Spotify
[Stock Geekout Ep 3 – 15 May 2021]

In Episode 3 of Stock Geekout, we geek out on audio streaming company Spotify with resident stock geek Thomas Thio.

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podcast Transcript

Reggie: Today in TFC Stock Geekout, we’re going to explore a company you Coconuts are very familiar with as a user. They have fundamentally changed the way music industry works today, creating an ecosystem with a suite of technological tools and user base. Recently, they’re going on a mission to consolidate the podcast space. They have been making multiple big acquisitions from content powerhouses like Gimlet to superstar Joe Rogan to podcast tech [indiscernible] like Anchor. They are spending their hearts out. 

So joining me today to geek out on this audio giant will be Thomas Thio, our stock and tech geek. Who better to go into this than him? We explored Spotify, breaking down its business beyond a product, understanding who are its competitors, how are its numbers coming along and whether or not it can actually become a successful player. Pun intended… especially when big boys like Amazon, Apple and Google are all attacking it. 

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For the sake of reference, this episode was recorded on 15th of May, 2021, and released early to our community members. Our discussion today is solely for education and entertainment purposes only. It does not serve as any form of advice or recommendation. Thank you for loving what we do and empowering us financially to do more for you. Let’s geek out!

Welcome back. Today, we are once again in the house together with Thomas. The other time, we talk about Facebook and you’re a tech geek. You definitely have a lot to talk about in the tech space from investing, from engineering viewpoint. So what are we going to be discussing today?

Thomas: Today, we’ll be going through Spotify. 

Reggie: Spotify. I think a lot of people may be listening on this on Spotify. So yeah, not a foreign company, but I think same as Facebook for a lot of these tech platforms, a lot of us, we are users, right? So we only use it from one angle, but we don’t actually understand the whole business as a collective as there are many other business processes within this thing. What does it take to make a Spotify? How did they become who they are today? 

Thomas: I think originally they started out with all these kind of mass consumer, low cost streaming model and they slapped on a paid model on top of it. So you remove the ads, it’s a premium listening experience. But recently, I think what has been interesting is that they’ve been going into podcasting as well and that’s a avenue which is quite new for all of us, but it seems like on its metrics, the take up rates are quite good.

Reggie: Yeah, insider information has it that our traffic for our podcast, 70% comes from Spotify. So yes, they are picking up most of the traffic in the podcast space. I think they have a much better user experience and they’re not shy on leveraging what they already have in the music streaming space.

Since a lot of these people that listen to music are also podcasts listeners. So that’s kinda that’s where it is. Yeah. Do you want to walk us through what is their main products since they have new stuff coming up? Their OG is music streaming, so is it the same like how we should look at it from like a Netflix angle? How does that work?

Thomas: I think Spotify is very seamless. You can just open any app and just play whatever you want. But for it to actually get there, there’s a lot of work that they actually needed to do to get you exactly what you need. Maybe we can split them into some of these components of Spotify. Then for those listening, you can just play around and say “oh, I didn’t know this feature existed.” 

The first one, maybe when you listen to music for the first time, you see like it’s pretty bare bones. You see a list of recommendations, it’s like “why? I don’t even listen to this stuff. I’ll just try that.” So Recommendations is basically trying to figure out what is your music tastes, your preferences. After one or two listens… or maybe you find some other soundtracks from elsewhere, you Shazam it and then you open it on Spotify. Spotify starts to…

Reggie: Shazam… wait, does Spotify own Shazam now? 

Thomas: No. Spotify integrates with Shazam. So me at least, I use it to try and figure out what is that song playing in the background. Let’s say you go to a cafe. “Eh this beat is nice”. 

Reggie: Yes, exactly. When I’m on a Grab, this uncle play a song. I was like “wow, this is like classic. Very cool song. What is it?” Then just Shazam it. 

Thomas: You paiseh (shy) to ask uncle, so you Shazam behind. 

Reggie: Modern day paiseh. It’s an interesting new phenomenon. Yes. 

Thomas: So actually, all these integrations are also pretty useful. You may not know that actually Spotify has a lot of different types of integrations and they all link back to these Recommendations, which is the core of their product, which is why you keep listening in the first place.

You can just shuffle a playlist and then it’s basically the next thing that you don’t mind hearing. If you don’t like it, then you can just jump to the next one. I think that’s not an issue, but it’s what makes it sticky. 

Reggie: Is this all similar to what we discussed about Facebook the other time where Facebook do all these different things to collect your data so then they can better aggregate the experience for advertisers? So Spotify is doing all of these different things to aggregate the data so they can better curate experience for the consumer?

Thomas: Yeah, exactly. There’s a whole different set of algorithms, designed just for sound, so it’s pretty interesting. We can talk about it another time. 

Reggie: Nice. 

Thomas: Shazam, for instance, for Spotify, there’s a certain beat, maybe certain BPM (Beats Per Minute) that you like or certain segments or like a chorus, maybe you like it very much. They would try to find something very similar to that and recommend you as the next thing to play.

So this is pretty different from the Facebook ones, which is looking at maybe more static kind of data. It looks at different kinds of dimensions and all that like your location, where have you last been and all that kind of stuff. Sound is a very different type of data, but yes, there’s machine learning and AI (Artificial Intelligence) going on to recommend you the best one possible.

Reggie: That’s why the hit rate is very high. So far, I think Spotify recommends me pretty good stuff. I do enjoy most of them. 

Thomas: And you would pay for it?

Reggie: The thing is I’m getting sufficiently irritated with the ads that I am going to pay for it very soon. You will probably see me pay for it in a month or two as I get more irritated with ads because I used to only use Spotify for podcast and in the podcast set, the ad is actually determined by the podcasters. So no random injection of Spotify ads and a healthy eating campaign, what kind of weird shit there is. 

That experience was a lot more curated from a podcast standpoint and that was great, but sometimes I get tired of podcasting and I want to listen to audio. I want to listen to music, favourite genre piece. I wanted to get some peace, but it’s not peaceful at all because 15 minutes in, there will be ads. 10 minutes in, there will be ads. So I think the ad experience is a way of pushing me to want to pay for premium. That’s an interesting thing that I’m experiencing from a user stand point. 

Thomas: Actually that’s a really good observation, because most other people also face that. It’s to do with their pricing models for Spotify as pricing models. Other than the Recommendations, you’ve got things that you can discover on a weekly basis rather than you get recommended next song and next song. Sometimes you just want to take a break and then when you come back… woah, it’s a fresh list of songs you’ve never heard before, but they’re all nice! Oh my gosh, and you’re just going to binge listen and things like that. 

You’ve also got a Release Radar. So Release Radar is basically a radar for upcoming releases and you have to really talk about the daily mixers. These are the things that you hear on a daily basis. So Recommendations is a core part of Spotify. Of course, there’s other kinds of things which is common in any music paying app where you have playlists. You have your own different kinds of collections of music. This is a song that you really like or brings you into the mood… the mood for gym, the mood for studying, staycation mood, all that kind of stuff. So you can put this into…

Reggie: You are thinking of night mood, right? 

Thomas: Chill, night mood. I don’t know what you are thinking. 

Reggie: Yeah, Netflix and chill, Spotify and chill… okay continue, continue. 

Thomas: You can share these collections with people. Music is a very community thing, actually, right? It’s like… maybe olden days, there are tribes and all that. They bond together with music. So when you share similar taste or genres with other people, you are including them in that kind of social dynamic.

So that’s pretty interesting where Spotify helps you to curate the “good” songs that you find for other people (close inverted commas) and then you share it to other people and you say “oh wow, your music tastes are so good.” Actually, it’s Spotify behind the scenes. For those who are not familiar with Spotify, when your friends are actually recommending really good songs, ask them where they got it from. It was not from YouTube or something. It’s probably from Spotify. 

Reggie: Premium users of Spotify. 

Thomas: Yes. Yes. 

Reggie: So that’s like the user part, right? You have all these different recommendations and all these features to help you curate a great music consumption experience. How do they then push you into the premium model? Do you have some thoughts on that? Because you can use it for free with random ads disturbing you, but then they’re trying to do the whole premium… they call it a freemium model: free first and then try to upsell you into premium. So how does that work in your view, their methods of doing that? 

Thomas: Sure. So let’s talk about the music part first. For music, if you happen to find a song online or somewhere, you open the link to Spotify, you can play that song maybe once directly. Any time else you want to add it to a playlist, you don’t get to actually play the song directly. You have to go through the entire recommended playlist and eventually you might hit the song that you wanted to play. 

It’s a good and bad thing because it invites you to add more songs which sounds like the thing that you want to play, so it recommends you more of what you want to play. 

Reggie: More data. 

Thomas: But it is annoying because you just want to play that one song, 

Reggie: Exactly. 

Thomas: Something’s stuck in your head and stuff like that. You don’t get there with the free experience. They will prompt you sometimes with advertisements, so in between… 

Reggie: Sometimes? Every time! They are prompting me again and again. Every five songs, there will be an add prompting me “hey, do you want a better Spotify experience? Join premium!”

Thomas: Spotify’s AI is like “Reggie, it’s time. It’s time to upgrade.” 

Reggie: Oh my goodness. It’s crazy. 

Thomas: So there are two different types of ads. Do you see the one which pops up if you use on your PC or your Mac? It’s actually visual ads that appear. 

Reggie: Wow, there are visual ads now? 

Thomas: Mmm, there are visual ads that pop up. So whenever you choose a new song, that appears. Immediately after a song that has finished, it has these kinds of… is it the correct term: interstitial ad? It’s more like sound ads. I’m not sure what’s the correct term. 

Reggie: Yup, yup. Let’s just call it audio ads. 

Thomas: Audio ads… These are in between the next song that you want to play or the next recommendation. So this gets annoying after a while. You’re like argh, the sound is so good but then they have all these blockers in my way of a good sound experience. Then you are like… 

Reggie: Yes. 

Thomas: “Spotify… the free trial (is) running out already. Ok lah, agree lah. US$9.99. It’s ok.” 

Reggie: Yeah, it doesn’t sound too bad. 10 bucks, okay. Let’s do it. That’s the very powerful freemium model which we can talk about later because apparently the numbers are not as sexy, at least where we’re seeing average revenue come down. That… we can talk about slightly later. 

But we also spend some time to talk about… since we’re at the process of understanding this whole product, we also need to understand that hey, it’s not just the front end user experience. There’s the backend for your creators, for your artists, for your professionals that are providing content for the platform. So what does Spotify do for these guys?

Thomas: Right, right. So Spotify has a really good backend platform for these creators to…. 

Reggie: Some creators will beg to differ because Spotify is paying very little for stream, but we can talk about that later… compared to its competitors, but yeah. Let’s please continue. 

Thomas: I see some tension there. 

Reggie: Yeah, yeah, yeah. Whoa, whoa, whoa. 

Thomas: All right. Spotify has… let me rephrase. Spotify has a not bad interface for creators to actually do their content. They have this tool called Canvas. Basically it’s like a looping visual for each of the tracks. When you play, say like a CD last time, right? Your CD, you have your record label, you’ll have your label art and all that kind of stuff. It looks nice, aesthetically pleasing. 

How do you produce that on a digital platform? So this is what Canvas does and it tries to make it interesting such that it will keep looping or you can look to any other visual to make the experience a little bit nicer. But this is actually quite engaging as compared to having nothing at all. So artists usually use this.

We also have the ad creator. Basically, it’s for advertisers. But also, this is something that may or may not be a good experience. You can put in audio, video podcast ads and all that, but what’s powerful about it is the capability, right? So you can target certain kinds of fans, customize the experience for your fans. This puts a lot of control onto the artists. It puts a lot of control to the ad creators as well. 

Reggie: Give a little bit of context for the ad creators. I think at this moment in time, Spotify is extremely sophisticated with audio, like music ads, right? They’ve spent a lot of time… that’s how they all build up. Between songs and all those kinds of stuff, they have done a great job in terms of building that whole ad marketplace and ad structure for advertisement and music. 

But the podcast space, they are still very young, it’s still very scattered. They acquired a few people. It is not as integrated yet. We’re still in the process of trying to build this ecosystem and nobody in the space has built that end to end experience yet. So Spotify is one of the leaders in trying to make this an end to end from a user standpoint, content creator, even to the advertiser standpoint, even on the podcast side of things. Still very early days in this thing, let’s make sure we put this out there. 

Thomas: To clarify, the podcasting space is still very recent and very new, Even for Spotify, they’re still trying to figure things out of how to actually optimize this for the podcasters as well as for the listeners . 

Reggie: Everybody is still figuring out, podcasters thinking about how to make money. We’ll figure that soon, yes.

Thomas: The next other thing I think is very useful, whether it’s a music creator or a podcaster would be the statistics. You want to see how many streams, what’s the performance of your podcast, how many people have seen it from where and stuff like that, and where are they actually discovering it from? 

I think the earlier example, we talked about Shazam and then to Spotify, right? Maybe that’s how I usually find out about new music. But for others, it may be very different. It’s pretty useful if we know this, because basically that’s where perhaps the bulk of your listeners will be. It’s perhaps something that you can also determine, the behaviour of these listeners. So from a sound data standpoint, these are very important as compared to Facebook, you have very static… “oh, I already know where the customer is. I already know the customer profile and all that kind of stuff.” 

But sound is very experiential. You could be on the go. You could be listening on your phone or you could be listening at home, let’s say in Covid times. These all matter, because the experience to switch between a phone to… let’s say you are using the phone halfway, you reach home already, then you cut off. I’m not able to listen to the song anymore. I switched the song and that’s it. The stream just got cut off. 

So you know that you shouldn’t maybe be releasing the songs in a certain time or maybe everyone just listens to your song on the bus, for example, on the train. That’s awesome. But you shouldn’t be listening to the song on the way back to home then kena cut (got cut)… that kind of stuff.

Reggie: Those data… extremely important to creators. I don’t speak for music creators, but I speak for podcasters. Amongst all the different platforms, I think Spotify provides one of the most comprehensive dataset from what is the stream numbers, where does it drop off? Because a lot of other platforms, they only tell you downloads. They don’t tell you what is the listen through rate, which is very important from an audio experience standpoint. So we’re very proud to say that our listen through rate is about 70+%. Woo! That’s great, because that means we’ve done a good job in trying to make sure the experience end to end is great where someone will listen through all the way to the end.

That’s extremely important from an audio advertiser standpoint, also from a consumer standpoint and from a sponsored content and creative standpoint. So I think that is like a one up for Spotify providing us all these content. But the thing is Spotify can give me all these content. It does not restrict me from streaming onto other people’s platforms also. 

Thomas: Oh, that’s awesome.

Reggie: The content gives me the reality as to what are audiences interested in, what is the kind of content format that works? But it does not say that I cannot refine it to test it on Spotify and prove that this structure works and then stream it on Apple and Amazon and Google and everywhere else.

Most of the podcasters actually do that because there’s a third party hosting platform. A world of difference here, but yeah, Spotify is definitely doing a great job in providing analytics for a lot of the audio content creator. So kudos to that. 

Thomas: Nice, nice. Yeah. So you can use Spotify like a proxy to go and determine… even let’s say it’s on Apple Music or Prime and stuff like that, but roughly your audience segments behave the same way.

Reggie: Should be the same. 

Thomas: Yeah. I think this is really handy. Yeah. 

Reggie: That’s a powerful thing. 

Thomas: The only complaint is the interface. 

Reggie: Overall, I think they’re doing a good job. Honestly, from my view as a consumer, as a producer, a content creation platform, I think they’re doing a very good job. One of the leaders in this space, from the product standpoint. But I’m relatively concerned about the business side of things, because there are not dominant. They’re not Netflix yet. When Disney comes in, when all these other guys come in, Netflix was already the big boy and all these guys come in to try to eat their lunch. 

But Spotify is at best a one-third player this game. There are a lot of other players, so they’re not dominant and all these other people are already fighting them. So I’m not sure if they can become that dominant player which is extremely important in a content streaming business, because the costs, the marginal costs is limited, right? Marginal cost per content piece creator is limited. The upside is unlimited. So every dollar that creates content… the more you stream, the better it is. There’s no upside cost, but can Spotify do that? Can we head towards that? 

That is the discussion, which is why they bought Joe Rogan. They do all this Spotify Exclusives and all those kinds of things which will be interesting and we can explore. But let’s take our time now that we understand the overall business from the user, artists and what do they actually do in between, all these important products and processes… 

Let’s run through the business model. How do they actually make money and where is their revenue coming from based on their business model?

Thomas: So a good 90% of that actually comes from the premium monthly subscriptions. The 10% only comes from the display ads or those kind of sound bites in between your music, so very much heavy on the subscriber base. They are very much looking at the loyalty of the customer. In this sense for subscriber, how long are they actually with the company? You want to have more people that stay on with the subscription and they don’t churn. I think we can go into the metrics data later. 

Reggie: How does this work? Let’s go in, man. Let’s go in now. How do they… 90% of their revenue comes from subscription, so how is that part of it business doing?

Thomas: That part of the business is actually like what you mentioned, the average revenue per user is actually falling. But what’s been happening is that the churn rates are reducing, so that’s a good thing. So what is the churn rate? Basically, it means that someone subscribed and then after a while, they unsubscribe. Then you lose a customer, you lose a paying customer, so they convert back into a free user or even worse, they don’t use Spotify. 

So what Spotify is trying to do is that yes, we sacrifice the short-term profitability for a long-term strong customer base that can give us this more stable and reliable revenue. 

Reggie: So what are the numbers looking like?

Thomas: Global paid subscribers, you have about 144 million globally. This makes up 45% of the monthly active users. Monthly active users is another metric. Basically, it’s the number of active listeners, paid or unpaid.

Reggie: Because it’s a freemium model, so a lot of people use free and then they try to push everyone up the premium side of things. 

Thomas: Right, and of course there’s different tiers. This number, it comes from basically all the different kinds of tiers. Maybe some people on a student trial, some on family plan and stuff like that. So you times that number and then… 

Reggie: I keep hearing that family plan ad also.

Thomas: Sharing is caring… the next one we talk about is average revenue per user. Basically, this has been declining. So from 2019, $5.50 and then 2021, it went down to $5.10. If you plot out amongst all quarters, this has been steadily declining, as you mentioned.

Reggie: Okay, I think an interesting thing to note is Q4 2020 actually came down to $4.26 per user. So that’s an interesting thing to note. Let me give you a little bit of what I believe is the causation. Based on our experience running the podcast, when people stop traveling, people stop moving, audio consumption actually comes down. Video consumption goes up because people are static at home. Audio is extremely flowy. You listen on the commute, so that is the kind of content that works extremely well on commute. 

But at home, nobody really listens to audio and we have cross-checked with all the other podcasters and major media players here in Singapore. Everybody says that during lockdown, audio consumption came down. So that may be a reason why revenue came down, as a result of lock down. People don’t feel the need to pay a premium for Spotify and people can potentially be cutting back on costs in that sense. 

So that’s my very shallow causation prediction. That may be a thing because if not, then it’s very hard to account for the anomaly in the trends. But we are seeing average revenue coming down and in your words, you believe that it’s because of pricing. They’re bringing down pricing so that they can get a bigger base. Is that what I’m seeing?

Thomas: Yeah, but this insider perspective is actually really useful. It’s to do with, again, the dynamics of how people consume different types of media. I have never thought of it. 

Reggie: Yeah, extremely important. If you are not using it, then you will close it. You will not pay for it. It’s kind like how I stopped paying for SG Bikes because I bought my own bike and because the SG Bikes too jialat (bad condition) already. Not enough bikes still tell me the SG bikes… but anyway. Side topic. 

Back to this thing… tell us a little bit about the free guys. The guys that are doing the ads or the guys that are coming in from the broader picture of the overall app, because the freemium is only the very top guys. Although they’re paying 90% of revenue… it’s coming from the premium guys, but the business model is a little bit bigger than just a premium. It’s like how Dropbox does it and all the other freemium guys. Free a lot, they also spend a lot of time acquiring customers in the free space and then they try to premiumize them. So paint us a rounder picture on this whole thing. How do they actually do it? 

Thomas: I wouldn’t say they purposely irritate you to the point where you upgrade. 

Reggie: Personal experience tells me otherwise, but yes, I get it. They have done some consumer research to a point where it irritate you sufficiently to upgrade, but don’t irritate you enough for you to delete the app

Thomas: We put it in a nicer way. They’ll give you a free look into their premium experience so that your sound experience with Spotify is exquisite and you will want to upgrade. 

Reggie: Branding, marketing angle. Yes. 

Thomas: And then you will know the the big difference one is once your free trial ends. So this free look basically is for a freemium model, they usually have these free trial periods. If you’re new to Spotify, maybe they check that you have never used it before. How about three month trial? Just try out and if you like it, you subscribe. If you don’t like it, then just use the free version and then you experienced how bad it is. 

But for the free trial, actually it’s very important because people just want to know “what am I paying for?” Is this content, is this quality going to be as expected or not? Is it as good as what my friends say? what your friend says, usually you will trust because it’s basically… it’s a circle of your influence and things like that, which brings onto other kinds of plans. 

There’s a family plan. It doesn’t have to be your direct family and all that by just saying that basically you can share the subscription. Maybe amongst three people, you can share the subscription and you can just use it whenever and of course the total net price is going to be lower. So you share the cost amongst each other. That spreads the usage across, say your friends. Some are heavy users, they can still use. Some are very light users here and there, but just want to try. But they finish their free trial already then sure, just hop on board. 

Reggie: Okay, okay. You want to paint us a little bit picture of how intricate some of these marketing efforts are actually? It’s not randomly they decide… give you free trial, randomly give you three months, right? Actually, a lot of these tech players, they have very intricate processes at the back. So you want to give us a little bit of clarity there? How is it decided? 

Thomas: From a marketer’s angle, we look at it in terms of a campaign. Every campaign has a certain kind of a target segment… your audience which you want to apply the campaign on to. Now with the data that Spotify has, they know, for example, when you first signed up. They can also know where’s the point where you put in your credit card, haven’t paid yet, but you just put in your credit card because they asked for a free trial. 

They also know the point where… the optimal point where people actually convert. That’s the time when they actually can be more influential about it by putting an ad front of you to say “please try our premium features. Your free trial is expiring soon”… things like that. Or they can put in sound bites in between your music as well.

So the frequency can increase depending on which stage of this whole cycle of acquiring a customer you are in. All these have different kinds of segmentations which marketers do have access to in… let’s say Spotify’s own company backend. They are able to automate all of this. Basically, once you are registered, they start clocking in when you’re listening, when you are actually… all your data belongs to them.

Reggie: Yes, yes. That’s the powerful part. Where are they in the business environment at this point in time? What is their market share? What is their growth looking like in this space? 

Thomas: For market share wise, actually they have about 35% of total paid subscriptions if you’re comparing to all other kinds of competitors. So what are these competitors? YouTube Music, Apple Music, Amazon Music. You have other, maybe smaller players like Tencent music and stuff like that. Out of the total, actually 35% is not bad. But then again, there are other much, much larger players, like full scale, huge tech companies that’s going to these spaces. 

Reggie: Yeah, exactly. These are paid subscribers. What about the overall user base? Are they the biggest or what are we looking at from a user base standpoint?

Thomas: For this one, I only have 2018’s data. Basically, they have a 70% market share of global streaming revenue, but it didn’t say anything about the listeners of music. 

Reggie: Nice, and I think that is pretty coherent with our personal experience here. 70% of our audience come through Spotify. I think they are indeed one of the biggest guys and then they try to make you pay premium on that. What are their financials looking like then, being a one-third big player in this paid subscription space?

Thomas: So, revenues first. We see that increasing in Euros, in billions of Euros is €2.1 versus €1.85. So that’s a 17% change year on year. That’s okay, but we want to also know how’s their expenses like, how their margins are. This is where maybe you take a backseat and then you say “okay, is this a company that I want to invest in or not?” 

Here’s why. Operating expenses went up a lot. It went from a gross profit of €575 to -€69 operating loss. These are in millions. For some reason, one quarter you’re spending €700 million plus… is it the Joe Rogan acquisition or something? This is huge.

Reggie: Did you manage to find out where do they spend their money?

Thomas: No.

Reggie: Okay. I think Spotify has been going on an acquisition process… buying other platform players in the podcast space, buying a lot of these big brands in the podcast space. I think they’re doing a lot of these kinds of content acquisition process. They are also taking out a budget to do originals. So I see this similarity with Netflix and also, essentially the similar problem with Netflix, endless need for more content, more content, and more and more expensive, more and more expensive, more and more expensive.

Why? We will talk about Netflix another time. So usually what they do is they will sign a one season plus two season extra licensing thing. So if it makes a hit, then they could do three seasons. But then after three seasons, the same crew and cast and producers will mark up a lot or they will sell this whole thing to HBO.

So it’s the same problem that Netflix face is they use their platform and their power to grow a brand that is not totally theirs because they only signed for a fixed period of time. Once it becomes big, they have to multiply their cost of production. They may be taking on this route and it can be a cause of concern depending on whether they can outrun their revenue based on the content cost that’s going to keep amounting.

Thomas: Yeah, I do see it as a bit dangerous because every time they have to do this, basically it’s just shelling out more and more cash. We haven’t even talked about say, other competitors that’s doing it as well. So let’s say for example, Netflix. How are you going to beat Disney+ if the whole Marvel Universe, Star Wars and everything is there? It captures everyone’s eyeballs for the next nine months at least. Netflix is like oh… I’m even hearing from friends who unsubscribed from Netflix. Nothing to watch! That’s terrible. That’s terrible. 

Reggie: Exactly. When Disney+ came out, when Disney announced that they’re going to do Disney+ Disney shares went down by 15% and I bought a hell lot during that period of time, because if anybody could fight Netflix, it’s Disney. Because Disney has no need for marginal costs for content creation. They are already creating like mad! That is like part of their business model. Streaming is just an extra distribution. So if anybody can fight Netflix, it’s Disney. 

But I think the train has left, for the Disney train. We can talk about Disney another time, but on Spotify, it’s definitely a cause of concern. How does that play out in the way you evaluate other parts of their financials in terms of their debt, in terms of the cashflow? What are we looking at?

Thomas: I would say that that’s a very pro stock tip there. Thanks for that. 

Reggie: No recommendation, no tip here. We’re in a discussion mode, discussion mode. 

Thomas: For cashflow, again, comparing year on year, it’s €0.29 billion. So that’s €290 million vs a -€0.2. It fluctuates. One reason why is because they have this kind of accounting concept of deferred revenues. Any time they change their pricing plans, when they change it, this gets affected and it also gets affected by the number of people that unsubscribe, resubscribe, and the people that are totally new to the subscription.

Some people… they actually have a subscription before and then they let the free trial end, for example, or they let their existing subscription end and then they re-sign on after that, after a certain period of time. So this cashflow part is a bit lumpy.

Reggie: But overall, we’re seeing revenue and cash coming in stable, although it’s just counted lumpy. Is that what I’m hearing? 

Thomas: Yes, yes. 

Reggie: Okay, okay. So not a big cause of concern in that part. 

Thomas: Cash is still coming in depending on what kind of investor you are. Some will prefer steady cash flows, cash in the bank always increasing, not up, down, up, down that kind of thing whereas some people actually don’t mind that kind of volatility in terms of cash. Up to the person to decide. 

Margins wise, this one… operating margin actually decreased. It’s -3% compared to -1%. Very… too close for comfort. The amount that they are making is just a sliver. I think it could be a little bit more, but same could be said for any other subscription kind of companies with the need for these kind of expenditures. 

Going back to the discussion about the expenses, having to shell out more and more cash, I think it’s definitely going to impact these margins. 

Reggie: Yes, and it doesn’t help that there are competitors, all these big boys with other places to make money. I think a lot of people, when they look into growth stocks, they always see “wah, very exciting! Grow, grow, grow…” But you need to realize that when you are competing with Apple Music, Apple can continue to sell computers and invest in music. YouTube can continue to sell you videos and invest in music.

But Spotify has no place to sell something else and invest in music or invest in podcast. So I think it’s a similar thing where a lot of growth companies will struggle, which is why there’s this whole thing about “oh, Amazon is out of this business. Yay! Amazon wants to come in. Oh shit.”

So I think a lot of investors, especially the younger ones that are newer in this investment space, you need to recognize that hey, growth companies are great. They’re growing very well. They’re interesting. They have a big future. They may become the thing. But as they’re growing, if all the big boys start to see that there is a business here, they have a whole machine of cashflow generation that they can then take the money and then double down and attack you. 

I think what we see from their financials is that at this moment in time, Spotify is in the heat of the combat. They’re trying very hard to be in the music space. It’s not super profitable, but then they’re taking on this new other podcast thing because all these other big boys are coming in to take on their music pie.

Whether or not it can come out, big question mark. I think maybe highly dependent on management or highly dependent on their team. What do you think? Where are they now at this moment in time? 

Thomas: If you look, let’s say from Amazon’s perspective, if they wanted to build their own Spotify in their portfolio of all the other products, it is just that one product. But their main core business actually is still AWS (Amazon Web Services) or e-commerce and they don’t actually need Amazon music to be profitable. They can just continue sinking more money into it until there’s more and more subscribers to Amazon Prime. So they don’t actually care whether or not they make money. But it’s actually eating more and more into Spotify main revenue pie.

Reggie: Yeah. 

Thomas: So someone else’s pie is not your same pie. That’s basically the analogy. 

Reggie: Yeah, yeah. Problematic. Yes, yes. But this is for our listeners to make their own educated decision to understand and take this concept with them, to look at every other big players trying to compete with a lot of these growth stocks. Don’t see the growth stocks as… on its own island and nobody’s competing with it. It does not happen. So who are behind Spotify?

Thomas: Okay, we can go down the roster. Basically, we have the CEO, he was also one of the founders, Daniel Ek. He founded Spotify in 2006. Previously, he’s got experience in starting an online ad company. This one was acquired. Then he has several roles at an auction company called Tradera. This one was then acquired by eBay. Then he was also the CTO (Chief Technology Officer) at Stardoll. Basically, Stardoll is a fashion and entertainment community for pre-teens. A little bit random, that one but yeah. 

Basically he has entrepreneurial experience, but he has played roles as a CTO as well. So as a tech company, I think he has the capability to understand the dynamics of running one.

Reggie: If you think about it, basically this is the whole Spotify, right? There’s a community portion. That’s the ad marketplace at the back. There is the whole auctioning within the ad space and then the front facing user interface. This guy sounds like he’s the one that created Spotify after all these experiences. Cool.

Thomas: I think is a combination of all the things. But for Spotify, other than having these experienced co-founders on board, they also need someone strong inside the music industry which actually, I don’t see. So we can go down into it and talk about it a bit more. 

Reggie: Definitely. 

Thomas: I mean, there’s people from… let’s say telecom operators is one of the biggest in Sweden. Also, the founder of this Tradedoubler company that was acquired by eBay. So basically, they are co-founders last time, they are co-founders now as well. And then, yeah… mostly business experience. What I’m not seeing here is a Chief Technology Officer. I’m also not seeing a person that is very good relations with industry or from the industry of music… recording labels and all these kind of things. For a tech company, you would want to have a very strong tech person, but at the same time, you want people from the industry. I don’t know. Question mark for me. 

Reggie: Question mark, especially I think a lot of people don’t recognize that the music industry is actually very syndicated. There are a lot of big boys that are controlling the whole space. Universal, Warner…. They’re all very big labels. They are all… essentially all the records are almost all done by these few big boys. 

I think Spotify did start as a protest to big labels, but I think they have reached a point where they really had to grapple. Either it’s lawsuits, a lot of lawsuits, which is coming up, or having actually some guys in industry to be on. So that is the… I get your cause for concern and I think there is a fair concern. But we are seeing some of these big gaming guys in the team, right?

Thomas: Yeah. Chief Freemium Business Officer, Alex Norström. He was the Chief of New Business in King.com. King.com is the company that basically created… 

Reggie: Candy Crush.

Thomas: Yeah, that super addictive game. I think they were the one of the poster boy examples of really monetizing games. Basically, your digital content, digital kind of products, they’re able to make money out of a game. You buy more candies. How crazy is that? Digital candies cannot eat one. People still spend money. Why? So it’s to do also with the experience. It’s to do with the kind of pricing plans which they embedded into the game itself. 

I think for this person to come on board, it’s pretty useful. You can see also the role he’s playing as a Freemium Business Officer. He’s really pushing through what he has done at King,com already to Spotify as well. But the nature of the business is different, so that’s not something that I think we can consider as well. King.com is primarily mobile games or in the sense, web games because it’s on Facebook also. 

But for Spotify, it’s a streaming service. The experiences are actually a bit different. There’s only so much that you can apply from games onto music or podcasts. Unsure, really unsure whether this will work or not yet. Spotify will have to have games, maybe I’ll have more confidence.

Reggie: I will be more concerned… I’ll be more concerned. I’m not sure, I’m not sure if it’ll work. Maybe it will, I don’t know. I mean, some of the big e-commerce guys have tried the whole game strategy and it’s working. They’re keeping more people on their platform and it’s really Ready Player One feature, so that’s that, but I’m not sure. When a company that is not dominant in any business yet try to go into a whole new set of processes, a whole new product of games within the ecosystem, it will freak me out. I will get a little concerned.

Thomas: It’s also about the stability. Just take for example the Apple Store or Google play. You can download all your apps and you can download all your games. Basically, you can also become a games publisher. From that perspective, it’s a lot different as compared to just a service that people subscribe to. So if you had that kind of backing, it’s very, very different as compared to just going out on your own and say “yeah, everyone likes my product.” So I see Spotify as a very product centric company. It will leave or die by the product, not in terms of the business. 

Reggie: Yes. Based on our discussion of financials and based on their model, they are at a point in their business where they still don’t have that big cashflow generator. Because in the publishing business, in the distribution business, you need a lot of cashflow. You need to be able to buy the distribution rights and stamp down on marketing and then content creators will work with you to get the kind of reach.

So Spotify is in this awkward position. I think that they may have a potential of getting out there, but we’re not sure. Based on that, do you see some moats or do you see some potential moats that’s coming out in Spotify? 

Thomas: There are several moats, but the river… not very deep. Not very wide also. Yeah. They are trying to put more water into it to make it deeper. 

Reggie: They pre moat… 

Thomas: Water seems to be leaking somewhere. Here’s why. Basically, we want to see Spotify growing, not just the product, but also as a business. The customers are very important. So for now, it seems that they have a quite sticky customer base.

Some stats where… we can share. Spotify user spends 49 minutes per day listening to something whereas premium spends 80 minutes per day. This seems like okay, not bad. But if you look in terms of attention as a market share, just attention in general of humans, this 49 minutes is insignificant as compared to say, Tik Tok. Tik Tok, people spend hours on it, nonstop even. They just keep swiping and swiping until finger pain also keep swiping. 

But for Spotify, there is a limit to this moat because we see people listen, you can still consider them customers. But you are limited to that aspect of a person’s lifestyle on the way to work, maybe at home. So that 49 minutes, it’s just nice… maybe you need to go to town or something like that, right? Yeah, average distance, to and fro or something like that. 

So they have this sticky customer base for now, but it has to do largely with the product, not because of the business dynamics. The churn rate is also about 50% per year. This has been steadily decreasing, which is a good thing. But again, this is a product related metric. I don’t see any other kind of business initiatives which will try to bring this down or business initiatives to try and get a stickier customer base. They’re trying to be podcasts, yes. But again, 49 minutes per day. Can you extend it more than that? That is the question.

Reggie: Attention span is the business and I’ve provided insight that when people are locked down, they’re not going out. Audio consumption comes down. There is also a whole discussion in the space of streaming, content streaming. Everybody is benchmarking Netflix as the price. So if Netflix is charging this price… it’s like chicken rice theory, right? $3 chicken rice, everything you compare to the chicken rice. “$3 for noodles. Sounds okay, same price as chicken rice. Will I pay $6 for nasi padang? Question mark, because I’m comparing to chicken rice.” 

So same idea, when Netflix is the benchmark price for streaming, Spotify struggles with that. There’s an upper cap as to how much they can charge and they’re not taking up as much consumption, daily consumption and like what you pointed out. 

Thomas: Unless perhaps they have some way to refresh their content or add additional kinds of value to to the users. It’s not just audio, it’s additional things. But then we’re going into Amazon Prime territory. You subscribe, not only do you get music, not only do you get podcasts, but you get free delivery plus more plus more plus more for the price of Netflix a month. So that’s a very big differentiator.

Reggie: Yes. Amazon is a cult, just sitting. Yeah. Cool, cool. Any other moats for them at this moment in time? 

Thomas: There’s another one. I think this lies with the social dynamics. So earlier on we shared about music as a community kind of activity, right? So people share it, they curate a playlist and all that. The Recommendations that come from Spotify are pretty accurate and this has been creating some kind of flywheel effect where people are still sharing more and more songs and more people come on board that way or so. But again, this is a product related thing. 

It’s also able to attract more artists with the mechanics of revenue system. Basically, they get a share of not just streams from the listenerships and all that, but also from the ads, and this is actually quite easy to analyze. I think this is quite clear for artists also to come on board. It’s like the go to, even though the interface is bad. So sorry. 

Reggie: No, it’s not bad. Okay. By relative terms, they are the leaders. I think a lot of people when they come to Spotify, on top of the data, on top of the… from a content creator standpoint is really the reach. They have one of the biggest reach and for a lot of these record labels, they are using their streaming reach and distribution to get there.

So I think that’s kind of what Spotify is really doing for a lot of these content creators. So yeah, they are building the ecosystem, which used to be very concentrated within the record. They already own the talk shows. They own the radio slots. They own… because not that they buy it, but they’re all very good friends and they essentially have the whole space to them.

It’s like how cosmetic companies, they just buy the whole rack whether or not they have new products, because that is their friends. So they block out market entrance. But Spotify has reshaped this whole platform and a lot of record labels have to work with them and a lot of artists will then in this process, work with them.

I think they have built a content creator platform that is pretty, pretty good. It’s not bad. I’m just being salty because they don’t pay us a lot to do all these things, but they have built this whole interface and this whole process. It’s pretty interesting. 

Thomas: So down to the product, really it’s very important. If somehow… say Google or Apple, they create a copy of the whole Spotify backend and it’s much better, that’s it. The artists are going to start moving over. 

Reggie: Exactly, exactly. 

Thomas: Once the artists move over and the quality of your content increases and then basically, people move from Spotify over to any other competitor.

Reggie: What is the kind of arrangement between record labels and Spotify?

Thomas: I think I only know one basic one. Basically, the major record labels, they have an existing business in CDs is of course declining. Everything’s moving on to digital. 

Reggie: Yes. 

Thomas: For some reason, these labels have not moved online. I don’t know why. But that is what it is. Basically, Spotify has a very large distributorship. It has these kind of reach. It goes to them and say “hey, CD’s still there, huh? Why you don’t want to go to digital? Come with me.” They do that sometimes in a slightly aggressive way because the major labels are just losing more and more listenership if they continue to CDs.

So Spotify being in the unique position that they are in, they will go to them and say “okay, why not you put your artists content onto our platform and then share some kind of cut.” Of course, that kind of cut may not be as lucrative but they do give these kinds of stats as you mentioned the same ones to these major labels as well. Because the major labels are the ones that represent these larger artists. For the smaller artists or… 

Reggie: Individual creators. 

Thomas: Individual creators and all that, they just use the platform itself. 

Reggie: The basic stream. 

Thomas: Basic streams and all that kind of stuff. So that is the relationship that I know of. I’m not sure about the other kinds of relationships that’s going on.

Reggie: And they’re not very open about this part. I think the record labels have a lot of secrecy in this thing, but just see the big records as an anchor merchant. It’s like Taylor Swift, Jay Z, they’re all here, so you will come in. So from a Spotify standpoint, they don’t need to make a lot of money from the record labels. They’re just really using it as a way of driving traffic so everybody can come in and listen and then you can continue to sell all these other side artists along on the platform.

Thomas: I think one… sorry, sorry. Can I talk about one other metric which is important for this point? It’s actually the stream worth. These are not the kind of numbers you can see on a daily basis but on a rough aggregate perspective, you can see how much higher or lower these platforms like Spotify or Amazon Music, actually pays to the artists. Amazon Music is the highest at 0.01196 cents per stream. 

Reggie: Per stream? 

Thomas: Per stream. 

Reggie: Sounds damn sad. 

Thomas: It’s one of the highest! 

Reggie: That’s why the music industry is protesting! 

Thomas: Whereas for Spotify, it’s 0.003. It’s almost three times less than Amazon. You already thought Amazon Music was less, right? On average, this is three times less. So how to make sense of this number? Basically, if you went with Spotify, you need at least 250 streams to make a dollar with Spotify. Haven’t shared a revenue yet, haven’t shared the revenue, this 250. 

Depending on how much they are going to share with you, you’re going to need times maybe a hundred or times 200, something like that.Back to the point of these major labels and all that, because these are closed off negotiations, right? You don’t exactly know what is this per stream amount. You also don’t know what is their revenue share arrangement. If you are a big artist then, okay. You can demand more. Taylor Swift leh, you sure you want to give 0.03 only? 

Reggie: Exactly, yes. To give everybody a little bit more context, from 2015 to 2020, actually Spotify halved their per stream revenue for individual artists, from 0.006 to 0.003. If you think about it, that means as an individual artist on Spotify, you’re making half of what you used to make per stream. So let’s see how that will react in the content creators’ space. I’m already hearing things that people don’t want to do it on Spotify anymore and all this kind of stuff.

If a lot of outflow of content creators from this platform, it may dilute it also. I’m not too sure. We’ll see how that goes because you used to pay me $1, now you pay me $0.50. You want me to do the same amount of work? Questionable! 

Thomas: Logical thing you would do is you try to expand your options, right? You go to the other kinds of distribution service. You’re not just tied to Spotify. You can go anywhere else. That’s a logical thing people would do. 

Reggie: Yes. Exactly, exactly. All in all, I think we… our consensus here is Spotify has created a great product, different from other people, from the user interface, from discovery, from the audience experience all the way to the backend from artist data and aggregated information that can help the artists continue to better create and the podcasters… 

But they are struggling from a business standpoint because they have all these other competitors. They’re not dominant. They don’t have a big cash generation platform. On their management team, they have experienced entrepreneurs, but nobody in real tech, nobody really in a big artist management role in terms of music content. So what do you see as… overall, what are some other things that we should know on a summary basis, and what are some headwinds and tailwinds for Spotify?

Thomas: Let’s talk about the tailwinds first. They have a few ways that they can go about expanding. One of them is through the podcast as we’ve already mentioned. Suddenly, there is a switch for more kind of long form content, interviews, people listening to other people’s thoughts and all that. But there’s also a shift from what people used to hear on radio… all these anchors, they are talking or the host is talking on radio and all that to a podcast format…

Reggie: Thank you, thank you. Our community tells us that 80% do not listen to Money FM. Just saying. They listen to us.

Thomas: Nice, nice. Yes, yes. Maybe because the format just doesn’t work anymore and people want to hear things on demand or they have very specific things that they want to know right now. They listen to the radio then you have to go through all the very structured schedule for the whole day. It’s very problematic. Yes. Listen to a few random ads… 

Reggie: Exactly. The random ads, random native ad where the radio DJ will start to banter about something and then they act like they’re very interested. Actually, it’s a native ad… so all those kinds of stuff. Yeah. I get that. I get that. Yeah.

Thomas: And then sometimes they have the segments whereby maybe they talk to another co-host and then they’ll just talk and… “oh, stay tuned to find out more.” Then you find out you have to keep waiting for the next two hours for what they actually wanted to say. 

Reggie: Exactly. My goodness. 

Thomas: They don’t have the time anymore. So people need to know things now, now, now and… quality content. So there is this opportunity, from the shift of focus from radios onto podcasts. Radios… Let’s say for active users in US, for example, radio is about 243 million whereas for podcasts, 73 million. There’s about three times, three times the kind of growth that they can achieve for podcast.

Similarly, we can see that for the hours per year, per active users as well as the ad revenue. So this is an area that is growing. It’s something that Spotify can tap on. So how they’re doing it is for example, the very good this listenership rate of the Joe Rogan podcast. They’ve already shelled out cash. They have actually get them on board.

Reggie: Yeah, same idea. If you think about it, same idea as Taylor Swift, big record labels being the anchor content creators. But this time, they went one step further, they just buy Joe Rogan. It makes it even… give them even more way to play around with this. They also bought Gimlet. It’s one of the biggest content creators in the podcast space. 

Thomas: South Korea, they are going to enter into it. It will be the six largest market. That is basically, it’s a standard way that you want to push a business, you want to go into different markets. Spotify already operates in 90+ markets. South Korea is a big one. This is of course a way that it can grow. Then it’s more of product related ways to grow actually. 

Product related growth strategies, one of them is more and more devices being connected together. More and more devices also having similar experiences, interfaces and you want to switch between these devices quite seamlessly. Spotify, another feature that they have is that you can resume playing what you were last play(ing) on any other device. So if you’re playing on your phone and then you pause, they sync it up with your PC version or your web version as well and you can resume where you last left off. 

So it is to try to tackle the problem where people stop listening when they open the door to your house. You can resume where you left off. This is trying to address that problem. But at the same time, you can play from anywhere else also. So you have the kind of control in your house, where you want to play your music. Sometimes you play from a speaker that is what… the bass, super good one. Some… you want to play on your headphones instead. You have the option to choose this. 

Slight trend on a technology point of view is that this will be favouring Spotify until the rest of the competitor products actually catch up and have these features as well. 

Reggie: Nice. 

Thomas: Another will be their ads, different types of ads. They call it streaming ad insertion. Basically, they’re trying to do something with ads on podcasts. 

Reggie: Like we’ve pointed out, the podcast infrastructure is very messy at this moment in time. So I think Spotify is trying to take that and potentially that could really make them grow to the next level. We’re not sure. I think some of the analysts are talking about music, being a very expensive content creation process where podcasting is a lot easier and more people can do it at a fraction of the cost. It’s also interesting content space, so I think that’s where Spotify really wants to play.

Is there any other headwinds that we want to talk about or is there any other thing that you want our listeners to be aware of when understanding Spotify? I think we talked about a lot already, the good and the bad and the management… any last things that we should know while looking at Spotify as a potential company to have in our repertoire? 

Thomas: As the middle man facing the independent labels or the customers, they are in a unique position. But at the same time, I think they have to be careful. There’s only so much that they can squeeze from the record labels. They have to be careful about that also, because any time there can be another larger competitor or another kind of product which can take that away from them.

I think maybe we try to be optimistic about Spotify. It’s a nice product, yes. You use it, it’s awesome and all that kind of stuff. But analyzing it from a business point of view, there’s a lot of other considerations which we have to think to account before we want to put any money into it. I’m not saying don’t invest… 

Reggie: No, we are not giving any recommendations here. We are just talking about it, giving knowledge and our perspectives. Do your study. But I think this was a great discussion because like you rightfully point out, not all good products actually make good businesses. I think that is where a lot of tech companies are struggling because in the early days, they just spent a lot of time developing a great product. After that… that’s the culture in the tech space, right? After that, then they think about “okay, now how to monetize?” This is the problem they started coming.

I think a lot of tech companies struggle with this and we can continue to talk about all these things in another podcast with other companies. Thank you for tuning in today. I’m sure everybody learns some good juices. Ultimately, this is for education and we enjoy spending time with you.

So please drop us any other stocks that you want us to geek out and talk about. I think Thomas will be very happy to talk about more and more techy stuff because he’s in the space and yeah, hope you had a good time. So take care. Bye!

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