The key to understanding the music streaming economy is the business model of the music streaming services, which has emerged in the negotiations between the major music rights holders and Spotify. It is based on advance payments that a music streaming service has to pay to the rights holders, which are offset against the revenues from streaming. This leads to a cost structure for the streaming services that makes it difficult to generate profits at all. This episode of the blog series on the music streaming economy explains why this is the case and how the business model of the streaming services works, using Spotify as an example.
The Music Streaming Economy – Part 10: Spotify’s Business Model
From the outset, Spotify had to grow to survive economically. However, it was not only the number of registered users that mattered, as many of them had simply signed up once and then remained inactive, but also those users who streamed music regularly and were considered active users for a certain period, for example per month. These are called Monthly Active Users (MAUs).[1]
Figure 1: Number of Spotify users, 2012-2023
Source: Music Business Worldwide, “How Spotify can become profitable”, May 11, 2015, Music Business Worldwide, “Spotify revenues topped $2bn last year as losses hit $194m”, May 16, 2016 and annual reports by Spotify Technology S.A. 2018-2023, accessed: 2024-08-18.
Spotify’s user growth is impressive. In eleven years, the number of active monthly users has grown by almost 3,000 per cent and the number of paying subscribers by as much as 4,600 per cent. This represents an average annual growth rate of 272 per cent and 418 per cent respectively. However, a closer look reveals that growth has slowed in recent years. Between 2017 and 2020, the growth rate for active users per month was around 30 per cent, falling to a level of 23 per cent in 2023. The decline in growth rates for Spotify’s paid subscribers is even more significant. While growth was still at 40 per cent in 2017 and 35 per cent in 2018, it fell to around 15 per cent between 2021 and 2023. This means that Spotify’s expansion into new markets, such as Asia and Africa, has enabled it to continue to see significant user growth, but fewer of the newly acquired customers are willing to pay for the streaming service, preferring instead to use the ad-supported free model.
Why is this distinction between paying and non-paying Spotify users so important? Spotify’s economic success depends not only on the number of users, but also on the conversion rate from non-paying to paying premium users. The importance of this conversion can be measured by the metric of average revenue per user (ARPU).
Figure 2: Spotify’s ARPU, 2012-2023
Source: Music Business Worldwide, “How Spotify can become profitable”, May 11, 2015, Music Business Worldwide, “Spotify revenues topped $2bn last year as losses hit $194m”, May 16, 2016 and annual reports by Spotify Technology S.A. 2018-2023, accessed: 2024-08-18.
In 2012, Spotify earned annually EUR 75 per user of one of its subscription models, but only EUR 3.70 per user of its ad-supported freemium offering. Although the revenue per free user could increase to over EUR 4.60 by 2023, this is still a tenth of the revenue per subscriber. In addition, the ARPU per paying user has been declining over the years and stood at EUR 49 in 2023. This is due to discounted subscription models such as family plans and the like. Therefore, it is not surprising that Spotify raised the prices of its subscription models in 53 countries by 10 percent in July 2023 for the first time in its history.[2] Spotify’s business model is therefore primarily based on selling subscription streaming models, which generate most of its revenue, as shown in fig. 3.
Figure 3: Spotify’s revenue, 2012-2023
Source: Music Business Worldwide, “How Spotify can become profitable”, May 11, 2015, Music Business Worldwide, “Spotify revenues topped $2bn last year as losses hit $194m”, May 16, 2016 and annual reports by Spotify Technology S.A. 2018-2023, accessed: 2024-08-18.
Although revenue from the ad-supported freemium model has increased over the years, it accounted only for 13 per cent of total revenue in 2023. Spotify’s economic survival, therefore, depends on revenue from premium subscription and converting non-paying customers into paying customers. This has always been the core of Spotify’s freemium business model, which has enabled its economic rise, and reflected in its rapidly growing revenues.
Total revenue grew from around EUR 10 million to EUR 97.5 million from 2009 to 2010, and in 2011 it already reached EUR 244.5 million.[3] Until Spotify’s IPO in 2018, the average annual revenue growth was 56 per cent. In 2014, annual revenue exceeded EUR 1 billion for the first time, in 2018 it was already more than EUR 5 billion, and in 2022 revenue exceeded EUR 10 billion for the first time. However, this exponential growth in revenue was also accompanied by an exponential growth in expenditure. As can be seen in fig. 4, with one exception in 2021, expenditure has always been higher than revenue, meaning that Spotify has only broken even once since its foundation.
Figure 4: Spotify’s revenues and expenditures, 2012-2023
Source: PrivCo, “SPOTIFY’s Just –Closed-Year Financials Obtained”, October 5, 2012, Music Business Worldwide, “How Spotify can become profitable”, 11. Mai 2015, Music Business Worldwide, “Spotify revenues topped $2bn last year as losses hit $194m”, May 23, 2016 and annual reports by Spotify Technology S.A. 2018-2023, accessed: 2024-08-18.
Figure 5: Spotify’s operating income, 2012-2023
Source: PrivCo, “SPOTIFY’s Just –Closed-Year Financials Obtained”, October 5, 2012, Music Business Worldwide, “How Spotify can become profitable”, 11. Mai 2015, Music Business Worldwide, “Spotify revenues topped $2bn last year as losses hit $194m”, May 23, 2016 and annual reports by Spotify Technology S.A. 2018-2023, accessed: 2024-08-18.
The losses are mainly due to cost of sales, i.e. the expenses directly related to revenue generation. Although Spotify does not disclose the composition of its cost of sales in its annual reports, it can be assumed that these are mainly royalty payments to rights holders, especially the music majors. Although cost of sales as a percentage of total revenues has been reduced from 104 percent (!) in 2010 to less than 80 percent, it was still a substantial 75 per cent in 2023. This means that the scope for spending on marketing, R&D and overheads is limited, as can be seen in fig. 6.
Figure 6: Spotify’s expenditures’ structure, 2012-2023
Source: PrivCo, “SPOTIFY’s Just –Closed-Year Financials Obtained”, October 5, 2012, Music Business Worldwide, “How Spotify can become profitable”, 11. Mai 2015, Music Business Worldwide, “Spotify revenues topped $2bn last year as losses hit $194m”, May 23, 2016 and annual reports by Spotify Technology S.A. 2018-2023, accessed: 2024-08-18.
As a result, Spotify needed to cut costs to free up spending to invest in R&D and marketing and sales. As such, the announcement in early 2023 that it intended to cut more than 500 jobs globally came as less of a surprise.[4] In June 2023, it was then announced that Spotify would be laying off a further 200 people to restructure its struggling podcast business.[5] The big bang came in December 2023 year when Daniel Ek himself had to announce that a further 1,500 employees would be released in the coming weeks. In total, Spotify had cut around 2,300 jobs by 2023, representing a reduction in its global workforce of around 23 per cent.[6]
However, the job cuts were just one measure to reduce costs. Spotify announced in October that from 2024 it would only distribute money to those rights holders who were able to generate more than 1,000 streams in the past year to reduce the administrative effort involved in distributing revenue shares to rights holders.[7] In a blog post, this measure is justified with the fight against streaming fraud and so-called white noise (i.e. non-music such as recordings of rain, thunderstorms and other natural sounds), but Spotify also calculates how much money can be saved with this measure: “Today, Spotify hosts well over 100 million tracks. Tens of millions of them have been streamed between 1 and 1,000 times over the past year and, on average, those tracks generated $0.03 per month. Because labels and distributors require a minimum amount to withdraw (usually $2-$50 per withdrawal), and banks charge a fee for the transaction (usually $1-$20 per withdrawal), this money often doesn’t reach the uploaders. And these small payments are often forgotten about. But in aggregate, these small disregarded payments have added up to $40 million per year, which could instead increase the payments to artists who are most dependent on streaming revenue.”[8] Reading between the lines, it is clear that Spotify is not only looking to save on bank transaction costs, but that the payouts for many rights holders are so microscopic that they do not even reach them. In doing so, Spotify is also indirectly responding to the recurring criticism that artists see little financial benefit from Spotify, a criticism voiced by some well-known stars in the media shortly after the Swedish streaming service’s launch.
Endnotes
[1] In addition also DAUs (Daily Active Users) and WAUs (Weekly Active Users) are in use as metrics.
[2] Music Business Worldwide, “Spotify is raising its price in the US and 52 other markets. How much money will that make the music industry?”, July 24, 2023, accessed: 2024-08-18.
[3] PrivCo, “SPOTIFY’s Just –Closed-Year Financials Obtained”, October 5, 2012, accessed: 2024-08-18.
[4] Music Business Worldwide, “Spotify to slash over 500 jobs worldwide, as Dawn Ostroff exits streaming platform”, January 23, 2023, accessed: 2024-08-18.
[5] Music Business Worldwide, “Spotify cuts 200 jobs as it restructures its podcast division”, June 5, 2023, accessed: 2024-08-18.
[6] Music Business Worldwide, “Spotify has laid off 2,300 employees this year. That’s a shock – but also kind of inevitable”, December 4, 2023, accessed: 2024-08-18.
[7] Music Business Worldwide, “Spotify is changing its royalty model to crush streaming fraud and introduce a minimum payment threshold. Its plan? To shift $1 billion in payouts towards ‘working artists’ over the next 5 years”, October 24, 2023, accessed: 2024-08-18.
[8] Spotify blogpost, “Modernizing Our Royalty System to Drive an Additional $1 Billion toward Emerging and Professional Artists”, November 21, 2023, accessed: 2024-08-18.
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