Hey everyone, before I share with you my thoughts on Spotify, I thought it might be a good idea to share a famous quote from Warren Buffett, which I think applies to the audio streaming market: 'When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact'.

This posts breaks down:

• Overview of Spotify
• Economics of the Audio Streaming Business
• Why I think its bad economics for investors

Spotify Overview:

Spotify is one of the world’s most popular audio streaming subscription service giving access to over 100 million tracks and 5 million podcasts to millions of members. Spotify is the leader in the audio streaming market with a market share of 30.5% and Spotify has been growing their premium subscribers every year with no signs of slowing down.

Premium Subscribers (In Millions)

In 2022, the global audio streaming market was around $34 billion. The audio streaming market is expected to grow to over $100 billion by 2030 according to research and markets. Despite Spotify's growth and the growth of the industry at large, the economics of Spotify and other businesses in this market doesn't appear to be looking good at all and in my opinion I don't see signs of improvement. I will explain the economics of the industry a little below but I will first present revenue and profitability in years 2015 & 2022:

Revenue (In Millions)

Profitability (In millions)

Although I only present these two years, operating losses for this company has been consistent in all years between this period. Someone has to cover the cost of the money losing operations of Spotify and it looks as if shareholders has been footing the bill. Shares outstanding has been increasing.

Shares outstanding:

I believe Spotify can continue to grow revenue but I think the path to profitability is no where near in sight. Looking more closely into the economics of the audio streaming business, it appears that Spotify doesn't have a moat and I don't think any competitor can gain an advantage in this industry.

Economics of the Audio Streaming Business

There are certain rules in this industry that prevent any company from gaining any real advantage from another. The audio streaming business is subject to a ‘most favored nation clause’, which sounds complicated but it essentially means that audio streaming providers such as Spotify is in some ways restricted from negotiating exclusive deals with artists. Let’s say Spotify has agreed to a deal with a music publisher at $10,000, and this deal contains a most favoured nation clause, if another publisher comes in and agrees to a $15,000 deal with Spotify, then Spotify will have to pay the same amount to first publisher. For example, let’s say Spotify signed an agreement that gives it permission to stream The Weeknd (which is the most listened artist on Spotify) on its platform. And this agreement contains a MFN clause. The way this works is that Spotify will need to pay royalties to the Universal Music Group, which is the Weeknd’s publisher, every time a song is played on its platform. The Royalty rates are set by the Copyright Royalty Board which establishes the minimum rate a streaming service has to pay their artists. If Spotify signs a new agreement with Rihanna, and Spotify pays Rihanna's publisher (Sony/ATV) a higher amount to stream her songs on the platform, then Spotify will have to pay the difference to the Weekend Publisher because of the clause agreement. This applies to other audio streaming services such as Apple Music, Youtube Music, etc.

Why this is bad economics for Spotify investors

Reason 1: Since it is in the best interests of music artists to go after those MFN agreements; this really prevents any audio streaming service from signing exclusive deals with music artists that prevent from being streamed on other platforms. It is also the goal of a music artist to promote their music as far and as wide as possible and be to paid the maximum amount, and to do that, any major artist, or any artist in general will also have similar agreements with other streaming platforms, giving none of these platforms any competitive advantage. This is very different from video streaming services such as Netflix and Amazon Prime, who has their own production studio and exclusive rights to TV shows and movies.

Reason 2: As someone who likes listening to music, it really doesn’t bother me what platform I use, as long I can listen to the music I like. So I really struggle to find any competitive advantage Spotify has and because of that, I’m not really sure if Spotify can maintain its position in the market without spending an excessive amount. And from what we have already seen, Spotify is already struggling to keep its costs down so achieving a sustainable level of profits in the future is very hard to predict.

Reason 3: Competition. Since the audio streaming market is huge and is expected to grow, this will attract new competitors into the market. Without a competitive advantage (other than a well-known brand – not very durable) Spotify will likely need to increase their costs further in the future to maintain and protect its market share of 30.5%. If more competitors enter the market, then Spotify will need to increase marketing costs to attract new consumers, this expense may increase by a lot. Since Spotify is a technology company, research and development costs will need to continually increase, since old and new competitors will be investing to improve their audio streaming service so they take market share from Spotify. Another problem is pricing. Let’s imagine a new competitor enters the market and sells their streaming service at a lower price than Spotify. Spotify will then need to reduce its subscription costs to prevent their members from cancelling their membership and signing up with a competitor.

Those are my thoughts on Spotify and the economics of the audio streaming business. As a consumer and a lover of music, we gain the benefit of competition. However, I think the consumer benefit will continue to come at the expense of shareholders. Of course, I could be wrong. Please share your thoughts on Spotify and whether you agree or disagree with my review, I welcome any discussion 🙂

Hope you are having a splendid day.