Spotify Q4 user growth exceeded expectations, but why still not make money?

In 2022, the Federal Reserve has raised interest rates violently for 7 times in a row, and the overall technology industry has been sluggish, from Meta, Google to Amazon, and large technology companies have successively announced layoffs for the winter.

The cold has been transmitted to a wider area. In late January, Swedish music streaming giant Spotify announced it would cut 6% of its workforce.

Has the music streaming business become harder to do? From Spotify's just-released earnings report, it is not difficult to see the answer.

User growth exceeded expectations and net losses surged

On the evening of January 31, Beijing time, before the US stock market, Spotify released its 2022 Q4 earnings report. According to the financial report, Spotify's total revenue in the fourth quarter was 3.166 billion euros, an increase of 18% year-on-year, of which paid service revenue was 2.717 billion euros, an increase of 18% year-on-year. Revenue from advertising and sponsorship services was €449 million, up 14% year-on-year. Monthly active users increased to 489 million, up 20% year-over-year, the strongest quarterly increase, and the company expects the number of active users to reach 500 million in Q1 2023.

After the earnings report, Spotify shares rose nearly 13% as of the close of U.S. stocks.

In the past year, Spotify's performance growth is inseparable from increased investment in marketing and content. In 2022, the company acquired podcast service Podsights, Chartable, audiobook content provider Findaway, digital security platform Kinzen and other companies, and also signed podcast exclusive agreements with popular fashion blogger Emma Chamberlain and others. According to the financial report, advertising revenue from podcasts increased by 30% in Q4.

However, the net loss widened to €270 million from €39 million in the prior-year quarter, and the company's gross margin fell slightly to 25.3% compared to 26.5% in the prior-year quarter. Over the past few years, Spotify has been burning money for a growth strategy and doesn't value profitability too much. Since listing, the net profit has mostly been negative. Now, as the macroeconomic environment changes and investors become less tolerant of tech growth stocks, Spotify will undoubtedly face greater pressure on earnings.

Affected by multiple factors, it is difficult to expand profit margins

According to the financial report, Spotify lost 270 million euros in the fourth quarter, or 1.40 euros per share, compared with a loss of 39 million euros or 21 euro cents per share in the same period last year, and the group's operating costs climbed 44%, mainly because the hiring boom during the epidemic pushed up costs. Spotify CEO Daniel Ek also acknowledged that it was "too ambitious" during the flu pandemic, when lockdowns in large economies caused consumers to spend more time online and prompted tech companies to expand aggressively.

In addition, although there is no detailed disclosure in the financial report, from the perspective of Spotify's business model, the impact of royalty expenses on a music streaming platform cannot be ignored.

In the streaming music industry chain, Spotify occupies a distribution position, and the music supply on the platform comes from major record companies. The tracks of the top labels (Universal Music, Sony Music, Warner Music, and Merlin, among others) make up 85% of Spotify's music library. These record labels are in a very strong position.

Unlike streaming platform Netflix, which spends on upstream studios to purchase and produce its own movies and TV shows, Spotify licenses content in the form of revenue shares, and pays royalties of $0.0033-0.0054 to record labels and songwriters for each broadcast on the platform. Therefore, the larger the volume of revenue, the more royalty expenses will be.

In 2021, a large number of artists complained on social media that their earnings from Spotify were too low. On March 24, 2022, Spotify also released the latest data through its Loud & Clear website, showing the helplessness of its own development. Data shows that Spotify has paid more than $30 billion in royalties (including songwriting and recorded music) to music industry copyright holders since its inception. Among them, more than $7 billion was paid in 2021, a year-on-year increase of nearly 40%.

In addition, Spotify is also facing competition from platforms such as Apple Music, YouTube Music, Amazon Music and even TikTok, and its market share has declined to a certain extent. According to the report, Spotify's market share in the second quarter of 2022 was 30.5%, down from 33.2% in the second quarter of 2018. It can be seen that when the involution of the music streaming market is intensifying, it is becoming more and more difficult for Spotify to achieve a breakthrough in the number of users and expand profit margins.

In 2018, Spotify briefly tried to sign copyright licensing agreements directly with musicians, and also encouraged musicians to get rid of record labels and release songs independently on its platform. But this digging was forced to end under the threat of several major record companies.

Spotify does this for a simple reason, the huge music library is the lifeblood of Spotify, grabbing the hottest artists (and representing their record labels) so that Spotify can attract users to pay for subscriptions - this part of the revenue accounts for eighty percent of Spotify's total revenue.

While free users can also use Spotify's service, they can only shuffle tracks and are required to watch ads. These ads have brought limited revenue to Spotify. In 2018, when Spotify went public, its advertising revenue accounted for about 10% of its revenue, and four years later, advertising revenue accounted for only 14% of its revenue.

Spotify added 25 million paid subscribers in 2022, which is certainly a brilliant achievement, but the company also admitted in its earnings report that Spotify's subscriber numbers in Europe, North America and Latin America declined last year, mainly from emerging markets such as India and Indonesia, and it was still based on vigorous marketing investment and the promotion of cheap multiplayer packages.

And, as early as last October, CEO Daniel Ek said that Spotify members will increase prices "at a certain point" in 2023. From this point of view, Spotify's strong growth in the number of paid users this year may be difficult to continue in 2023.

From benchmarking Netflix to benchmarking YouTube

In order to get rid of the oppression of record companies, Spotify is also actively diversifying its business. In recent years, the rise of podcasts has given Spotify an opportunity to explore a new growth curve. And this time, Spotify is determined to start from the content supply side so as not to fall into the dilemma of being slaughtered by suppliers again.

In 2019, Spotify acquired Gimlet, a well-known podcast production company, and Anchor, a podcast service, and then paid a lot of money to invite head comedian Joe Rogan, former first lady Michelle Obama and Kim Kardashian to exclusively distribute shows on its platform. In October last year, the company also announced that it would test the audiobook business, striving to transform from a single music streaming platform to a giant in the audio industry chain.

However, after billions of dollars in investment, Spotify abruptly adjusted its content strategy earlier this year.

Previously, under the influence of Barry McCarthy, the company's former CFO and former CFO of Netflix, Spotify has always wanted to benchmark Netflix - relying on exclusive original podcast content to attract users to pay.

However, the harsh macro environment in the European and American markets is making it more and more difficult to do paid subscription business. In December last year, after seven consecutive interest rate hikes by the Federal Reserve, the US CPI (Consumer Price Index) still rose by 6.5%, and the UK CPI rose by 10.5% year-on-year, at a 40-year high. High inflation directly affects users' willingness to pay.

According to a survey by CNBC, 36% of American consumers plan to cancel some of their subscription services as prices rise month by month. Film and television streaming services such as Netflix and Disney+ are the first to bear the brunt.

In the first quarter of 2022, Netflix's subscribers dropped from 221.8 million at the end of 2021 to 221.6 million, losing 200,000 subscribers in three months. This is the first time in a decade that Netflix subscribers have declined. Netflix's stock is down 15% so far last year.

During the recession, Netflix is no longer a good comparator by betting on the input/output ratio of blockbuster content, and Spotify's heavily invested podcast business needs to change direction. Now, the company wants to target YouTube.

Spotify currently has more than 5 million podcasts, covering markets in various countries around the world, and the company also hopes to reach 50 million podcast creators to create an audio ecosystem created by professional content producers and ordinary users.

In January, many of the 600 people laid off by Spotify came from podcast production teams, and Dawn Ostroff, chief content officer who signed celebrities such as Joe Rogan and Michelle Obama to distribute podcasts on Spotify, also announced his departure. These celebrity shows do contribute a lot to Spotify's user growth, but the high cost of signing exclusive agreements with them will put Spotify in a similar predicament to the music business.

When the European and American economies are in the danger zone of recession, Spotify wants to make money and give its investors some confidence, it may be a good idea to switch from the PGC platform to the PUGC platform, which obviously has more imagination than pursuing unstable blockbuster programs.

epilogue

In the earnings call, Spotify CEO Daniel Ek said that in 2022, the company's investment in marketing and content has achieved remarkable results, which have been translated into real user increments. But at the same time, he also said that he will slow down the pace of investment and try to control costs.

Last year, YouTube's advertising revenue reached $30 billion, more than double Spotify's annual revenue. Moreover, YouTube does not need to pay taxes to upstream content providers, and it shares nearly half of its advertising revenue with creators on the platform, promoting the ecological benign operation of the entire platform.

On the road to becoming a giant in the audio industry chain, Spotify needs not only the head KOLs, but also thousands of small and medium-sized content creators. A win-win ecosystem like YouTube is clearly a model worth emulating.

Author: Chang Jiayi