Spotify’s Bet on Podcasting
Moving from music to the centre of the audio economy
Since launching in 2008, Spotify has dragged record labels from the jaws of piracy. It has done so by flipping the industry’s approach on its head: if music is free to copy and distribute, rather than making it scarce (by cracking down on piracy websites), make it abundant and charge for the convenience of accessing everything in one place. Along the way, Spotify has become a giant, generating $7.5 billion in revenue in 2019 and engaging 286 million Monthly Active Users (MAUs) as of April 2020.
Despite these impressive numbers, Spotify’s success has taken an eternity to translate to the bottom line, only recording its first profitable quarter in Q4 2018. Recognising this issue, Spotify has embarked on a bold new strategy to shift from being purely a ‘music’ company to an ‘audio’ company. This shift, for now at least, is all about podcasts.
In March 2019, Spotify announced the strategic acquisition of 2 podcasting companies: Gimlet Media and Anchor for a head-turning $340 million. Gimlet is a podcasting studio behind hits such as Homecoming and Reply All, while Anchor is a New-York based startup that offers novice podcasters the tools to build high-quality podcasts out-of-the box. A month later, Spotify also acquired Parcast, a true-crime podcasting studio for $60 million. And in February 2020, Spotify acquired The Ringer, Bill Simmons’ sports media company with over 30 podcasts under its belt, for around $200 million.
“It’s really about expanding our mission from just being about music to being about all of audio”
— Daniel Ek
So what’s Spotify’s play here? Although podcast listening is booming globally, with 65% of active listeners starting only in the last three years, the revenue of the podcasting industry as a whole is only estimated to be ~$650 million in 2020. How can these massive acquisitions be justified? To answer that question, we first need to understand how Spotify makes money.
Spotify’s business model
Like many venture-backed startups, Spotify runs on a ‘freemium’ model. Users can sign up for free, but can’t download content and have to listen to ads. Alternatively, premium users can listen offline and access all content ad-free by paying a monthly subscription fee.
However, Spotify’s business model is also very different to most venture-backed tech companies. Software startups that raise VC funds often require large amounts of upfront investment in fixed costs such as R&D expenses, in order to develop and build a great product. They then make up for this in volume, as making more copies of the same software costs next to nothing. Revenue scales exponentially while costs scale linearly, generating profits in the long-run, which looks something like this:
However, Spotify is very different in this regard. Its main cost driver is not these upfront costs but royalties to record labels, publishers and songwriters on a per-stream basis (estimated at between $0.003 and $0.006 per steam). For this reason, its cost of revenue fluctuates between 80–90% of revenue and its financials look more like this:
Since costs scale with revenue, Spotify has struggled with profitability despite its size. The worst part is that Spotify’s marginal costs are completely at the mercy of the three main record labels: Universal Music Group, Sony Music Entertainment and Warner Music Group. These labels account for over 85% of music on the platform and have banded together so that if Spotify wants to reduce royalties, all three companies have to collectively agree.
Thus, to increase profitability, Spotify has two options:
- Reduce its fixed costs. This will likely be difficult as Spotify is already fairly lean in this respect, with fixed costs accounting for ~30% of revenue.
- Find a way to decouple revenue and cost of revenue. This is difficult to achieve in the music business due to the power of record labels.
Podcasts as the solution
Spotify is taking the second option through its podcasting strategy. For Spotify, podcasts are fixed costs, as they pay upfront to produce or acquire a podcast series. In the long run, this will reduce total costs, by drawing listener hours away from licensed songs. For example, if a Premium subscriber spends an hour listening to The Bill Simmons Podcast versus an hour streaming Queen’s A Night at the Opera, they will provide the same revenue to Spotify without the costs of royalty payments. If all goes well, podcasts will likely drive a small percentage of revenue but a significant percentage of profits.
Podcasts are also a path to ‘original and exclusive’ content of the sort that has become so crucial for video streaming companies like Netflix. Exclusivity in podcasts is much more viable than exclusivity in music. Artists have a strong incentive to share their music as widely as possible, as their largest moneymaker is touring. The wall that Spotify can put up around podcasts is much stronger, as podcasters will have few other options to turn to. Having Spotify exclusive podcasts will also differentiate the company from Apple and drive new users to the platform, eventually converting them to Premium subscribers.
Still, paying hundreds of millions of dollars for a relatively small number of podcasts doesn’t completely make sense. This is where the Anchor acquisition comes in.
Anchor allows anyone to easily make and distribute podcasts, essentially bringing a supply of fresh new content onto Spotify. This allows Spotify to cement its position as the central location for all podcasts. This centralisation has benefits for both listeners and advertisers. Listeners will find it easier to discover new podcasts, due to Spotify’s data analytics capabilities powering smart recommendations, improving user retention. Spotify’s machine-learning powered Discover Weekly Playlist has been wildly successful for music and it hopes to do the same for podcasts.
More importantly for Spotify, centralisation will drive their targeted advertising strategy. Google and Facebook have demonstrated that centralising advertising can increase the value of the industry as a whole. Spotify can build consumer profiles from the troves of data it will collect on podcast-listening habits and offer businesses the opportunity to reach the right customers at the right time. On top of this, ads in podcasts have become so accepted that Spotify will likely get away with including ads for Premium users.
This centralisation was a key reason that Gimlet founders Alex Blumberg and Matt Lieber thought selling to Spotify made sense.
“A lack of discovery and data was inhibiting Gimlet’s growth and monetisation. Spotify could solve both these problems as it has a massive audience that is already listening to audio”
Is it working?
Early signs for Spotify have been promising. There are now over 1 million podcasts on Spotify and over 60% of these are powered by Anchor. Although COVID-19 has disrupted listening patterns, 19% of MAUs currently engage with podcasts, up from 16% in Q4 2019, and consumption is growing at triple digit rates year on year. In Q1 2020 alone, Spotify launched 78 exclusive podcasts including Made in Medellin, about the life and music of J.Balvin, and Le Nuage, a ‘facts-based thriller’ that became the #1 podcast in France the week it launched.
Further, Spotify has reported positive trends in engagement, retention and conversion to Premium stemming from increased podcast consumption. For example, retention has seen a very strong 4–5% increase for active podcast listeners.
Despite these early positive signs, Spotify’s transformation still has a long way to go. While the company has paid big bucks for certain podcast exclusives, most of its content remains freely accessible on other platforms. And while the underlying economics of its strategy makes sense, it will be a while longer before their investments feed through into profits.
The company will also face steep competition from other podcasting companies such as Stitcher and Luminary, which recently raised $100 million to launch a subscription-based podcast service. Another potential risk is the recency bias for podcasts, i.e. the tendency to consume new content relative to other entertainment. For example, Netflix benefits from having a massive back catalogue of licensed and unlicensed content. It is much more likely for a Netflix user to re-watch The Godfather than it is for a podcast listener to go back and re-listen to the first season of Serial. This could detract from the goal of being the central location for all podcasts.
Positive trends, uncertain future
With global audio consumption exploding around the world, Spotify seems to be well placed to become the go-to podcast app. Early trends in retention and engagement are encouraging and beating the company’s internal expectations. Only time will tell if this will drive long-term profitability for the streaming giant, or be an unwelcome distraction from its core music business.
Check out more stories like this at Textbook Ventures’ Medium publication.
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