How Does Spotify Make Money? Business Model of Spotify


How Does Spotify Make Money

Spotify is a popular music streaming and audio entertainment app. The platform generates revenue from various sources.

Spotify primarily makes money by offering its music streaming service via subscriptions. It also earns money by selling advertisements that appear on Spotify’s website and app.

Founded in 2006 by Swedish entrepreneurs Daniel Ek and Martin Lorentzon, Spotify was created to provide users with a legal alternative to shady music download sites. At the time, illegal music downloads were at an all-time high. Even though Napster got taken down, many other sites rose to replace it.

Daniel Ek realized that the best way to draw people away from such platforms was by creating a superior service that offered better value. On Spotify, users could listen to their favorite music for free. The songs on the site were all licensed, which meant the artists were getting paid for their work.

Spotify (SPOT) is a public company that is headquartered in Stockholm, Sweden but is listed on the New York Stock Exchange. The company reports its revenue in Euros.

What is Spotify & How Does It Work?

Spotify is currently the most popular music streaming service. It has 433 million users worldwide, of which 188 million are paying subscribers.[1] The app is available across 183 countries and contains over 80 million tracks.

The app is designed to work across a very wide range of platforms to provide users with maximum accessibility. It has a web app for playing music directly from the browser. Users can also download a native application to their computer or tablet.

Spotify offers multiple membership models, with the basic plan being completely free. The free plan exposes users to unskippable audio ads that play between songs along with other types of ads. Members of the Premium plan enjoy a completely ad-free experience along with enhanced audio quality.

Mobile users with a Premium plan get access to on-demand streaming with unlimited song skips and plays. Desktop and web app users aren’t restricted to shuffle mode. They can also skip as many times as they want, even with a free plan.

With Spotify, users get a unique socialized music experience through integration with other platforms like Facebook. The app lets users share their playlists, follow artists, and connect with friends. By connecting a social media account to Spotify, users can find their friends on the music streaming platform and see what everyone is listening to.

An AI algorithm tracks users listening habits and constructs specially curated playlists based on their preferences. The AI doesn’t just recommend songs or artists of a similar genre or sound profile. It analyzes sub-patterns within a user’s music listening history.

Then it compares these patterns to other users on the platform with similar tastes. Because of this highly advanced algorithm, the automated recommendations on Spotify are considered the best in the entire music streaming industry. Spotify’s AI also uses language processing models to scan lyrics and web-crawled data for more satisfying music recommendations.

The app provides users with three different types of playlists- editorial, algorithmic, and listener. Editorial playlists are manually crafted by a team of music and genre specialists from around the world. They allow users on Spotify to discover new and exciting music types that they otherwise wouldn’t have looked up by themselves.

Algorithmic playlists are automated by AI and use behavioral patterns to target specific user subgroups with music that they might find interesting. With its algorithmic playlists, Spotify drives massive user engagement and keeps people hooked on the app for hours on end. There are weekly playlists that are unique to each user and get updated every Monday.

Finally, the listener playlists allow individual users to update and maintain their very own custom collections. Users can set a playlist’s status to either ‘public’ or ‘private,’ depending on whether they want to share it with others. Companies often use this feature to curate their own publicly shared playlists and promote a specific brand image among their followers.

Apart from music, Spotify also contains over four million podcasts. It has signed exclusive deals with some of the world’s most popular podcast hosts. By providing additional value through podcasts, Spotify engages a wider user base and keeps them on the app for longer.

The company faced controversy, however, when it recruited podcaster Joe Rogan to join the app in 2022. The controversial figure has been criticized for spreading misinformation about COVID-19 and being homophobic, transphobic, and anti-feminist.

Spotify reportedly signed a contract with Rogan worth $200 million. The addition of Rogan to the site saw an exodus of users and artists. For example, Neil Young pulled his entire music catalog from the site in 2022.[2] Spotify has had to remove episodes of his show from their platform due to racist and insensitive language.[3]

 

Business Model of Spotify

Spotify’s business model is centered around a freemium system. It provides licensed music for free, but moderates the user experience tightly to encourage the purchase of a premium membership.

Spotify has built up a massive userbase from 183 countries around the world. This incentivizes more record labels and publishers to put their music on Spotify.

Recently, Spotify has been making a push for getting indie artists on the platform. By cutting out the middleman, Spotify is able to decrease its cost of operation per song streamed. At the same time, artists get a bigger payout from the deal because they don’t have to go through a record label.

Spotify also uses a highly advanced AI algorithm that many believe is the best in the entire music streaming industry. It analyzes sub-patterns in users’ music listening behaviors to create highly individualized recommendations that feel organic. Through these automated playlists and artist recommendations, Spotify succeeds in increasing the average amount of time a user spends on their app.

The more time a user spends on Spotify, the more likely they are to discover and follow new artists or genres. Every time they add a new playlist or follow a new creator, Spotify gains a more loyal customer. These users are likely to renew their subscription in the future and promote Spotify within their social circles.

Spotify also works as a light social media app by allowing users to integrate it with platforms such as Facebook. This way, Spotify users can promote the service for free by sharing their favorite playlists and artists on other platforms through links. It helps Spotify cut down on marketing expenses and energizes the userbase by encouraging social interaction through shared musical experiences.

Because of Spotify’s diverse music collection and social features, it attracts one of the most youthful userbases of any music streaming app. While the age of an average Spotify user can vary from 18 all the way to 55 and above, its largest demographic is comprised of 25 to 34-year-olds.[4] This is an extremely lucrative segment for advertisers.

Spotify’s biggest rival is Apple Music, as they both offer similar services. Apple Music even has a price structure that mirrors Spotify, although its family membership for six is a dollar cheaper per month. In terms of audio quality, Apple Music takes the lead with its support for lossless 48 kHz and Hi-Res 192kHz audio.

Spotify uses the AAC codec, which is also the standard format for Apple Music. But Apple also has its proprietary Apple Lossless Audio Codec (ALAC), which delivers a studio-like experience for audiophiles.

The majority of users who stream music online don’t own expensive digital-to-analog converters (DAC). Nor do they use expensive headphones or surround sound, which makes Spotify’s audio quality more than adequate for most.

Spotify does restrict free users to a bitrate of 128kbits per second, while Apple Music has a standard bitrate of 256 kbits per second.

Apple Music doesn’t have a free membership tier and is available on fewer platforms, which restricts its accessibility. The automatically curated playlists on Apple Music are not as engaging or organic as the algorithmic playlists on Spotify. As a result, Apple Music has a smaller userbase compared to Spotify.

In 2021, Apple Music was estimated to have 78 million subscribers.[5] It is the second largest music streaming platform behind Spotify, with 19% of the market share compared to Spotify’s 35%.[6] Apple Music also doesn’t have many of the social features that are present on Spotify, such as Wrapped. Wrapped is an annual analysis of a user’s music listening habits that is created to be shared on social media.

Spotify has significant operational costs that keep growing each year as the platform aggressively expands into new markets and adds features. In 2021, the company generated a total revenue of €9.6 billion. However, the cost of revenue was €7 billion- which is 73% of the total revenue.[7]

That isn’t the entirety of Spotify’s operational costs. The company spent €912 million on research and development, €1.1 billion on sales and marketing, and €450 million on administrative expenses. As a result, their operating income was just €94 million from a total revenue of €9.6 billion before financial costs.[8]

 

How Does Spotify Make Money?

Spotify makes money from two different revenue streams. These are subscriptions and advertisements.

In 2021, Spotify generated €8.4 billion from its pool of 180 million Premium users. The Premium average revenue per user (ARPU) in 2021 was €4.2. This was a slight decrease from the Premium ARPU of 2020 which was €4.3.[9]

Ad-supported revenue for 2021 was €1.2 billion. When compared to the total revenue of €9.6 billion, Premium memberships generated the vast majority of revenue at 87.5%. Followed by ads, which accounted for 12.5% of total revenue.[10]

Subscriptions

Spotify offers its Premium membership through four separate packages:

  • Individual: At $9.99 per month, this is the subscription plan for one person who just needs a single account for themselves. It allows ad-free music streaming with no skip or playback limits. Music can also be downloaded for offline listening.
  • Duo: Costs $12.99 per month and is designed for a couple that needs two accounts. Individual users can easily upgrade to a Duo membership plan, and all their playlists will be carried over. The plan supports separate playlists and unique recommendations for both accounts.
  • Family: Users pay $15.99 per month, and gain access to six Premium accounts. A Premium Family membership also comes with parental controls for kids.
  • Student: For a discounted rate of $4.99 a month, any student can get a Spotify Premium membership. They must be studying at an accredited higher education institution, with no prior Premium membership. The Student plan also includes an ad-supported Hulu subscription and SHOWTIME subscription.

According to estimates, the average per-stream payout to a music rights holder is between $0.003 and $0.005.[11] An algorithm uses data like geolocation, artist value, and more to calculate the optimal payout for each rights holder. The typical revenue split is 70% to the rights holders and 30% to Spotify.[12]

 

Advertisements

Spotify runs three main types of ads on its app. These include:

  • Audio Ads: These play in-between songs and are not skippable. Audio ads are accompanied by an image swap. Which changes the album cover to an image provided by the brand being promoted.
  • Video Ads: When a user is browsing through their feed or looking at search results, they might be shown a video ad. The video ads on Spotify play with sound turned on. Users are provided with an option to watch a short video ad so they can gain 30 minutes of uninterrupted music playback.
  • Podcast Ads: An ad in the format of a podcast. These are an excellent way for brand marketers and representatives to tell a story, while capturing the undivided attention of listeners. Podcast ads can also be streamed by users.

 

Spotify Funding, Valuation & Revenue

Spotify Technology S.A. (SPOT) currently trades on the New York Stock Exchange (NYSE). The company went public on the NYSE through a direct listing in 2018 with a reference price of $132 per share.[13] As of September 2022, the company’s stock traded for just over $104 at a valuation of $20.12 billion.

To date, the company has gone through 18 successful funding rounds and raised a total of $2.1 billion. Notable investors include EquityZen, SharesPost Investment Management, Tencent, and Harmony Partners.[14]

Spotify hasn’t been profitable for quite some time and is focused on growing its business. In 2021, the company reported a net revenue of €9.6 billion with a net loss of €34 million.[15] Spotify incurs significant costs in royalty payments, hosting, research and development, and marketing.

In 2021, the company spent €912 million on research and development. It also spent €1.1 billion on sales and marketing. General and administrative costs made up a further €450 million.[16]

YearTotal RevenueNet Income
2019€6.7 billion(€34 million)
2020€7.8 billion(€581 million)
2021€9.6 billion(€186 million)

 

Is Spotify Profitable?

Despite its revenue growth and increasing popularity, Spotify has yet to be profitable. In 2021, Spotify reported a net loss of €34 million.

The company generated €9.6 billion in revenue in 2021, up from €7.8 billion in 2020 and €6.7 billion in 2019. Despite this, it continues to lose money as Spotify’s operating costs, and financial costs are quite significant. [17] 

As Spotify continues to cut down on operating costs as a percentage of its revenue through better agreements with rights holders, the company’s profits might increase.

Spotify is also focusing on indie artists to increase its revenue share per stream by skipping the record labels altogether. The company is also growing its Premium subscriber base at a steady rate each year by providing new features and improved value.

 

Conclusion

So, that’s how Spotify makes money. It’s a smart business model, and it’s helped Spotify grow into the global powerhouse it is today.

The thing about music is that people have to hear it in order for it to have any value. You can have a really good song, but if no one ever hears it, then it’s not worth anything.

Spotify has figured out how to make money off of the fact that people love music, and they’re doing it by making the music available to people at a low price—and then being able to monetize those users through ads and subscriptions.

The industry has changed dramatically since Spotify first launched in 2008, and it will continue to change as well. One thing we know for sure is that streaming will only become more popular—and with its large user base, Spotify has an opportunity to make even more money from this trend.

As more people become comfortable paying for streaming services, there’s room for them to grow their revenue streams by offering new content or other perks such as exclusive discounts on merchandise or live events.

Some newer trends could affect how people listen to music in the future—for example, voice-activated devices like Amazon Echo may become more popular over time, which would increase demand for music streaming services that work well with these devices.

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  11. Daffodil
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