Spotify’s Q2 earnings are out, and despite CEO Daniel Ek’s efforts to put a positive spin on things during the company’s earnings call, the results paint a mixed picture.
While the streaming giant has beaten expectations on subscriber numbers and seen improvements in its profitability metrics, its monthly active user growth continues to disappoint, slumping even further than last quarter’s 2.16% quarter-on-quarter growth rate to just 1.79%.
This a far cry from the heady growth seen in previous years where - even as recently as Q2 2023 - Spotify was able to boast nearly 7% quarterly growth in its monthly active users.
Despite that, total net new premium subscribers were up by 7 million, a 2.93% increase from the previous quarter. Compare that, though, to previous Q2 growth and it’s not so impressive. In 2023, Q2 premium subscribers grew by 4.76% against the first quarter, with 2022 and 2021 delivering 3.3% and 4.43% respectively.
Total revenue is up 21% year-on-year, hitting €3807 million, which brings trailing twelve months revenues to €14471 million. Compare that to Q3 2022 to Q2 2023’s €12421 million and you can call it a 16.5% increase.
After last quarter’s catastrophic ad-supported revenue performance - which saw ad sales drop from €501 million in Q4 2023 to just €389 million in the first quarter of this year - the ads business is slowly clawing its way back, and at €456 million is up 12.9% year on year. However, Ben Kung, Spotify’s interim CFO, cautioned that “marketer spend on upper funnel related campaigns continue to be volatile”.
Advertising revenue still only makes up a tiny proportion of Spotify’s overall revenues though, at a whisker under 12%, a far cry - as noted by analysts on today’s call - from Ek’s promise that he wants 20% of Spotify’s revenue to be derived from ads.
More broadly, Spotify’s profitability metrics have shown significant improvement over the quarter - as would be hoped in light of the company’s aggressive lay-offs, designed to rebalance costs. As a result, operating income was its highest yet, at €266 million, aided by gross profit strength and, crucially, those lower operating expenses driven by the huge reduction in headcount the company has seen.
In Q4 2022 - arguably Spotify’s peak profligacy period where costs were an eye-watering 32.6% of revenue - the company had 10151 employees. Fast forward to today, and that headcount figure is just 7372, the lowest it has been since Q2 2021.
That’s seen costs as a percentage of revenue drop to just 22.22%, a significant slim-down. Spotify’s costs are now at their lowest level since Q1 2022, helping the company’s free cashflow, which is now at €490 million. If Spotify can keep things on track and deliver consistent free cash flow at this level, that potentially projects forward over the next couple of years to around €4 billion, which could be critical as debt falls due.
One notable point from today’s call was the way Spotify is grappling with a significant shift in its user acquisition and conversion strategies - and in particular, how it views the relationship between its ad-supported and premium tiers.
Ek said, “The easiest way to understand Spotify’s business is through the lens of our free and paid segments”, going on to clarify that the business is now “bifurcated” and views its paid subscription business as one anchored in developed markets where growth is driven by premium subscriber additions and price increases.
The ad-supported segment of the business, meanwhile, is focused on developing markets, where the potential to convert ad-supported users to paid subscribers takes place over a much longer horizon.
This bifurcation is reshaping the company’s approaches to user acquisition, and in particular top-of-funnel marketing approaches. Ek noted, “While we talked about the importance of reinvesting in marketing to attract new users to Spotify, we’re only going to spend money to attract listeners if it meets ROI expectations”.
In particular, in developing markets this can have its own challenges. “Engagement looks different in these markets”, said Ek, “as do the channels to acquire users, and conversion to paid can be a bit slower”.
Conversely, in developed markets where Spotify already has strong penetration and high brand awareness, splurging money on marketing makes little sense, so the company is focusing more carefully on very targeted acquisition activities. Apart from anything else, in strongly developed markets where Spotify has significant market share, there’s a law of diminishing returns for all marketing activity.
“Historically our conversion funnel was quite straightforward”, said Ek. “A listener would come in as a free user and over time convert to our standard premium tier”. This has now evolved, and in developed markets, “with both the widespread awareness of our offerings and the strong affinity for Spotify products, we see many users subscribing directly to our paid tiers without any trial period”.
In a surprise announcement - which was, of course, a surprise to no-one - Ek revealed that Spotify’s long-rumoured ultra-premium or ‘Supremium’ tier is moving closer to reality.
While no specific launch date was mentioned, Ek’s comments made it clear that the offering is well into its development phase. “We’re 246 million paid subscribers. We’re one of the largest subscription services on the planet”, said Ek. “Interestingly enough, a huge part of that success is driven by a very simple one size fits all proposition. What we do see is that there’s a good subset of that group now that want a much better version of Spotify, huge music lovers who are looking for even more flexibility in how they use Spotify”.
According to Ek, the ultra-premium tier is likely to land somewhere around $5 above the current premium tier. “It’s probably around the $17 or $18 price point, but sort of a deluxe version of Spotify that has a lot more control, a lot higher quality across the board, and some things that I’m not ready to talk about yet”.
While Ek was tight lipped on specific features, the focus on ‘control’ and ‘quality’ is no huge surprise, with long-time speculation that Spotify would be forced sooner or later to offer higher resolution audio.
“The primary objective for the team”, he continued, “is to continue delivering against these goals while increasing our innovation to the benefit of consumers and creators all over the world. We’re quite excited about it, but it’s early days”.
