Spotify is awesome.
As a consumer, having a giant library of music spanning hundreds of years available at your fingertips is a pleasure.
As an investor, Spotify is addressing a universal human problem. How can a person listen to any music any time they want? Music is ingrained into our DNA. Everyone loves music. Spotify’s total addressable market (TAM) is the entire world. Google, Facebook, and Amazon. Those are the businesses that scale the best.
Beyond the giant TAM, Spotify is attractive as an investor for its business modal. Spotify has a diversified revenue stream. The much-criticized targeted ad model and the much-beloved subscription model.
As a product person, on the other hand, having one product with two business models is a nightmare. Making product decisions that can satisfy both business models is a hell of a challenge.
Ads
Spotify uses ads to monetize their 109 million ad-supported users. In Q3 of 2018, Spotify pulled in 143 million euros from ads. This breaks down to 1.31 euro per ad-supported user. Ad-supported tech companies is nothing new. Facebook and Google make over 90% of their revenue from ads.
That being said, ads are a lightning rod for criticism. In order to serve the most effective ads, data of users must be harvested to allow targeting. This harvesting of data can be perceived as creepy or worse, can be exposed in a breach, damaging reputation. This has most recently played out with Facebook and its stock price is suffering.
Furthermore, many like to think that in an ad-supported business model, the user IS the product. The user’s attention is being sold to advertisers.
That sentiment is extreme but has a grain of truth. The company’s interests can become less aligned with the users’ interest in an ad-driven model. Users may tolerate an ad, perhaps even benefit from it, but it’s not something a user would opt in to. The key here as a product manager is to match the best ad to the user and to find the sweet spot of ad inventory that doesn’t alienate the user.
Spotify is using their self-serve Ad Studio to power their ad business. Like Facebook before it, Spotify is allowing customers to target specific users based on data. An advertiser can target a user based on their age, gender, location, activity, and music taste.
This set of targeting options pales in comparison to Facebook’s. The limited targeting options and the mostly audio-only ad inventory is reflected in Spotify’s Average Revenue Per User (ARPU). Facebook pulled in $6.09 per user in Q3 2018 compared to Spotify’s $1.48 ad-supported ARPU.
Subs
Ad-supported business models are more controversial than subscription business models, which tends to better align the company and user.
The good news for Spotify is their 87 million premium subscribers generated the vast majority of their revenue. Nearly 90% of revenue in Q3 came from subscriptions.
Strategy
With the risks of an ad-supported business model and 90% of revenue coming from subscriptions, the strategy to focus first and foremost on the subscription business appears clear.
Spotify can appeal to everyone and therefore it’s important for Spotify to always have a free tier. This free tier, supported by ads or not, should be treated like other freemium models – as a way to give people a taste of the product and to entice them to upgrade to the premium tier.
Unlike Facebook, who only has an ad-supported tier, Spotify should treat their ad-supported business model as a second-class citizen. Spotify should never sacrifice the product to make more ad money. Spotify should optimize the free tier to entice users to upgrade. Unlike most ad-supported models that are finding the sweet spot of ad inventory and user alienation, Spotify needs to purposefully alienate the free users enough that they will be enticed to upgrade, but not leave Spotify for a competitor.