By: Julie Feng
Spotify is a music platform that many of us use every day; more precisely, over 104 million active users use Spotify. Every. Single. Day. Talk about connection. Yet, globally, out of Spotify’s 406 million monthly active users, more than half do not pay a dime to use the services. Considering that Apple Music, Amazon Prime Music, and YouTube Music charge each of their consumers a small monthly price to access valuable music content, have you ever wondered how Spotify makes money?
Simply put, the answer is: they don’t. That’s right, ever since its launch, Spotify has generated billions of dollars in loss. Despite all the controversy surrounding Joe Rogan costing Spotify billions of dollars in equity and the expensive rights holders to artists, Spotify is disappointing for other reasons, from an investor’s perspective, of course, and here is why. No ads, I promise.
The problem
At the core, Spotify is a corporation. I am stating an obvious fact here because Spotify’s negative profit margins and its struggle to retain renowned artists are linked back to Spotify’s failure to acknowledge that it is a corporation. Spotify is not a non-profit organization whose purpose is to supply hundreds of millions of listeners with the option to listen to music for free. Spotify being a platform one can use free of charge, has converted many of these free users into premium users — 25 million users in 2021 to be specific — but how does that number compare with the 209 million active free users they have? Why would Spotify’s free users pay for a premium subscription when Spotify makes it so incredibly accessible for them to stream songs and podcasts, while allowing users to change freely between their mobile, desktop, and tablet? In other words, there is a lack of incentive for free users to start paying a premium.
Canva - A success story
Canva is students’ and small businesses’ favorite graphic design platform. It has become one of the world’s biggest privately-owned companies at a value of $40 billion. Though Canva and Spotify belong to two completely different industries, their business model surrounds the same concept: free for everyone with the choice to upgrade for premium at a relatively similar price per month. However, the difference is that Canva provides many additional features to their Canva Pro membership, including access to high-quality premium content, the option to collaborate, and 100 GB of cloud storage.
The importance of exclusivity
Compared to Spotify’s Free versus Premium membership, Canva provides more reasons and incentives for users to take out their credit cards. In 2021, Spotify finally released its in-app lyrics feature after years of demand, but beware, Spotify made this feature available for both free and premium users.
In other words, the pattern in Spotify’s business model is that there is little differentiation between both memberships. Exclusivity matters. Think of first-class airplane seats, VIP Cinema tickets with comfortable and full recliner seats, Amazon Prime’s free and fast shipping etc. Members pay a mark-up price so they can access premium benefits. More importantly, exclusivity elicits other psychological rewards, allowing companies to take this opportunity and create personalized experiences.
Regarding their in-app lyrics feature, Spotify could have integrated collaborative karaoke as part of an exclusive feature for premium users. This feature could have created serious FOMO (fear of missing out) for free users, just like they did with Spotify Wrapped, which was a very successful campaign considering that 90 million people engaged with it the year it was released. During the first week of its release in 2020, Spotify downloads increased by 21%. Therefore, Spotify's recipe for success might very well be creating this sense of missing out among its vast audience of free users.
A missed opportunity
Unlike Spotify, which didn’t integrate the karaoke feature into their platform, Tesla did. In 2019, Tesla released Caraoke, a play on words on the term karaoke, allowing drivers and passengers to sing their favorite songs, be it Pop, Latin 1980’s, or Disney classics, with lyrics displayed on the screen. Fast forward to now, Tesla has started selling TeslaMic, a microphone for in-car karaoke, which launched in China and completely sold out within an hour. Tesla turned a simple activity, driving, into a pleasant one. This is an opportunity Spotify could have grasped onto especially with their considerable audience base, but they didn’t.
Next steps for Spotify
When looking at Spotify’s profits from an accounting perspective, Spotify is in no position to decrease further its cost of goods sold, at least not in the short term. Until Spotify decides to form its own label like Netflix, the majority of its payments are made to content creators, which does not allow Spotify to decrease its costs.
Investors may wonder why Spotify is not generating more revenue considering that its low price point gives Spotify power compared to its competitors’ prices which charge around USD 10 per month for their streaming services. This question ultimately comes down to how Spotify can increase its number of paying subscribers by significantly boosting paying subscribers’ benefits or eliminating their free subscription option in the safest and best way possible. Scary right? Hear me out.
Spotify’s new reality
Spotify was released on April 23, 2006. Daniel Ek and Martin Lorentzon founded it to create an ethical alternative to music piracy, ultimately kicking Napster out of the industry. It was a success. Spotify thrived in European and U.S markets, raising $2.1 billion in funding. However, we are not in 2008 anymore, when people turned to non-authenticated websites to listen to their favorite tracks. In 2022, large tech giants like Apple and Google have joined this same industry which Spotify is competing in for a market share. Where Apple and Google have branched out to different lines of products, Spotify’s only product is their platform. Yet, they are the only company among all competitors to offer a completely free option to stream music. The music-streaming industry is costly. In the most literal sense, every content creator generates more profit than the company itself.
Moreover, Spotify has failed to show premium subscribers their value. They are the majority source of revenue for the company, and they deserve more for that. Spotify investors themselves have voiced their concerns regarding how Spotify will sustain itself. Furthermore, piracy is no longer a threat like it was a decade ago. Spotify has forged many other competencies that will allow them to thrive, namely its incredibly user-friendly UX/UI. It is, therefore, time for Spotify to move away from its philanthropic mindset of providing free music towards a more sustainable philosophy.
Music has value
Whether Spotify chooses to revamp their subscription for paying subscribers or not, there is one main takeaway from their freemium: music has value, and so does creative talent. Music has played an essential role in so many aspects of our life: socially, emotionally, and physically. In a world where consumers expect to spend a few extra dollars every month for entertainment, they see nothing wrong with paying an inconsequential portion of their budget to support their favorite artists who put in the effort, time, and money to create those songs.
By eliminating the freemium membership, Spotify will financially be set to rightfully pay artists and license holders and see a potential increase in its share value after consecutive years of decline.
