Why Spotify’s “Grand Strategy” Will Fail

Summary

Spotify, once facing competition from smaller players, now contends with tech giants like Apple and Amazon. Despite being the largest music streaming service with 239 million subscribers, Spotify has never turned a profit due to high royalty costs and a variable cost structure. The company has explored diversification into podcasts and audiobooks, investing heavily in exclusive content, but has yet to achieve profitability. Spotify's strategy of chasing the next big thing distracts investors and brings in new listeners, but it struggles to monetize these ventures effectively.

Takeaways

• 🎧 Spotify faced immense competition from Apple Music, which had several advantages such as pre-installation on devices, wide reach, and established industry connections.
• 📈 Despite competition, Spotify remains the largest music streaming service with 239 million paid subscribers, outpacing Apple Music.
• 💰 Spotify has never been profitable in its eighteen years of operation, with revenue increasing but profit remaining stagnant.
• 🚀 The music industry's decline was caused by piracy, but Spotify's unlimited streaming model helped revive it, surpassing its 1999 peak.
• 🎵 Spotify is often criticized for underpaying artists, but artists overall earn more today compared to a decade ago.
• 💸 The company is caught between high demands from record labels and competition from other platforms, leading to low profit margins.
• 📉 Spotify's variable costs mean that any price increase could lead to more customer frustration than profit, unlike fixed-cost businesses like Netflix.
• 📚 Spotify's strategy to diversify into podcasts and audiobooks has been challenging, with high-profile deals not leading to the expected profitability.
• 🔄 The company's attempts to find new revenue streams, such as merchandising and original content, have not yet resulted in significant profit.
• 🔄 Spotify's approach seems to be a cycle of investing in new industries, attracting users, and then moving on to the next 'big thing' without achieving sustained profitability.

Q & A

What challenges did Spotify face in 2015?

In 2015, Spotify faced the beginning of the end with the launch of Apple Music, which had several advantages over Spotify, including the ability to pre-install on top smartphones, reach billions of devices with notifications, advertise in physical stores, bypass the App Store commission, and leverage long-standing music industry connections.

How has Spotify managed to stay ahead of its competitors despite the challenges?

Despite the challenges, Spotify has continued to grow and is still the largest music streaming service with 239 million paid subscribers, which is twice the size of Apple Music. It has done so by offering a compelling service that continues to attract and retain users.

Why has Spotify never been profitable in its eighteen years of operation?

Spotify has never been profitable due to the high costs associated with paying record labels and the low margins in the streaming business. It has to pay a percentage of revenue to labels, which means the more it earns, the more it owes.

How has the music industry evolved since the advent of digital piracy and services like Spotify?

The music industry had been in rapid decline due to piracy until services like Spotify introduced a subscription model that offered unlimited streaming for a fixed price, which helped revive the industry and surpass its 1999 peak by 2021.

Why does Spotify pay so much to record labels?

Spotify has to pay a significant amount to record labels because it doesn't pay per stream, which would be risky, nor per user, which labels wouldn't allow. Instead, it pays a percentage of revenue, which means its costs are variable and high.

What strategies has Spotify attempted to diversify its business and escape the unprofitable music streaming industry?

Spotify has tried to diversify by investing in podcasts, audiobooks, and even online courses. It has also explored other revenue streams like merchandising, concert tickets, and music production tools.

What was the outcome of Spotify's investment in podcasts and exclusive deals with celebrities?

The investment in podcasts and exclusive celebrity deals did not lead to profitability as expected. High-profile deals with the Obamas, Joe Rogan, and others did not result in a significant or lasting increase in user engagement or revenue.

How does Spotify's business model differ from Netflix's in terms of profitability?

Netflix's costs are fixed for producing original content, so every new subscriber after the content is paid for contributes to profit. In contrast, Spotify's costs are variable and tied to the number of streams, making it difficult to achieve profitability.

What is the potential risk of Spotify offering free audiobooks to its premium subscribers?

The risk is that users may not see the value in paying for audiobooks when they are offered alongside free music, potentially commodifying the audiobook medium and reducing the willingness of users to pay for it.

What advice did Reed Hastings, co-founder of Netflix, give in his book 'No Rules Rules' that could be relevant to Spotify?

Reed Hastings advises on the Netflix 'innovation cycle' that empowers employees to experiment with new ideas and offering generous severance packages to maintain high talent density, which could help Spotify in finding a path to profitability.

How does the Imprint app relate to the discussion about Spotify and the challenges of learning from books?

The Imprint app distills influential books into their most essential lessons, providing an alternative for busy people who may not have time to read full books. This is relevant to the discussion as it suggests a way for Spotify to potentially learn from successful business strategies without getting bogged down in lengthy reading.

Outlines

00:00

🎧 Spotify's Battle for Survival

The paragraph discusses the challenges Spotify faced since its inception, particularly with the launch of Apple Music in 2015. Despite competition from industry giants like Apple, YouTube, and Amazon, Spotify not only survived but also thrived, becoming the largest music streaming service with 239 million subscribers. However, the company has never been profitable in its 18 years of operation. The paragraph explores the reasons behind this, including the music industry's decline due to piracy, the introduction of affordable music by Apple on iTunes, and Spotify's own business model offering unlimited music streaming for a fixed price. It also touches on the criticism Spotify faces for underpaying artists and the difficulty of competing in a winner-take-all industry where record labels hold significant power.

05:01

💸 Spotify's Struggle with Profitability

This section delves into Spotify's financial struggles, explaining why the company has not been able to turn a profit despite its revenue growth. The main issue is the complex contracts with record labels, which require Spotify to pay a percentage of its revenue, making its costs variable and directly linked to its earnings. Any attempt to raise prices could alienate customers without significantly increasing profits. The paragraph contrasts Spotify's situation with Netflix's profitability model, where fixed costs for content allow for greater profit margins. Spotify's attempts to diversify into podcasts and audiobooks are also discussed, along with the challenges of creating a coherent strategy when users may not see these mediums as interchangeable.

10:02

📚 Spotify's Diversification into Audiobooks

The paragraph examines Spotify's expansion into audiobooks, viewing it as part of the company's broader strategy to become a destination for all things audio. It discusses the potential of the audiobook market and Spotify's efforts to offer free audiobooks to premium subscribers, with the option to purchase additional hours. The narrative questions whether bundling music, podcasts, and audiobooks into one platform is truly beneficial or if it creates a mismatch between what Spotify wants and what users need. The risks of commoditizing audiobooks and the potential backlash from users are also considered.

15:05

🔄 Spotify's Cycle of Distraction

The final paragraph reflects on Spotify's history of trying various strategies to become profitable, from merchandising to original content, and its current focus on audiobooks and courses. It suggests that Spotify's approach might be more about creating distractions for investors than finding a sustainable business model. The paragraph also mentions the company's tendency to lose out on the value it creates for others, such as podcast listeners and audiobook publishers, and the frustration it causes among its paying customers with unwanted new features. The conclusion is that Spotify may continue this cycle of distraction or eventually have to confront the reality that it might not achieve the profitability its investors expect.

Keywords

💡Disruptive Innovators

Disruptive innovators are entities that introduce new technologies or business models that disrupt existing markets by offering a different value proposition. In the script, Spotify is described as a 'disruptive innovator' that revolutionized the music industry by offering unlimited streaming of music for a fixed monthly fee, which was a game-changer compared to traditional music consumption methods.

💡Winner-Take-All

The 'winner-take-all' concept refers to a situation where the majority of the rewards go to the winner in a particular market or industry. In the context of the video, it is mentioned that music has always been a 'winner-take-all' industry, where a small percentage of artists receive the majority of payouts, illustrating the inequality in earnings within the music industry.

💡Piracy

Piracy, in the digital context, refers to the unauthorized use or distribution of copyrighted material, such as music, movies, or software. The script discusses how file-sharing applications like Napster and LimeWire led to a culture of piracy, which devalued music and contributed to the decline of the music industry before the advent of streaming services like Spotify.

💡Music Streaming

Music streaming is a method of delivering music content to users over the internet, allowing them to listen to music on-demand without the need to own a physical or digital copy. The script highlights Spotify as the largest music streaming service, emphasizing its role in the resurgence of the music industry and its current dominance with 239 million paid subscribers.

💡Record Labels

Record labels are companies that manage the production, distribution, copyright management, and promotion of music and music videos. They are mentioned in the script as entities that Spotify has to negotiate with, often having to pay a significant percentage of its revenue to them, which contributes to Spotify's struggle to become profitable.

💡Market Saturation

Market saturation occurs when a market has reached the point where all potential consumers have been served and further growth is difficult. The script implies market saturation in the music streaming industry with the entry of major competitors like Apple Music, YouTube, and Amazon, which did not deter Spotify's growth but intensified competition.

💡Profitability

Profitability refers to the ability of a company to generate income (profit) from its business activities. The script discusses Spotify's struggle with profitability, noting that despite its growing revenue, the company has not been able to turn a profit due to high costs associated with licensing music from record labels.

💡Commodification

Commodification is the process by which a product or service becomes similar to a commodity, where it is treated as interchangeable with other products or services. The script suggests that the unlimited access to music on platforms like Spotify has contributed to the commodification of music, leading to lower perceived value and resistance to price increases.

💡Exclusives

Exclusives refer to content that is available only on a specific platform, often used to attract users and differentiate the platform from competitors. The script mentions Spotify's strategy of signing exclusive deals with celebrities for podcasts, which was seen as a way to attract users but did not lead to the expected profitability.

💡Audiobooks

Audiobooks are recordings of books read aloud, which users can listen to. The script discusses Spotify's venture into audiobooks as a new revenue stream, acquiring the publisher 'Findaway' and offering free audiobooks to premium subscribers, representing a strategic move to diversify beyond music streaming.

💡Synergy

Synergy refers to the interaction or cooperation of two or more organizations, substances, or other agents to produce a combined effect greater than the sum of their separate effects. The script suggests that Spotify is trying to create synergy by offering a variety of audio services (music, podcasts, audiobooks) under one platform, aiming to become a one-stop destination for all audio needs.

Highlights

Spotify faced intense competition from Apple Music and other tech giants.

Apple Music had significant advantages over Spotify, including pre-installation on top smartphones and extensive marketing reach.

Spotify managed to become the largest music streaming service despite competition.

Spotify has never been profitable in its eighteen years of operation.

The music industry was in decline before Spotify's founding, with piracy devaluing music.

Spotify's subscription model helped revive the music industry.

Spotify is criticized for underpaying artists, with a significant portion of payouts going to a small group.

Artists as a whole earn more today than a decade ago due to streaming services.

Consumers expect unlimited access to music at a low price, affecting Spotify's profitability.

Record labels demand high payments from Spotify, leaving little room for profit.

Spotify's variable costs make it difficult to raise prices without alienating customers.

Spotify's strategy to diversify into podcasts and audiobooks has not yet led to profitability.

Spotify's investments in exclusive content have not always paid off.

Spotify's diversification strategy includes offering free audiobooks to premium subscribers.

There is a tension between Spotify's desire to diversify and users' satisfaction with music streaming alone.

Spotify's business model may be commodifying audio content, reducing its perceived value.

Spotify has tried various strategies, from merchandising to online courses, with limited success.

Reed Hastings' advice in 'No Rules Rules' could offer insights for Spotify's strategy.

Transcripts

June 30th, 2015 should’ve been the  beginning of the end for Spotify.

Before that, it was playing on “easy” mode.

Its biggest competitors were Pandora,  

which mistakenly put all its eggs in the  radio basket, and a niche service called  

“Deezer,” which attracted just 14,000  subscribers in its first three months.

This was the era of cheap capital, blind optimism,  

and endless patience for money-shredding  startups disguised as “disruptive innovators.”

At its peak, nearly 125 startups reached  billion-dollar valuations in 2015 alone.

Then the music stopped — so to  speak. With the launch of Apple  

Music in June of that year,  the writing was on the wall.

Apple had every advantage Spotify was missing.

It could pre-install Apple Music on not one but  all of the top seven best-selling smartphones.

It could bombard 2.2 billion  devices with notifications,  

advertise in its 500 physical stores,  bypass its own 30% App Store commission,  

and capitalize on its long-standing  music industry connections.

Today, Spotify’s three biggest  competitors are the 2nd, 4th,  

and 11th most profitable companies in the world.

And yet the end never came. Quite the opposite.

Not only is Spotify still the  largest music streaming service  

with 239 million paid subscribers, it’s  also twice the size of Apple Music.

Looking at this graph, it’s not even clear  that the much-feared entrance of Apple,  

YouTube, and Amazon made a difference.

Spotify just continues to grow and grow and grow.

…That is, in every way but one.  (and it’s kind of a big one!)

While its revenue keeps on climbing,  its profit, conspicuously, has not.

In fact, not one of its now eighteen  years in business has been profitable.

In fairness, this isn’t really Spotify’s fault.

When it was founded in 2006, the  music industry was in rapid decline.

File-sharing applications like Napster and  LimeWire had created a culture of piracy,  

devaluing music in the process.

Apple, hoping to reverse this trend, introduced  ninety-nine cent songs on iTunes. It hoped that by  

making it so easy and so cheap to pay for music,  consumers would prefer it to the hassle of piracy.

As you can see, these digital sales helped  offset some of this loss, but not nearly enough.

Then Spotify took this simple yet  revolutionary concept one step further.

Ten dollars a month. For unlimited streams  

of every song ever made. It was  simply too good a deal to resist.

Soon the industry began growing again  and by 2021 it had fully recovered from  

its twenty-year decline, even surpassing  its 1999 peak — all thanks to streaming.

Now, Spotify is often criticized  for underpaying artists.

The bottom 85%, for example, receive  only about 5% of all payouts.

But, like most creative industries, music  has always been winner-take-all. And artists,  

as a whole, earn a whole lot more today than ten  

years ago — about twice as much  if this chart is any indication.

Sure, it’s hard to argue that  the ability to play any song  

at any time for no additional cost hasn’t  contributed to the commodification of music.

But again, it all goes back to demand. The threat  of piracy gives consumers an unusual degree of  

control over the music industry. And we use that  control to keep prices low and access, unlimited.

Whereas one household might subscribe to some  combination of Netflix, Hulu, Amazon Prime,  

Paramount+, and HBO, we expect nothing less than  every song ever made from a single music service.

These companies, therefore, can’t really compete  on the thing you and I care about most: content.

And if you and I are tough to please,  record labels are downright demanding.

Just three control roughly 70% of the entire  

industry. Universal alone  represents all these artists.

Spotify, therefore, virtually has to pay  these labels whatever they ask for — 63 cents,  

to be precise, of every dollar it collects.

It’s caught, in other words,  

between two behemoths — platforms like  Apple on one side and labels on the other.

In this low-margin business,  

there’s only room for so many middlemen  and Spotify is simply one too many.

Worse, Spotify is the public face of this broken  

and unfair industry that it  fails to make money from.

It takes all of the blame and none of the profit.

Now, you might be wondering why  Spotify doesn’t raise its prices.

If music is underpriced, why not pull  one of the few levers in its control?

After all, even one more dollar  each month — multiplied by 239  

million users — is a huge sum of money.

But this is not nearly the  solution it appears to be.

The devil lies in the details — the complex and  varied contracts it signs with record labels.

The basic problem is that Spotify  doesn’t pay per stream. That would  

allow one determined user to bankrupt the company.

But it also doesn’t pay per user. Labels  would never sign away so much control.

Instead, it typically pays a  percentage of revenue. Meaning,  

the more it earns, the more it owes.

Think about just how incredibly  terrible this is for Spotify. Any  

price increase would necessarily annoy  customers more than it would benefit the  

company — one dollar of customer frustration  for every thirty-seven additional cents earned.

This is the critical difference between Netflix —  which is profitable — and Spotify — which isn’t.

The former pays a fixed cost  to produce an original movie.  

Anyone who signs up after it  earns this back is pure profit.

Whereas Spotify’s costs are variable.  Even though it’s in the software business,  

it’s still constrained by the laws of physics.  More ones and zeros are free for Netflix to  

produce but not for Spotify — as if it has to  physically manufacture more CDs or cassettes.

It can’t even set its own prices  without worrying about jeopardizing  

its all-important relationship with labels!

To be clear, it can, has, and probably  will raise prices again. But doing so  

would only allow it to — at best —  eke out a small, consistent profit.

And that’s simply not good enough for a  publicly traded company. And certainly  

not for one in the tech industry that  investors expect to “take over the world.”

So… what do you do when you’re stuck in an  unprofitable industry? You try to escape.

You do what Apple and Google  and Amazon do — subsidize  

music with other, more lucrative products.

Spotify needs to find its iPhone. Or,  to be more realistic, something that  

isn’t giving away the entire universe  of music for pennies on the dollar.

At first, it thought that  “something” might be podcasts.

And not without reason. Over the  last ten years, podcasts have grown  

from a tech-industry niche to a mainstream  source of entertainment on par with radio.

183 million Americans, or 64% of  the population aged 12 and up,  

have now listened to one. 42% listen at  least once a month, and 31% once a week.

The average listener consumes over  nine hours of podcasts each week.

That’s a huge opportunity, especially  given our strong tolerance of podcast  

advertising over YouTube, TV, or radio.

So, Spotify went all in.

It started by buying Anchor,  Gimlet, Parcast, Megaphone,  

Podz, and The Ringer, for a combined $877 million.

It then signed exclusive deals with the Obamas,  

Joe Rogan, J.J. Abrams, Dax Shepard, Meghan  Markle, Prince Harry, and Kim Kardashian.

Investors saw this as Spotify’s “House of  Cards” moment — a pivotal turning point that  

would finally lead it to profitability.  Its stock price soared to new highs.

But… the turning point never came.

The Obamas left for Audible, Meghan Markle  and Prince Harry’s podcast was canceled,  

and Joe Rogan is no longer exclusive.

Two years later, it began to seem  as though the company may have  

simply thrown away a billion dollars for nothing.

The problem wasn’t with the concept of  exclusives, which can be an effective  

way of getting users to try out a new platform.  But when you don’t give them a reason to stay,  

it just feels like they’re being held hostage  and they’ll escape the first chance they get.

In other words, there’s no real  reason to listen on Spotify. The  

interface wasn’t any better, nor  were there any unique features.

And it may have learned from this mistake and  slowly adjusted its strategy except that it  

chose to do this in the most risky way possible:  with hundred-million-dollar celebrity deals.

So, with podcasts far from the silver bullet  the company was hoping for, Spotify moved on  

to its next idea: audiobooks, paying 125  million for a publisher called “Findaway.”

Like podcasts not so long ago, the audiobook  world is small yet ripe with potential.

While only 23% of Americans have  listened to one in the past year,  

that’s twice as many as ten years ago.

Today, Spotify offers 15 hours of free  audiobooks each month to premium subscribers.  

After that, users can pay 12.99 in  the U.S. for 10 additional hours.

Now, the company has tried very  hard to sell all this — music,  

podcasts, and now audiobooks —  as different phases of a single,  

coherent, and ambitious “grand strategy” to  become the destination for all things audio.

The unspoken assumption is that users prefer  the “simplicity” and “convenience” of using  

one app for everything. That, like the Apple  Watch and iPhone, each of these three mediums  

are better together — what someone wearing  an expensive suit might call “synergy.”

But what if this is just wishful  thinking — a business solution  

to a consumer problem that doesn’t exist?

What if, despite their technical similarity as  longer or shorter audio files, most people think  

of music, podcasts, and audiobooks as entirely  different mediums, serving different purposes?

This creates a fundamental tension between  Spotify, on one side — desperate to diversify  

— and users on the other — who were perfectly  content with all the world’s music alone.

Don’t assume, however, that just because  users aren’t happy, the company is.

Ironically, this may not be a clear-cut case  of greedy shareholders versus angry customers.

Don’t underestimate Spotify. It’s  perfectly capable of losing billions  

of dollars and annoying its  customers at the same time.

It’s not clear that the company had  a net positive effect on podcasts,  

audiobooks, or their listeners.

A few years ago, it inspired a massive  bubble around podcasts. Shortly after  

Spotify’s acquisitions, Amazon and Sirius  XM went on shopping sprees of their own.

But when the bubble popped, fans watched in  dismay as their favorite shows were canceled.

…And yet it’s also not clear that  this is good for Spotify, either.

When Neil Young protested its  relationship with Joe Rogan,  

for instance, Spotify’s existing business  — music — became a liability, not an asset.

Likewise, it’s now betting that  it can capitalize on audiobooks  

by introducing its 618 million  monthly active users to the medium.

Yet, it may do just the  opposite: squander its potential.

The question is, how annoyed will listeners be  

when they get stopped 15 hours  into a 16, 18, or 20-hour book?

And will they then pay the extra fee or will  they simply wait another month for free?

In the latter case, Spotify  has created a new expense  

without receiving any additional revenue  — digging its financial hole even deeper.

Eventually, the company will surely start  charging for those first 15 hours of listening.

But, by then, will it have done to audiobooks  what it did to music — commodifying and thereby  

reducing their perceived value  until we’re unwilling to pay?

Think about it this way: are you more or  less likely to see an audiobook as a valuable  

item worth paying for when it’s squeezed  between two songs you listen to for free?

Rather than pursuing a single, coherent strategy,  it sure seems like Spotify is just jumping from  

one unprofitable industry to the next, repeating  the same mistakes over and over and over again.

First, it blindly dumps millions of dollars into  the next “big thing” — podcasts, then audiobooks,  

and soon, online courses. This is critical to  distracting investors, who reward this short-term  

behavior. As long as there’s some breakthrough  right around the corner, they won’t realize that  

Spotify is stuck in an unprofitable position  within a low-margin industry and that it’s at  

a disadvantage in each new one it enters. And  while the enormous checks it writes may seem  

entirely wasteful, the truth is that they serve a  valuable function: again, distracting investors.

Second, by virtue of its sheer size alone  — not to mention the billions it spends  

on exclusives — it attracts millions of  new listeners to its latest obsession. It  

then justifies this new venture using these  cherry-picked impressive-sounding numbers,  

sustaining the faith of its investors  just long enough that it can…

Three — move on to the next big thing,  

an act of desperation it invariably pitches  as the next “phase” in its grand strategy.

Notice how at no point in this process  does Spotify actually earn more money.  

Even when it does create new audiences,  other companies always seem to capture  

this value. Podcasts gain new listeners, who  they take off-platform. Startups cash in on  

the hype. And publishers consolidate  their control, leaving Spotify right  

back where it started — minus several  hundred million dollars, of course.

Spotify’s real core competency, it seems,  

is generating large amounts  of money for other people.

Oh! And along the way, the  company annoys its paying  

customers by bombarding them with  new features they didn’t ask for.

At this point, Spotify has  tried nearly everything.

At first it was merch, then concert tickets, paid  discovery for artists, building an alternative to  

record labels, an $89 in-car speaker, short-form  video, live audio, music production tools,  

an artist-for-hire service, original videos,  podcasts, audiobooks, and now courses.

After nearly two decades, it  may finally be running out  

of useful distractions. It may soon  be forced to reckon with the simple  

fact that it will likely never be as  profitable as its investors imagine.

…Or it may just invent some new distraction,  starting the cycle all over again.

If only Spotify had listened to the advice  of co-founder of Netflix, Reed Hasting,  

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