What began as a music-only streaming platform evolved into a broader audio platform that included podcasts and audiobooks. Now, Spotify is venturing into video — in both snippets and long-form content, although the latter is only in an experimental phase.
During Tuesday’s Q2 earnings call, CEO Daniel Ek and interim CFO Ben Kung repeatedly referred to “the Spotify Machine” when explaining the company’s expansion beyond music. As Ek explained, the term means the company “isn’t just a sort of one-trick pony anymore, but it’s actually multiple verticals working together” to create more choice for consumers and drive more engagement.
“Because you may come for the music and stay for the audiobooks,” Ek said. “Some customers may come for the podcast and stay for the audiobooks.”
Trending on Billboard
The term makes sense: Spotify is an increasingly complex product with multiple moving parts, numerous audio and video formats, and a variety of paid tiers. Each new component to the machine is meant to make the company more valuable as a whole. Similarly, concert promoter and ticketing company Live Nation uses the term “flywheel” to describe how its various products and business segments provide momentum for the larger entity. But “the machine” has a better ring to it.
The machine is integral to becoming a sustainable, profitable company. As Spotify detailed in its 2022 investor day presentation, branching out from music will help improve its gross margins and become the profitable company it has long aspired to be. Music margins are roughly 30% of revenue — the remaining 70% goes to rights holders — and will top out at 35%, the company has said. At that 2022 presentation, Spotify said podcast margins can reach 40-50% gross margin and overall gross margin can get to 40% (gross margin rose to 27.6% in Q1 from 25.2% a year earlier).
The machine helps increase engagement. Spotify is more valuable if people spend more time using it. When engagement increases, churn decreases, which in turn reduces the expense involved in bringing those lapsed customers back. When engagement increases, free users are more likely to become paid subscribers. The last thing a streaming service wants is an infrequent customer who doesn’t enjoy the features or delve deep into its content. Audiobooks are a good example of keeping people hooked: Ek said that in the markets where audiobooks are available, 25% of users are listening to them. What’s more, in the first two weeks a Spotify user listens to audiobooks, Spotify sees “over two and a half hours of incremental usage on the audiobook side,” he said.
The machine gives users greater freedom of choice. Ek confirmed Spotify will have an audiobook-only subscription tier along with a music-only tier; the standard subscription tier offers both music and audiobooks. Over the years, Spotify has given consumers multiple options to choose from: an individual plan, a two-person plan called Duo, a multi-user family plan, and, in certain markets, the ability to purchase one day at a time. Spotify wants to provide “as much flexibility as possible in this next stage of Spotify” to convert more users to paid subscribers, Ek explained.
The machine is built to maximize value. Ek and Kung frequently mentioned a particular internal metric, a value-to-price ratio, that Spotify uses as a North Star these days. By adding podcasts, audiobooks and education, as well as features such as Wrapped — Spotify’s personalized year-end recap — Spotify delivers more value than it provided when it was a simpler, music-only service. Ek singled out the videos that Spotify has added in “11 or 12” markets and built anticipation for video clips that will allow artists to tell stories about their new releases. Such videos are one way Spotify is “focused on winning discovery” to make the platform a better listening experience, Ek said. Spotify’s recent foray into educational video courses in the U.K. is another stab at adding value.
The machine ultimately gives Spotify the ability to raise prices. When Spotify adds products and features, EK explained, it increases its value-to-price ratio. That, in turn, allows it to occasionally raise prices to capture the value it created. “The way you should think about this as investors is the better we can improve the product, the more people engage with our product, and the more value we ultimately create,” Ek said. “And the more value we create, the more ability we will have to then capture some of that value by price increases.” After more than a decade of value creation and stagnant prices, Spotify raised rates in July 2023. In April, it again hiked rates in select markets — including the United Kingdom and Australia — and is expected to expand those increases to additional markets.
The machine also requires a feat of engineering. “It’s a fairly complex machine,” Kung said, because Spotify has both variable-cost models, such as revenue sharing and per-hour royalties, and fixed-cost models — some in-house and licensed podcast content, perhaps. Ek added that “the machine takes care of all the complexity on the back end to deal with what was historically a very difficult problem to solve, which is multiple business models in one consumer experience.” Spotify’s engineering challenge is incorporating additional verticals into a seamless user experience without getting clunky — a criticism often launched at iTunes, which started as a music store and added videos, books, apps, podcasts and iTunes U, a place for educational materials. “Simplicity is hard,” a former Apple product designer once wrote. “Very hard. But when you get it, it’s beautiful.”
The machine might take some getting used to. As Spotify branches out to non-music verticals, it has stakeholders other than the music rights holders, artists and songwriters it has served for more than a decade. Now, Spotify also supports podcasters, authors and — although in the early stages — educators. That has already created some tension between music publishers and Spotify following news that Spotify considers its music-audiobook subscription offering to be a bundle under the Phonorecords IV mechanical rate structure in the United States. Subscription bundles allow Spotify to pay a slightly lower royalty rate. But really, is anybody surprised that the machine is trying to save a little money?