The Business of Streaming

by Overheard Wall Street

The global music industry has experienced a seismic shift in the way music is consumed, with a staggering 26.4% surge in music streaming subscribers to 523.9 million during the Covid pandemic. In the US, music streaming now accounts for a whopping 84% of the industry's revenue, with 82.1 million Americans now paying for on-demand music streaming. Americans are streaming an average of 75 minutes of music per day, with 3.6 music streamers for every paid subscription. 

The music streaming industry has dramatically changed the business of music in several ways. Prior to streaming, the music industry was primarily based on physical sales, such as CDs, vinyl records, and cassette tapes. The major music labels controlled the distribution of music through deals with retailers and music stores, and the sale of physical albums was the primary source of revenue for both the labels and the artists.

The Business of Streaming

With the rise of music streaming services like Spotify, Apple Music, and Amazon Music, the business model of music companies has shifted from physical sales to digital distribution. The music industry now generates revenue from subscriptions, advertising, and data analytics. Streaming services have also created new opportunities for artists to reach a wider audience and earn revenue through streaming royalties.

Streaming has also transformed the way in which music is consumed. With the ability to access millions of songs on-demand, listeners are no longer limited to the music that is available in their local record store or radio station. This has allowed for greater diversity in music tastes and has created new opportunities for independent artists to gain exposure and build a fan base.

However, streaming has also raised concerns about fair compensation for artists, as streaming royalties are often much lower than what artists would earn from physical sales. 

History of Streaming

The music streaming industry has rapidly grown and evolved over the past few decades. The first music streaming service, called Rhapsody, was launched in December 2001. However, it was not until the launch of Spotify in 2006 that the industry really took off.

Spotify, which was founded in Sweden, was one of the first music streaming services to offer a freemium model, allowing users to listen to music for free with ads or pay a subscription fee for an ad-free experience. This model proved to be successful, and Spotify quickly gained a large user base.

Other music streaming services soon followed, including Pandora, Apple Music, Tidal, and Amazon Music. These services offered different features and subscription options, such as curated playlists, exclusive content, and higher-quality audio.

In recent years, the music streaming industry has faced some challenges, such as disputes over royalty payments to artists and labels, and concerns about the dominance of a few large players in the market.

Streaming Business Model

Music streaming companies primarily generate revenue by charging users a subscription fee for access to their music library, as well as by selling advertising space on their platform. Their business model involves acquiring music licenses from record labels and artists, then making that music available to users through their platform.

In terms of revenue, music streaming companies generate the majority of their income through paid subscriptions. The monthly subscription fees vary, but typically range between $5 to $15 per month. Some companies also offer ad-supported free tiers to users who don't want to pay for a subscription.

Advertising revenue is another significant source of income for music streaming companies. They generate revenue by selling ad space on their platform to advertisers. Companies like Spotify and Pandora also offer sponsored playlists and branded content as part of their advertising strategy.

Their main costs include music licensing fees, technology infrastructure, employee salaries, marketing and advertising expenses, and other overhead costs.

Universe

Here is a list of music streaming companies in the US, ranked by monthly active users:
  1. Spotify ($SPOT) - 489 million users/205 million paid subscribers (as of Q1 2023)
  2. Apple Music ($AAPL) - 406 million users, 55 million subscribers (as of 2019, Apple hasn’t released figures in a few years)
  3. Amazon Music ($AMZN) - 55 million paid subscribers (as of Q1 2023)
  4. Pandora ($SIRI) - 47 million users, 6.7 million subscribers (as of Q1 2023)
  5. YouTube Music ($GOOGL) - 2 billion users, 50 million subscribers (as of Q1 2023)

Spotify Spotlight

Spotify has become a leader in the music streaming industry through a combination of innovative features, a vast library of music, and a successful business model. Spotify had 489 million monthly users as of February 2023, including 205 million paid subscribers.

Here are some of the key factors that have contributed to Spotify's success:
  1. Early entry: Spotify launched in 2008, before the music streaming market had become too crowded. This allowed Spotify to establish itself as a dominant player early on.
  2. Vast music library: Spotify has one of the largest music libraries of any streaming service, with over 100 million tracks available, as well as 5 million podcasts. This extensive selection makes Spotify an attractive option for users looking for variety and depth in their music choices.
  3. Algorithm/Personalization: Spotify's algorithms use machine learning to personalize music recommendations based on a user's listening history and preferences. This personalized approach has helped Spotify retain users and increase engagement.
  4. Successful business model: Spotify's business model is based on a freemium model, where the company offers a free version with ads, as well as a premium version with additional features and no ads. This has allowed Spotify to generate revenue from both advertising and subscription fees.

Spotify went public in 2018 and has since been listed on the New York Stock Exchange (NYSE) under the ticker symbol "SPOT." The company has experienced rapid growth over the years, and its investing outlook is trending upward.

Financial Outlook

Spotify's revenue has grown consistently over the years, with a revenue of $12.81 billion in 2022, an increase of 21% from 2021. The company's revenue comes primarily from its premium and ad-supported subscriptions.

EBITDA had been positive since 2016, so last year’s -$514 million was an anomaly as Spotify struggled to compensate for its expensive podcast deals. In 2021, Spotify's EBITDA was $399 million, up from $202 million in 2020.

Spotify's profitability has been a point of concern for investors as the company has struggled to turn a profit since its inception. However, the company has made significant progress towards profitability, with its operating loss decreasing by 62% to $42 million in 2021. The company’s net loss in 2022 was $470 million, but the company instituted layoffs and is considering raising subscription fees.

Business Strategy

Spotify's business strategy revolves around three pillars: content, distribution, and engagement. The company aims to offer a unique and personalized listening experience to its users while also expanding its reach through partnerships and collaborations with other companies.

One of the key catalysts behind Spotify's growth is its focus on innovation and customer-centricity. The company has continuously updated its platform with new features and capabilities to enhance the user experience. For example, Spotify was one of the first streaming services to offer a personalized music recommendation algorithm based on user preferences and listening history.  

Another factor that has contributed to Spotify's growth is its aggressive expansion strategy. The company has expanded into new markets around the world, including Asia and Latin America, which has helped it increase its user base and revenue. Additionally, the company has forged partnerships with hardware manufacturers such as Samsung and Amazon, which has helped it reach even more users.

From a financial perspective, Spotify's strengths include its recurring revenue model and its ability to generate high gross margins. The company's subscription-based model ensures that it has a steady stream of revenue, while its gross margins have remained consistently high due to the low cost of content acquisition. However, the company has struggled to turn a profit, with losses reported in the majority of its quarters. Additionally, the company faces stiff competition from other streaming services, which may impact its future growth.

Podcast/Profitability Problem

The key question for investors is: was last year an anomaly, or did Spotify truly take a significant step back after its podcast deals? Were Spotify’s layoffs and writing off podcast losses enough to reset the company’s fundamentals, or is there a larger threat to the company’s business model?

Here are some of the key issues holding Spotify back from a path to profitability:
  1. High royalty costs: Spotify pays a significant portion of its revenue to record labels and artists for the right to stream their music. This can be a major expense, especially as the number of subscribers increases.
  2. Intense competition: The music streaming market is very competitive, with a number of players vying for market share. This can lead to increased marketing and development costs in order to keep up with competitors.
  3. Expansion efforts: Spotify has been expanding into new markets and investing in new features such as podcasts and live audio. While these efforts may pay off in the long run, they can be expensive in the short term.

Spotify has invested heavily in podcasting, which has become an increasingly popular medium in recent years. But after throwing the bag at celebrities and shoring up podcast deals with Joe Rogan, the Obamas, and the like, Spotify lost a staggering ~70% of its value during 2022.

However, despite these setbacks, Spotify remains determined to bounce back and is currently considering raising its subscription prices to help shore up its finances. Even a modest $1 price increase to Spotify's premium plan would lead to an extra $200 million in revenue, providing a much-needed boost to the company's bottom line. 

Spotify's stock has bounced back 63% YTD due to a string of cost-cutting methods.

Bulls
  1. High Engagement: Spotify's users are highly engaged with the platform, spending an average of over two hours per day listening to music, podcasts, and other audio content. This high engagement makes the platform attractive to advertisers and creates opportunities for monetization.
  2. Strong User Base: Spotify has almost 500 million users, including over 200 million subscription-based members (strong recurring revenue).
  3. Diversified Revenue Base: Between its advertisement revenue and subscription base, Spotify has multiple ‘moats’ to ensure it’s bringing in revenue.

Bears
  1. Competition: Spotify faces fierce competition from other music streaming platforms such as Apple Music, Amazon Music, and Tidal. This competition may limit Spotify's ability to increase its market share or raise its prices.
  2. Profitability: While Spotify's revenue has grown steadily, the company has yet to turn an annual profit. This may be a concern for investors who prioritize profitability over growth.
  3. Dependence on music labels: Spotify relies heavily on music labels to provide content for its platform. Any changes in licensing agreements or pricing may have a significant impact on Spotify's operations and financial performance.
  4. Regulatory risks: The music streaming industry is subject to complex and evolving regulations, which may increase compliance costs or limit the company's ability to operate in certain markets.

Conclusion

In conclusion, despite facing numerous challenges in recent times, Spotify's expansive reach and position as a leading player in the music industry make it an attractive choice for those seeking to diversify their portfolios with a music exposure. The potential for growth is evident as analysts predict that the streaming giant could achieve profitability by 2024. 

It's worth noting that Spotify's stock has risen by an impressive 63% this year, although it still remains 63% below its all-time highs. This presents a potentially enticing buying opportunity for those who believe in the company's long-term prospects. 

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