Spotify doesn't make profit from music streaming, despite having over 400M monthly active users.
Despite being the king of music streaming, Spotify is struggling financially, but why?
Spotify is the world’s most popular music streaming service, outperforming competitors like Apple Music and YouTube Music, with its 220 million premium subscribers and over 400 million monthly active users.
It offers access to over 70 million songs, podcasts, and other audio content from various genres and artists.
While operating on a freemium model, Spotify allows users to listen for free with ads and limited features or without ads by paying a monthly fee.
Spotify was founded in 2006 in Sweden by Daniel Ek and Martin Lorentzon, who wanted to create a legal alternative to online music piracy that was rampant at the time.
They managed to convince the major record labels to license their music catalogs to Spotify in exchange for a share of their revenues and company equity.
Spotify launched in 2008 and quickly gained popularity, especially after partnering with Facebook in 2011. It expanded to many countries and had its IPO in 2018 with a valuation of $26.5 billion.
However, despite being the king of music streaming and having a loyal fan base, Spotify has never been profitable.
It has lost money year after year, accumulating over $4 billion in losses by 2022. Also, its market cap has dropped by more than 60%, to $27 billion, since its peak of about $69 billion in February 2021.
For a company that has revolutionized the music industry and changed the way we listen to music, one would expect Spotify to be making a lot of money.
But the reality is that Spotify is still struggling to make money from streaming songs.
So, what are the challenges Spotify faces when it comes to making money? And what steps is the company taking to overcome them?
In this article, we will explore these questions and look at Spotify’s current strategy and prospects.
High Cost of Royalties
The main challenge Spotify faces is that it pays high royalties to the owners of the music it streams.
For every dollar Spotify makes from music streaming, about two-thirds goes to the rights holders of the music, which include the record labels, publishers, songwriters, and artists.
This leaves only one-third of its revenue to cover other expenses, such as research and development, marketing, administrative, and tax expenses.
One-third of its revenue is not enough for Spotify to break even, let alone make a profit.
So why does Spotify pay such a high percentage of its revenue in royalties? And why can’t it negotiate for lower rates since it’s a big market player?
The answer lies in the power imbalance between Spotify and its music suppliers, namely the major record labels that control most of the music streamed on Spotify.
Spotify licenses most of the music it streams from three companies: Universal Music Group, Sony Music Entertainment, and Warner Music Group, also known as The Big Three.
Together, The Big Three hold a 70% share of the music recording industry and a 60% share of the music publishing industry, forming a sort of unholy monopoly over the music industry.
They help artists with the promotion and distribution of their music, and in return, they own the rights to their music.
Being so influential in the industry, they are the ones who decide how much Spotify must pay them for streaming their music.
Without these licenses, Spotify would not be able to stream the millions of songs that its users want to listen to, and that would make it lose customers to its competitors, such as Apple Music, Amazon Music, or YouTube Music, which all have licenses with The Big Three.
The difference between having or not having The Big Three’s music catalog is a life-or-death situation for Spotify.
This gives The Big Three a lot of leverage over Spotify and forces it to pay them nearly 70 cents of every dollar it makes, leaving little room for profits.
Another problem with Spotify’s business is its lack of uniqueness.
These days, whenever you want to listen to a song, you can easily find it on any music streaming app you use, be it Spotify, Apple Music, etc.
With all major streaming apps providing access to most of the world’s music, this is great for you as a consumer because you can listen to all the music you like in one place.
However, this is bad for the music streaming companies that run them.
Because when all the platforms offer the same content, there is no product differentiation between them, nothing unique about anyone.
And pricing becomes the main factor they compete on, as music streaming is commoditized, therefore reducing their revenue.
The Difficulty of Owning Content
One possible solution for Spotify to increase its revenues is to own the content it streams, rather than licensing it from others.
This is what Netflix did when it started producing its own original shows and movies, which reduced its licensing fees and improved its profitability.
However, the problem for Spotify is that the record labels anticipated this move and prevented Spotify from ever owning music content and competing with them.
They included terms in their licensing contracts with Spotify that forbid Spotify from owning content and streaming it exclusively on its platform.
These contracts make it extremely difficult for Spotify to own songs without violating the terms given by the record labels, which could result in expensive penalties and even legal actions against them.
Spotify is dominated by The Big Three and Merlin (an organization representing independent labels), who own over 75% of the streamed music, giving them too much power.
This was why when Spotify tried to license music directly from artists in 2018, bypassing the record labels, it was sued, forcing Spotify to stop within months.
The key factor that differentiates Spotify from Netflix is the concentration of suppliers in their respective industries.
The music recording industry is highly concentrated, with The Big Three holding a 70% market share.
In contrast, the movie and TV studio industry had seven major film studios, with the three largest holding just 45% of the market share back in 2012, the year when Netflix started producing its first original show, House of Cards.
This made it easier for Netflix to negotiate with its suppliers, compared to Spotify, and also allowed Netflix to get exclusive streaming rights from some studios, such as Disney, for a fixed fee.
Netflix had content exclusive to its platform, differentiating it from the competition like Hulu and Amazon Prime Video.
Spotify couldn’t get exclusive streaming rights, and had to pay royalties based on its revenue.
The Gamble on Podcasts
For Spotify to have any chance of making profits, it must diversify beyond music streaming, its core business.
This is why in 2019, Spotify announced its strategy to transform from a music streaming platform to an audio platform, with podcasts being one of the main drivers.
The main logic behind their decision was that the cost of streaming podcasts was much lower than the cost of streaming music.
In the podcasting space, Spotify can negotiate better licensing fees, outside the territory dominated by the major record labels.
Spotify claims that the long-term gross margin for podcasts is around 40–50%, which is much higher than the current 25–30% for music.
So as Spotify’s audience listens to more podcasts, the proportion of total revenue paid out in royalties for music decreases, resulting in higher margins and potential profits for the company.
This is why Spotify has invested heavily in podcasting, spending over $1 billion to acquire several audio companies and sign exclusive deals with celebrities such as Joe Rogan, Kim Kardashian, Prince Harry and Meghan Markle, and even the Obamas.
According to Spotify’s own data, podcasts increase the amount of time people spend streaming on Spotify.
Although listening to podcasts does cause a slight drop in the time users spend listening to music, the extra time spent on podcasts more than makes up for it, and the net result is a 20% increase in total streaming time on average.
In theory, this strategy should lead to higher profits for Spotify, right? But it isn’t.
Looking at Spotify’s financials, this has not been the case so far. Despite the company previously indicating that profitability was expected to improve in 2023, the first half of 2023 has been even more unprofitable than the same period in 2022, with gross margin, operating margin, and net income margin all decreasing.
Apparently, podcasts were not as profitable as Spotify originally anticipated.
One possible explanation? Spotify’s podcast revenue is still too small to offset its music royalty costs
Although Spotify has seen fast growth in its podcast audience, reaching over 100 million monthly active users in 2022, its podcast revenue only accounted for 4% of its total revenue in the same year.
This means that Spotify still depends heavily on music streaming for its revenue.
Moreover, Spotify’s podcast revenue is mostly derived from advertising, which has lower margins than subscription fees.
Spotify’s ad-supported revenue had a gross margin of 18% in 2022, compared to 28% for its premium revenue.
Therefore, even if Spotify’s podcast revenue grows faster than its music revenue, it may not necessarily translate into higher profits.
Another possible explanation is that Spotify’s podcast investments are too expensive and risky.
Spotify has spent over $1 billion to acquire several audio companies and sign exclusive deals with celebrities, but these acquisitions and deals may not generate enough returns to justify their costs.
Taking a look at the most popular example of this, Spotify paid $100 million to secure the exclusive rights to stream The Joe Rogan Experience, one of the most popular podcasts in the world.
However, this deal also meant that the podcast had to be removed from other platforms, such as Apple Podcasts and YouTube, where it had a large and loyal fan base.
This alienated some of the existing listeners who preferred to access the podcast through their preferred platforms and limited the potential reach and growth of new listeners who do not use Spotify.
Furthermore, Spotify also faced backlash from some of its own employees and users who objected to some of the controversial guests and opinions featured on Joe Rogan’s podcast. Therefore, reducing the value and appeal of the podcast for Spotify and its audience.
In addition, Spotify’s podcast strategy also faces fierce competition from other players in the audio space.
Apple, Amazon, and Google are all investing heavily in podcasts, offering their own original and exclusive content, as well as tools and features for podcast creators and listeners.
For example, Apple recently launched Apple Podcasts Subscriptions, a service that allows podcasters to offer premium content to their subscribers for a monthly fee.
Amazon acquired Wondery, one of the largest independent podcast producers in the world, to bolster its Amazon Music and Audible platforms.
Google integrated podcasts into its Google Search and Assistant products, making them more accessible and discoverable for users.
These moves by Spotify’s rivals may pose a threat to its dominance and differentiation in the podcast market.
The Unending Search for Profitability
For years, Spotify’s executives have consistently emphasized the company’s prioritization of growth over short-term profits.
Daniel Ek, the company’s CEO, has repeatedly underscored to Spotify investors that user growth is the foremost metric for future success.
But at the end of the day, profit is what ultimately matters.
With music streaming unlikely to yield any profits as long as The Big Three are around, and with podcasting not living up to expectations, it is hard to imagine Spotify producing any meaningful profits anytime soon.
As a result, Spotify executives will most likely continue promoting the narrative of prioritizing user growth to divert investors’ attention away from its losses and buy time.
But, without any substantial changes that would lead to profits, it is only a matter of time before investors run out of patience and Spotify runs out of money, which may lead to the sale of the company to one of its competitors.
However, in the meantime, we might continue to see Spotify doing things like layoffs or even raising prices, both of which we have witnessed recently in 2023.
In conclusion, when suppliers possess excessive bargaining power and competitors offer similar products, it can significantly impede any company’s profit generation. This applies even to a renowned tech company like Spotify, which holds the position of a market leader in one of the most popular consumer trends of its time.
Also, here is another article you will get value from: