5 of Spotify’s biggest imminent challenges in 2019

In many ways, Spotify enjoyed a spectacular end to 2018.

The company finished the year with its first ever quarterly operating profit – €94m ($107 million) — something that challenged many of the long-term naysayers about its business model. In addition, amid its year-end financial-results announcement, Spotify confirmed that it was set to spend between $400 million and $500 million on acquisitions throughout 2019, including the recent buyouts of podcasting content company Gimlet Media and distribution platform Anchor.

What’s more, Spotify could now hit more than 100 million paying subscribers worldwide by the end of March, having topped 96 million at the end of December, and its day-end share price this week (February 14th) reached its highest point ($146.87) since late October last year.

Things are looking up for Daniel Ek and his green machine — but Spotify still faces a few stark challenges. Here are a few of them.

Its advertising revenues remain unspectacular.

In Q4, Spotify’s revenues from its ad-supported tier reached €175m ($200 million). That represented just 11.7 percent of its total revenue haul of €1.495 billion ($1.7 billion) in the three months.

This was a slight improvement over the percentage of overall revenue that ad-supported sales achieved in Q4 of the prior year (11.3 percent). Yet Spotify continues to make a measly amount from advertising versus the subscriptions paid for by its Premium users, who contributed €1.32 billion ($1.5 billion) in Q4. That’s more than seven times the cash generated by ads.

One way Spotify hopes to accelerate growth in advertising is podcasts (which we’ll come back to). That’s partly because the company believes it can double-dip: It’s already embedding audio ads in podcasts listened to by both its “free” users and its paying subscribers (the latter group typically avoids marketing content).

Furthermore, Spotify CFO Barry McCarthy told investors on February 6th that self-serve advertising, whereby clients upload their own ads and target audiences themselves, is now “our fastest-growing [ad] channel.” Spotify Ad Studio, the firm’s self-serve platform, is currently available to varying degrees in markets including the U.S., U.K. and Canada, ahead of an expected wider global rollout.

“[We] continue to invest aggressively from an R&D perspective in growing [self-serve],” said McCarthy on Spotify’s Q4 earnings call. “We need that channel to be successful for us over time in order to right-size our cost structure, but we’re starting off a very small base.”

Cracks are beginning to show in Spotify’s relationship with the record labels.

There have long been whispers in the background from record companies that they are unhappy with some of Spotify’s moves. The major labels’ biggest bugbears have included Spotify’s declining Average Revenue Per User (ARPU), in addition to the platform striking direct licensing and distribution deals with artists. Now, though, these concerns are really starting to bubble to the surface.

Speaking to investors on an earnings call on February 5th, Warner Music Group CEO Steve Cooper stopped short at mentioning Spotify by name — but his growing frustration with some of the service’s practices was seemingly apparent.

First, Cooper (pictured) tackled the growing trend for Spotify (and other services) to ink direct deals with artists, cutting out labels. “It’s important to remember that [streaming services] are not organized to create value for artists, they are not organized to create artist careers,” said Cooper.

“Presumably [streaming services] will not steer [the popularity of cheaper music], which I’m sure you’ve seen complaints of already — where music is popping up in people’s playlists and they don’t know how it got there.”

Steve Cooper, WMG

“If you look at what we invest in our artists’ careers, A&R, marketing and promotion, it is a meaningful high-nine or low-ten-figure number [quarterly].”

He also accused such platforms of “utilizing sources of music outside of the major [labels] in the hope of lowering [the overall royalty rate paid out to rightsholders].” He called on Spotify et. al not to deliberately steer customers to this cut-price independent music via first-party playlists.

Said Cooper, “I think we will continue to see streaming services try to move to lower-margin products. . . . Presumably [streaming services] will not steer [this], which I’m sure you’ve seen complaints of already — where music is popping up in people’s playlists and they don’t know how it got there.”

That was a blatant reference to recent reports of mysterious plays of suspicious tracks appearing in Spotify user play-counts, despite these users saying they’ve never heard these songs before. Did Steve Cooper just suggest Spotify itself could be to blame?

A potential struggle to keep up momentum.

Spotify’s 2018 saw the company add 25 million paying subscribers around the world. That was up on 2017, when it added 23 million paying subs.

Spotify appears likely to have bested Apple Music, globally speaking, in the year. Apple‘s Spotify rival counted 40 million paying subscribers last April, according to the Cupertino giant’s Eddy Cue. And, according to Apple CEO Tim Cook, speaking on the firm’s earnings call last month, the platform counted “over 50 million paid subscribers” as of January 28th.

Spotify’s bold prediction for 2019 is that it can repeat the trick: It’s projecting that it will add anywhere between 21 million and 31 million subscribers by the end of this year. Its biggest challenge, however, is exactly where these subscribers are going to come from.

Spotify’s fiscal reports show the percentage breakdown of where its paying subs reside. In terms of the year-end of 2018, that went like this: Europe, 38.4 million; North America, 28.8 million; Latin America, 19.2 million; and the rest of the world (ROW), 9.6 million.

Judging by prior financial reports, Spotify added just 2.1 million subs in ROW in the last six months of 2018, or around 350,000 per month. In a region housing billions of potential customers, that was . . . unspectacular.

Analysts at MIDiA Research have predicted that 2019 will likely be the year that streaming subscription growth slows in the North America and Europe — meaning that Spotify will really need to up its game in the Middle East and North Africa (MENA) region, where it launched in November.

It will also need to launch successfully in India, where 1.3 billion potential customers reside, but where Spotify’s arrival is currently being delayed by major labels refusing to grant it vital licensing permissions.

Its less-than-positive economics.

Spotify might have posted an unusual operating profit in Q4, but across the full year of 2018, it was a loss-maker yet again. In fact, in a year-end SEC filing, Spotify revealed that, since its inception, in April 2006, it has incurred “significant operating losses,” which, as of December 31st, 2018, amounted to an accumulated deficit of €2.51 billion ($2.8 billion).

The firm’s FY operating loss in 2018 stood at €43 million, narrowing considerably on the €378 million it suffered in 2017. Yet in its forecast for 2019 — partly due to that acquisition budget of $400 million-$500 million — Spotify is projecting another annual operating loss of €200 million to €360 million.

Daniel Ek will hope that Wall Street continues to buy his reasoning for this loss-heavy trend: that Spotify must now perpetually invest heavily in global expansion, marketing and product quality in order to consolidate its number-one market position, and lay the pathway for future profits.

Some investors, however, may point to Spotify’s own SEC filings, which warn, “[We] cannot assure you that the growth in revenue we have experienced over the past few years will continue at the same rate or even continue to grow at all. We expect that, in the future, our revenue growth rate may decline because of a variety of factors, including increased competition and the maturation of our business.”

Its untested reliance on podcasts.

Spotify has reportedly just paid more than $200 million to acquire New York-based podcasting production company Gimlet Media, in addition to podcasting distribution house Anchor. If this wasn’t indication enough that Spotify is banking its future on the spoken word, Ek told investors this month that his company expects more than 20 percent of listening on Spotify will be dedicated to podcasts, rather than music, in years to come.

One key factor to achieving this objective, said Ek, is exclusivity, although he acknowledged only future Gimlet Media productions will be exclusive to Spotify — existing content from shows such as StartUp, Reply All, Homecoming and Mogul will remain widely available. So how can Spotify use podcasts to improve its financial numbers as time wears on? Ek was asked this precise question on the Spotify Q4 earnings call.

“If I could draw a Netflix analogy, when we launched [original content creation] at Netflix, first year, we spent [$50 million on it], and then every year after that we doubled it… There are many similar analogies that have the opportunity to play out here as well.”

Barry McCarthy, Spotify (pictured, main)

“Having great content is the long and the short of it,” he replied. “If we can drive a virtuous cycle, we’ll win; if we can’t, we won’t. And virtuous cycle [here] means investing in content that people engage in [and] seeing overall engagement increase. . . . Because [people are] excited, they tell more friends about the service, so your mix of paid versus free acquisition shifts in favor of free [and] your subscriber acquisition cost goes down.”

It’s interesting to note that both Ek and Barry McCarthy made Netflix analogies about Spotify’s podcasting potential in the wake of the Gimlet and Anchor deal, referencing the financial advantages of being a streaming service that is also a content creator. That’s a comparison Ek has tended to avoid in the past, presumably for fear of upsetting major music rights-holders.

Said ex-Netflix exec McCarthy, “If I could draw a Netflix analogy, when we launched [original content creation] at Netflix, first year, we spent [$50 million on it], and then every year after that we doubled it. . . . [This] greatly enhanced the value proposition for users, and over time it shifted the [company’s] cost structure from variable to fixed. There are many similar analogies that have the opportunity to play out here as well.”

The above article originally appeared on RollingStone.com through here. MBW has entered into an ongoing global content partnership with Rolling Stone and Penske Media Corporation.Music Business Worldwide

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