Jun 12, 2024 9 min read

Spotify needs to find a path to consistent profitability. Are high res audio and AI playlists really the answer?

With its deadline to repay $1.3 billion in debt getting closer, Spotify needs to do anything it can to increase top line revenues and hit a consistent streak of profitability. It’s time to talk SUPREMIUM again!

Spotify needs to find a path to consistent profitability. Are high res audio and AI playlists really the answer?
  • Rumours of a Spotify “super-premium” tier are being reported again
  • Spotify’s “Supremium” offer will include high quality audio and AI playlisting features says Bloomberg, with pricing rumoured to be 40% on top of current premium subscription pricing
  • Will people really pay more? And if they do, what does that look like for Spotify’s business model?
  • Spotify loses tens of millions of premium subscribers each year to churn

As ‘industry sources’ once again start talking up the prospect of a higher-priced Spotify ‘Supremium’ offering, what does that actually mean? And is it likely to help Spotify hit a consistent streak of profitability?

According to Bloomberg, Spotify will finally launch a long-rumoured high-priced premium tier later this year, aimed at the streaming platform’s “most ardent users”. Part of that new tier will be high resolution audio - something that has long been missing from Spotify, and has become an increasingly visible omission as other platforms double down on innovative high resolution audio formats including Dolby Atmos and Apple’s Atmos-based Spatial Audio. 

Does anyone really care about premium audio?

The inclusion of high resolution audio is not only a no-brainer for Spotify, it’s pretty much essential if it wants to introduce a new tier. However, premium audio in its own right has proven to be a bit of a commercial flop, and most other streaming platforms which were offering a standalone premium audio product have folded that down into their standard premium subscription. 

So there may not be enough people who care about premium audio in its own right for it to be a significant driver of increased revenue for Spotify. Which is, presumably, why there’s something else being thrown into the mix. This will be in the shape of “new tools for creating playlists and managing song libraries”, according to Bloomberg. 

Those new playlisting tools, says Bloomberg, will allow users to “instantly generate custom playlists for certain activities, dates and times of the year” - which sounds very much like a full roll out of Spotify’s previously hyped AI playlist tool, which Spotify pushed out as a beta to premium subscribers on mobile in the UK and Australia at the start of April.

That feature, said Spotify at the time, allows users to “effortlessly turn your most creative ideas into playlists” including, it suggests, making “a playlist that makes me feel like the main character”. This is achieved by pairing Spotify’s “powerful personalisation technology with AI to deliver the perfect musical mix, just for you”. 

Are people going to be happy to pay more?

However, the new higher-priced tier is set to cost “at least $5 more per month” - a price that will, says Bloomberg, “vary depending on each user’s base plan but will average out to about a 40% markup”. 

This means that individual Spotify premium users will be paying as much as $60 a year more. Meanwhile, Family Plan users - who pay £19.99 in the UK, or £17.99 if they opt out of audiobooks - could face a price hike of nearly £100 a year. On the face of it users aren’t getting a whole load more for that significant jump in pricing. 

A lot of the success of Spotify Supremium will be about creating a compelling offer for existing subscribers - or entirely new subscribers - that persuades them to opt into a new plan and pay more. While there have been a number of recent price rises, that's a passive decision - do you stay and swallow the price rise, or do you cancel your subscription? Opting into an entirely new tier and paying more is a much more active choice.

For many Spotify users an incremental price increase is a necessary evil - accepted, even if somewhat reluctantly, because the reality is there’s no real alternative choice. Sure, you can move to a different streaming platform, but you’ll pay pretty much the same, for the same service. 

Spotify’s playlist moat

Music streaming is unlike video streaming. With video streaming there are different content offerings across different platforms and some users will chop and change depending on what shows are on what platforms. With music streaming, the service offering has very little differentiation across platforms: premium subscribers have unlimited access to all the music, all the time. 

Not only is there less incentive to change platform, but there are active disincentives. Again, unlike video streaming platforms where you may watch a show once, music streaming is about repeat listening. Repeat listening, it turns out, is something that Spotify is pretty good at, compared to some other streaming services. 

Spotify users appear to listen to more music than users of other platforms, a fact which is hinted at by the higher “average per stream rates” paid out by some other platforms. While part of this comes from the fact that some platforms do not offer free or ad-supported tiers, there’s also evidence that suggests that Spotify’s premium users listen to more music than paying users on other platforms - meaning that the pot of money is shared between more people, reducing the overall “per stream” rate.

On this front, playlists are arguably Spotify’s killer feature. Early on, the ability to create playlists tapped into many people’s desire to curate their own listening, picking and choosing their favourite tracks to create the perfect soundtrack to their day. 

As other music streaming services launched and grew, playlists became a moat for Spotify, and a lock-in for users: migrating playlists to other services was challenging at best, and simply impossible for most, and for many people Spotify’s playlist features were just better. This meant unhappy Spotify users looking to switch music streaming service faced a bleak choice: stay with Spotify, or switch elsewhere, but lose your carefully crafted playlists, and potentially have a less well executed playlist experience. 

So Spotify has a lock-in on existing users, which is good for the long term viability of its business. Getting more money out of those users is a different matter. 

The Supremium incentive for Spotify and its investors

However, you can see the incentives. If Spotify could convert just 1% of its existing premium subscribers - 2.4 million subscribers - to Supremium, that could bring in an additional $140 million in revenue. Make that figure 5% of users switching to Supremium and it would add over $700 million to Spotify’s topline revenues. 

Now, of course, a significant amount of that revenue walks straight out of the door to copyright owners, but with Spotify keeping around 26% of its revenues (averaged over the last eight quarters) then over a twelve month period that could represent an increase of as much as $182 million in gross profit for Spotify, which would be a 5% bump. That’s a meaningful increase - and would go a long way to driving sustainable net profits, which, in turn, should lead to a long-term increase in the value - and share price - of the company. 

However, persuading nearly twelve million people to pay an additional 60 quid a year for something is easier said than done. Many Spotify users still complain that the platform’s bog standard playlist and library functions don’t meet their needs - and, as referenced earlier, high quality audio has not been the driver that many thought it would be. With that in mind, you have to wonder how many people will see the value in paying more for a combination of AI generated “functional” playlists and better audio. 

What’s likely is that we’ll see a flurry of marketing activity focused on shifting existing subscribers to Supremium when it launches, and the results of that campaign will largely inform the future direction - and potential - of the Supremium product. But also, maybe, Spotify itself.  

Spotify subscriber churn means they lose tens of millions of premium subscribers a year

When Spotify released its Q1 financials at the end of April it revealed that it had only managed to grow its premium subscriber numbers by 1% quarter on quarter, from 236 million at the end of 2023 to 239 million by end of March 2024. 

Of those premium users, 65% are in the EU or North America - breaking out to 38% and 27% respectively. This means that the company has somewhere in the region of 91 million premium users in Europe and 64.5 million in North America, both considered “top tier” territories where consumers are likely to be less price sensitive. 

Indeed, this lack of price sensitivity seems to be borne out in recent figures from Antenna Insights, and confirmed to CMU by Music Watch, that Spotify’s monthly churn rate - the number of subscribers who cancel their subscriptions - came in at 2% per month across the last year. 

On a month-by-month basis, that means that out of the 239 million premium subscribers Spotify had at the end of March, it would have lost 4.78 million to churn by the end of April. 

This is thrown into fairly stark relief when you look at it differently. If Spotify stopped doing anything to acquire new ad-supported users, convert ad-supported users to premium subscribers, win back lapsed premium subscribers, or directly acquire new premium subscribers (so bringing customers in as premium subscribers without converting them from ad-supported), then in just three years its premium subscribers would drop by almost half, from 239 million at 31 Mar 2024 to 115.5 million by 31 March 2026.

Why does this matter? Quite simply: the less opportunity there is for Spotify to acquire new users and new premium subscribers, the more expensive dealing with churn becomes. You either have to spend more to acquire new customers, or spend more to retain the customers you already have. In parallel, as your business matures and acquiring new customers becomes harder and more expensive, you have to find ways to squeeze additional revenue from your existing customers.

Spotify’s premium subscriber numbers for 2023 by quarter (Q1/Q2/Q3/Q4) were 210 million; 220 million; 226 million; 236 million. At the end of 2022, it had 205 million premium subscribers. 

This means that total premium subscribers had grown by 31 million over the year. When you account for churn, Spotify will have had to have brought in significantly more premium subscribers than that to deliver that growth.

Taking a blunt approach calculated on a monthly basis but based off quarterly numbers, and ignoring new additions each month (which would slightly but not significantly alter these calculations), then between 31 Dec 2022 and 31 Mar 2023, Spotify may have lost 12 million subscribers. In Q2, 12.4 million, in Q3 13 million, and in Q4 13.3 million. That’s a total of 50.7 million premium subscribers gone in just one year. 

So in reality, quarter by quarter it needed to add 17 million, 22.4 million, 19 million and 23.3 million, to combat churn and grow its total premium subscriber numbers - a total of 81.7 million premium subscribers.

Of course some of those may be lapsed premium subscribers who are won back - though that still costs money - but it also represents a significant investment in marketing and conversion initiatives to bring in new ad supported users, convert ad supported users to premium, and to bring in entirely new premium subscribers.

Over 2023 Spotify also added 83 million freemium users. We don’t know the churn on freemium, but it’s almost certainly significantly higher than premium churn - so to add 83 million freemium users over the year, it’s going to need significantly more than 83 million freemium signups. 

The economics of Supremium

Can we put a figure on those 81.7 million premium subscribers and the 83 million additional freemium users? Yes. In 2023, Spotify spent a combined €3258 million on sales and marketing activity, and R&D - nearly a quarter of its entire revenue for the year. 

While sales and marketing is a fairly obvious lever for driving user numbers and conversions, R&D is also a key part of the mix. R&D spend delivers the new features that attract users to Spotify over other music streaming services, convert users from ad-supported to premium, and keep premium subscribers engaged and listening. If paying subscribers aren’t listening often, if they aren’t saving songs, if they aren’t creating playlists, then they may feel less reason to continue their subscription. 

However, that’s around $19.78 per user - freemium and premium combined. In reality, the number will be slightly lower, because the number of freemium signups will have been higher (possibly much higher) than 83 million. 

On the face of it, adding 164.7 million users - of whom 81.7 million are premium users paying $10.99 a month -  for $19.78 per user seems a pretty decent return. That’s a couple of months premium revenue per user… Until you remember that Spotify doesn’t get to keep much of that revenue. In fact, with just 26% of the money coming in staying with Spotify, that means a premium subscriber is worth just $2.86 each month, or $34.32 a year. 

In the world of subscription businesses, churn is one of the most critical metrics behind the financial model. If you know how many users you’re going to lose each month, you can work out how many you need to replace to hit your targets, but you can also calculate the lifetime value of each subscriber. 

On a five year projection, Spotify’s lifetime value for a $10.99 premium subscriber is $89.72. Take a $15.99 premium subscriber, and assume 28% margin rather than 26% (which is not out of reach, following trends in recent quarterly filings) and reduce churn on that cohort just slightly - 1.8% churn rather than 2% - and suddenly lifetime value is $140.85 - an increase of 57%. 

For the labels and publishers, the lifetime value of a Supremium user over five years could be $362.20, versus $255.35 for a premium user, an increase of 41.8%. If Spotify can launch a compelling Supremium offering, optimise margin, and even fractionally improve churn over time, it could deliver a long term route to profitability. And if it can convert 5% of its 239 million existing premium subscribers to Supremium then that could be worth hundreds of millions of dollars in additional revenue to the music industry each year. But that’s a lot of very big “ifs”.

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