Spotlight on Spotify

Spotify, one of the leading streaming services, released its Q2 2024 results last week. Revenue for the quarter was €3.8 billion, up 20% year on year. Spotify also reported an operating profit of €266 million, an improvement from the operating loss of €247 million recorded a year ago. 

Spotify generates its revenue through two streams: its premium subscription and advertisements through its ad-supported subscription service. In the recent quarter, there were 626 million monthly active users, with 62% of these users utilizing the ad-supported subscription. However, revenue generated from advertisements only accounted for 13.6% of Spotify’s total revenue. Moreover, the ad-supported gross margin was 13.4%, and in some previous quarters, it has even been negative.  

Spotify’s gross margin increased from 24.1% a year ago to 29.2% for the recent quarter. Despite this increase, the gross margin remains relatively low compared to other tech companies. For instance, Netflix, which funds a good portion of its own content for television, reported a gross margin of 57% for its most recent quarter. 

Spotify’s low gross margin is primarily due to the high fees required by music labels. These labels generally hold the rights to the music streamed on the platform. In 2020, 78% of streams on Spotify’s platform came from four major record labels: Sony, Warner, Universal, and Merlin. Losing any of these deals could result in a significant loss of monthly active users, who might switch to other music streaming services, such as Apple Music, Amazon Music, or YouTube Music, with relative ease. 

Spotify also uses AI algorithms to creates playlists and recommendations based on listeners’ preferences and play history. Anecdotally, this is better than competitor’s app recommendations. 

In addition to the low gross margin, Spotify pays sales commission fees to Apple and Google, which host their apps in their respective app stores. Apple’s policy is to take a 30% commission on all in-app purchases in the first year an app is on its store, reducing the fee to 15% in subsequent years. Spotify is reliant on these app stores as they are the primary platforms through which people access their music on Apple or Android devices. This resulted in Spotify’s operating margin reducing to 7% this quarter.