I woke up over the weekend to the news of Netflix’s foray into live sports getting off to a terrible start.
The Jake Paul vs Mike Tyson game just buffered for most viewers, giving a completely different (but equally terrible) experience to the heavily pixelated disaster that was the Springbok game on my DStv app the previous weekend.
Streaming of live sports still has some way to go, it seems. I wouldn’t bet against the technology, as this is clearly where the world has to end up.
In the meantime, if there’s one thing that seems to be working beautifully in the streaming space, it’s music and podcasts. Spotify’s share price has increased by more than 140% year to date, an exceptional return by any standard.
This is a platform that many people (including me) use every day, yet the user adoption hasn’t translated into great financial results until recently.
Of all the things I pay for every month, I think Spotify Premium would be one of the very last things I cancel. I’m clearly not alone in this view, with the company boasting an exceptional conversion rate.
There are 640-million monthly active users, of which 252-million are premium subscribers. The rest are in the ad-supported tier, suffering through endless adverts designed to bully them into going premium.
It’s worth noting that though 33% of monthly active users are in the rest of the world (that is, not Europe, North America or Latin America), only 14% of premium subscribers are in that category.
It takes a while to convert users in new markets, which is why Spotify pays a lot of attention to what it calls the top of the funnel — the number of free users joining the platform. Affordability is also a major factor, especially in emerging markets.
The key to success is to keep driving arpu higher even in developed markets, something that Spotify can clearly do
The money is made in premium subscriptions, so it’s little surprise that Spotify pushes that angle so hard. It generated €3.52bn in revenue from premium subscribers in the latest quarter vs just €472m from the ad-supported tier.
Clearly, each premium subscriber is worth far more to Spotify than each ad-supported subscriber. The growth rate in premium revenue also tells a story, up 21% despite the number of subscribers only growing 12%.
The difference in growth rate lies in average revenue per user (arpu), which Spotify managed to increase substantially. This speaks to how much value the premium subscribers place on the platform, with a willingness to absorb pricing increases.
Considering arpu in the context of the rest of world user stats reveals an issue that all technology platforms face: the high growth areas (that is, emerging markets) offer lower arpu than developed markets.
As platforms scale on the global stage, this can put the unit economics under pressure, leading to initiatives like Netflix offering ad-supported tiers to try to improve affordability across various markets.
The key to success is to keep driving arpu higher even in developed markets, something that Spotify can clearly do. With gross margin at record levels of 31.1%, up a lovely 473 basis points year on year, the benefit of higher pricing is clear. This drove record-high operating income at an 11.4% margin.
The importance of the premium model is further supported by the competitive bloodbath in the advertising model. Juggernauts like Meta and Alphabet are slugging it out for consumer attention on the internet. Amazon is also right in there, with its e-commerce platform offering a perfect place for advertisers to get involved right at the point when a customer wants to buy something.
Conversely, interrupting someone’s music or podcast with an advert seems like a less natural choice. The premium business ran at a gross margin of 33.5% in the latest quarter, while ad-supported gross margin was only 13.1%. It’s clear where the pricing power sits.
Part of why these tech companies look more lucrative these days is that they were forced to get a lot tighter on costs. Gone are the days of ballooning costs and vast stock-based compensation, while management teams abused the definition of adjusted earnings before interest, tax, depreciation and amortisation as far as possible to try to hide the true costs of the staff in the business.
Well, perhaps not gone entirely, but certainly better. In the latest quarter, operating expenses fell 8% year on year. It’s therefore little wonder that free cash flow generation exploded, coming in at €1.8bn for the past 12 months.
Like so many other platforms (Uber and Amazon come to mind), Spotify has finally blossomed into a solid business.
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