’s revenues come from its Premium Service, which provides online and offline ad-free music streaming to paying subscribers.
  • Spotify aims to continue generating revenue through the retention of current users, attraction of new ones, and conversion of users of the Ad-Supported Service to the Premium Service.
  • After years of net losses, Spotify was profitable during the first nine months of 2019.

Spotify’s Financials

Spotify files financial statements with the U.S. Securities and Exchange Commission (SEC), but as a foreign entity, the company is not required to file in accordance with Generally Accepted Accounting Principles (GAAP). Instead, Spotify files in accordance with the International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB). The company does report certain non-IFRS measures, including earnings before interest, taxes, depreciation, and amortization (EBITDA), and Free Cash Flow (FCF).

Spotify’s revenue rose 28.6% to €5.3 billion in 2018. It was the company’s slowest annual growth rate over the past four years. Nearly half of Spotify’s revenue originated in the following three countries: the U.S. at €2.0 billion, the U.K. at €576 million, and Luxembourg at €3 million, for a combined revenue share of 48.5%. The other 51.5%, or €2.7 billion, originated in other countries throughout the world.

Despite the strong revenue growth, the company recorded a net loss of €78 million for 2018. But that loss was still an improvement compared to the previous four years, in which Spotify’s annual losses were markedly greater.

The past year looks to have been a pivotal one for Spotify, at least judging by the first three quarters. For the first nine months of 2019, the company posted year-over-year (YOY) revenue growth of 30.4%. Compared to Spotify’s annual figures, this marked an acceleration in revenue growth after four consecutive years of decelerating growth. Most important, the company managed to generate net income of €23 million over the nine-month period, putting it on track for its first full year in the black.

Spotify’s Business Segments

Spotify monetizes its streaming services through two main business segments: Premium Service and Ad-Supported Service. The company provides segment break downs of revenue and gross profit, the latter of which was reported as €1.4 billion in 2018, generating a consolidated gross margin of 26%.

Premium Service

Spotify offers music-streaming services to both paying and non-paying members. However, paying members, known as Premium Subscribers, are able to enjoy unlimited online and offline access to Spotify’s entire music catalog without having to listen to commercials. Spotify generates revenue from its Premium Service segment through the sale of a variety of subscription pricing plans.

The segment posted revenue of €4.7 billion in 2018, comprising 89.7% of total revenue for the year. Gross profit came in at €1.3 billion, or 92.8% of 2018’s total gross profit, for a gross margin of 27%. The segment’s revenue grew 28.4% throughout 2018 compared to 38.3% throughout 2017. Gross profit grew 55.8% in 2018 versus 84.9% in 2017, and gross margin was up to 27% in 2018 compared to 22% in 2017. Throughout the first nine months of 2019 the segment posted YOY revenue growth of 30.9% and YOY growth in gross profit of 32.0%.

Ad-Supported Service

Members who do not pay for a premium subscription are able to access Spotify’s Ad-Supported Service. Such users have limited online access to the company’s music catalog and their streaming experience is interspersed with advertisements. Spotify’s revenue from its Ad-Supported Service segment is generated through the sale of display, audio, and video advertising space on its non-premium streaming platform.

The segment posted €542 million in revenue in 2018, comprising 10.3% of total revenue for the year. Gross profit was reported as €97 million, or 7.2% of total gross profit, for a gross margin of 18%. The segment’s revenue grew 30.3% throughout 2018 compared to 41.0% throughout 2017. Gross profit grew 125.6% in 2018 versus 222.9% in 2017, and gross margin increased to 18% in 2018 from 10% in 2017. Throughout the first nine months of 2019 the segment posted YOY revenue growth of 25.6% and YOY growth in gross profit of 13.6%.

Spotify’s Recent Developments

Although 2019 is shaping up to be a financial turning point, the real milestone may have taken place in the final quarter of 2018. In a note to shareholders, Spotify reported that its operating income, net income and free cash flow in Q4 all came in positive for the first time in the company’s history. The company will look to continue its strong end-of-year performance when it reports Q4 2019 results on February 5, 2020.

One of Spotify’s most impressive areas of recent growth has been in user engagement with podcasts. In its Q3 2019 letter to shareholders, the company noted that it saw the number of podcast hours streamed grow at an exponential rate and that certain aspects of the increased engagement were “extraordinary, almost too good to be true.” During that three-month period, subscriber growth, gross margins, and operating profit all exceeded Spotify’s own expectations.

Source: Investopedia

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