7 hidden Spotify features you probably didn't know about

Mention the name “Spotify” and chances are you will likely find it as a mainstay application on the devices of many. Since its founding in 2006, it has grown to become among the most popular digital brands in the world. 

What does it do and how does it make money?

Spotify (NYSE: SPOT) is at its core, a music streaming service. It first started out as a solution to the issue of piracy in the music industry. Its two founders, Daniel Ek and Martin Lorentzon, realized that music files were being shared illegally across peer-to-peer sharing networks, which resulted in huge blows to the industry. By building a library of titles through paying recording labels and artists, and then selling free to premium subscription services to listeners who now did not have to physically download songs, Spotify had essentially created new incentives to discourage such illicit activities. 

Spotify operates on a “freemium” model where it offers different subscription plans to users. At the most basic level, there is the free account. Advertisements are placed in between songs and mobile users have  limited functions like not being able to select specific songs for playback. For a small cost a month, premium subscribers can listen to music ad-free and are able to play their music offline. In recent years, Spotify has branched into various premium plans, like the Individual, Duo, Family and Student accounts, to cater to the different pool of users on its platform. 

Spotify has been growing its MAUs at a growth rate of approximately 25% for the past 6 years. In its recent third quarter earnings report, Spotify reported that total monthly active users (MAUs) grew 19% year on year to 381 million in the quarter, up from 365 million last quarter. Premium subscribers make up 45% (172 million) of the total subscribers while ad-supported MAUs, ie. free accounts made up the rest (55%). However, premium subscribers contributed the lion’s share of revenue, ~87% at €2.17 billion while ad-supported MAUs only made up ~13%. This goes to show how highly important premium subscribers are to Spotify’s financials. 

Similar to its MAUs, Spotify has been growing its revenue at a rate of approximately 25% in the past 6 years. In the recent third quarter, total revenue grew 27% year on year to ~ €2.5 billion. Premium revenue’s growth was 22% y-o-y, while ad-supported revenue grew at a stunning 75% rate to €323 million. Spotify is expected to report approximately €9.5 billion in revenues this year.

Spotify’s Premium gross margin was 29.1% in Q3, while the same metric for the Ad-supported business was  10.5%. The company consolidates investments in its podcasts business under the latter.

It is important to note that despite its burgeoning brand and growing revenues, Spotify is still not making much money. In fact, in its recent quarter, it was barely profitable, making 2 million Euros in net income. Nevertheless, breaking even is an encouraging sign, given that it was consistently unprofitable in the previous years. 

Growth opportunities and where does Spotify go from here?

Podcasts and Audiobooks

In the past few years, Spotify has branched into podcasts, an area which is believed to have higher margins as the company now does not need to pay labels due to the independent production nature of podcasts. In fact, in the recent quarter, advertising revenue grew 75% year on year to $366 million, with podcast revenue growing in the triple digits according to management.  

Spotify has invested in its podcast library and acquired Gimlet Media, a highly rated podcast publisher and also partnered with shows from Joe Rogan, Kim Kardashian, Michelle Obama and many others. In the last two years, Spotify acquired Anchor and Megaphone, companies which help creators record, publish and monetize their podcasts through advertising. In essence, Spotify is building its own podcast supply chain. 

In 2021, Spotify announced that it would acquire leading audiobook platform Findaway. This creates an additional revenue stream for the company where Spotify acts as a distributor of audiobooks. More importantly, it is another step towards Spotify’s vision – to be the destination for all things audio both for listeners and creators. With Spotify increasing its product suite via podcasts and audiobooks, it could make it more attractive for more ad-supported users to convert over to premium accounts or even increase its monthly subscription for paid users.

Two-sided Marketplace

As a result of its increasing user base, Spotify has now become a place where artists can also pay to promote their work on users’ homepages or playlists. This essentially creates a marketplace, where both artists and fans can discover and connect over a common platform. Labels can either buy discovery spaces or artists can purchase advertisements directly on their own. As Spotify grows, I believe this network effect could become stronger. 

Risks and Valuation

Increasing Competition

In my opinion, I believe the main risk of Spotify is its competition. Spotify competes mainly with Apple Music, Youtube Music and Amazon Music in most markets, while Tencent Music is the dominant music streaming service in China. Given that these competitors are largely among the world’s biggest and richest companies, profitability of their music streaming services may not be a priority. This would mean a tougher competitive landscape if any of these major players decide to compete on price.

Valuation

As of 24 December 2021, Spotify is trading at a price to sales ratio of approximately 4.5. In my opinion, this is not a very high valuation, given Spotify’s revenue growth rate. However, it is important to note that it should not be simply compared to other software companies, given that Spotify’s gross margins are comparatively  lower. This could indicate that the company will not be as profitable in the future as some of the wildly successful tech companies.

Conclusion

Spotify is a popular product that has been a mainstay for many users since its founding. Execution will continue to be key for Spotify to continue to grow in the years ahead. Growth in MAUs and improving margins are important metrics to look out for moving forward. If all goes well, Spotify could very well be the next star in the making. 

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