Pardon the interruption — Spotify ft. Spotify

Horn. Engine. Wind. Engine. Horn.
Wait, did anyone bring any music?

Need some more rice? Hot sauce?
How about a pickle?

If you use Spotify Free, chances are you read the above lines in the infuriating voice from the Spotify ads; and that you are in a love-hate relationship with the No.1 music streaming app in the world. We all love Spotify’s intuitive music player, curated playlists, and recommendation system, but genuinely hate listening to the same few ads every few minutes. Sometimes it feels like an ad-streaming app that plays music occasionally (okay that’s an exaggeration)

In this piece, we look at why Spotify interrupts our music listening experience with ads about Spotify, and if this strategy is good enough.

Spotify’s take on Freemium

So you might already know this — Freemium is a pricing model where a product is provided free of charge, with the option of paying for additional features and services. Spotify has a basic free version that allows music streaming and a premium version with features like ad-free music, high-quality audio, and offline listening. And like most companies, Spotify’s free plan is riddled with ads — you’ll hear an ad after every third or fourth song. But unlike other companies, these ads don’t sell you your everyday products; 8 out of 10 times, they just ask you to buy Spotify Premium. Now with over 185 million Spotify Free users, one would think that it is a great opportunity for Spotify to sell this ad space to the highest bidding advertisers and make good money. And that is indeed a very good short term strategy. But when you are the most used music streaming app in the world, you go bigger. Hence, instead of generating revenue through ads, Spotify focuses on converting Free users to Premium users by literally telling them to go premium every five minutes.

Let’s do some math. Spotify generates roughly 700 million USD from ads annually, a mere 10% of its revenue. That’s roughly 60 million USD per month. Now with its 185 million free users, it generates an average revenue of $0.32 per user per month. Comparing this with the $9.99/month plan that Spotify offers, one can see the incremental revenue Spotify can earn from a premium user vis-à-vis from showing ads to that user. Secondly, with the $9.99/month plan, Spotify needs roughly 6 million premium users to surpass the revenue it generates through ads. That means it just needs to convert 3.24% of its Free users into Premium to generate a higher revenue than that from ads. That explains why Spotify is so adamantly telling everyone to join Premium; even if just 4 out of 100 people agree, Spotify benefits.

On the plus side, your data is safe(r)

As a marketing student, I know how important targeting is. It helps advertisers deliver a more personalized ad experience that results in better conversion. However, the current industry practices, looking at you AdSense, are borderline creepy. You talk aloud about a product, and you see an ad the next time you go online. There is very limited transparency of what data is collected and shared with advertisers in the name of personalization. With Spotify, users have comparatively better control of their data — after all, you don’t need to know much about your users if all your ads tell them just to go Premium. And for whatever third-party ads the platform has, Spotify has created their own Ad Studio for advertisers to publish ads; hence they do not rely on platforms like AdSense, giving them a better control of what data they will collect and how they will share it. Users can also disable sharing personal data with advertisers for tailored ads.

The economics of price discrimination

The Freemium model that Spotify and other companies use has a price discrimination practice where you charge different prices to different users depending on the features they use — more specifically, second-degree price discrimination. Spotify knows there are two types of users — Free and Premium, but doesn’t know which user belongs to which group until the purchase is made. Hence, they need to decide the features available in both versions and the price of Spotify Premium keeping two constraints in mind — Participation constraint, to ensure that each type of user uses the platform, and Self Selection constraint, to ensure each type of user chooses the plan most appropriate for them. And since they are trying to make everyone a Premium user, it boils down to two conditions.

The first equation simply means that the price of Premium can’t be more than the utility users derive from it, or else they won’t buy it. The second equation is the interesting one. It says that the net utility that a Premium user derives should be more than that he can derive from using Free, else he would switch back to Free. And since the price of Spotify Free is 0, the equation further simplifies to the difference between utilities from Premium and Free being more than the price paid.

Is the difference enough?

So essentially, the discussion boils down to the question — Is the difference between Spotify Premium and Spotify Free more than the ₹120/month price that they ask? (Mind you that a feature doesn’t have any utility by itself; utility only exists if it provides value to the user. So even though you get the option of playing music with your friends with Premium, if you don’t use the feature, it provides no utility to you). Rewriting the above equation we get,

To ensure that Free users convert to Premium and then stick with it, Spotify can either reduce the price of premium or increase the difference between the utilities of Free and Premium. We have seen Spotify reducing the prices by introducing cheaper alternatives such as day plans, family plans, and now even Spotify Mini starting at ₹7/day. But there is a limit to how low you can charge and still be profitable — you need to start looking at the left side of the equation at some point in time. In our survey, we found that almost everyone who bought Spotify Premium did it for ad-free music; utility from other Premium features is non-existent. And that’s where the problem lies — Spotify relies so much on ads and removing ads. If ad-free music is the only major reason for users to buy Spotify Premium, users might switch to alternate apps that provide more utility at the same price point, for example, Amazon Prime Music, which gives access to much more than ad-free music.

Giving too much for free?

Now increasing the difference between the utilities might be easier said than done for Spotify, which already gives a lot to its Free users. This makes the utility of Spotify Free high and the difference in the utilities significantly less. And Spotify can not lower the utility of Free as given the competitive nature of the music streaming industry, reducing the features in Spotify Free might cause Free users to shift to alternative platforms. Currently, the difference between Free and Premium is bridged primarily by ad-free music, which might not be enough for all Free users to convert to Premium. Spotify needs to roll out more innovative features for Premium, which increases the gap between the plans and makes the price point more desirable. These features could include early access to album releases, Spotify originals, online concerts, and what not — Spotify needs to be innovative here and build a sustainable competitive advantage.

The switching cost

One other thing that Spotify needs to do to ensure that users stick with the music streaming platform is increasing the cost of switching that users incur when they move from Spotify to any other alternate app. This can be done by providing features and services that offer a unique, enriching experience that the user will miss if they change the way they stream music. The highly personalized Spotify Wrapped playlist that Spotify curates from the users’ most played songs and artists can be an example of such costs. With everyone sharing their top songs on social media, users who switched from Spotify to other music apps missed out on this opportunity. Adding a social element also makes it difficult for users to switch if their friends still use Spotify. Spotify can look at adding features like artists/genres of the month, and social integrations, etc., to make the music listening experience more personalized and sociable, especially for Premium users.

Spotify revolutionized the music industry with its streaming service; now, it needs to disrupt the competitive industry once again to stand out from the crowd with a more sustainable approach.

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