Why I’m Buying: Spotify

The Context

Spotify is a product-first company with a weak business model.

The Market Opportunity

Spotify isn’t moving into podcasting, it’s moving into audio. That’s news, serialised shows, interviews, education and sport.

Why Spotify Wins

I am consistently awed by the pace of product innovation at Spotify considering its scale, everything from small UI changes that improve the listening experience to data-driven personalisation.

Data-Driven

The application of the recommendation algorithm to podcasts is yielding results quickly. While in late 2019 my recommendations were truly terrible, today they are almost perfectly in line with the content I want to discover.

Curated

Spotify understands the importance of human-led curation, and it’s easy to foresee a range of curated playlist options that increase engagement:

  • Joe Rogan curating a weekly playlist of his favourite podcast episodes from other creators
  • A Crossfit Games winner recommends their favourite fitness and nutrition audio content
  • The best-of Sam Harris. A selection of his ten most influential episodes

Focus

The Impact on Spotify’s Unit Economics

Spotify has poor unit economics today and the shift into audio is designed to improve every element of the Spotify business equation.

Customer Acquisition

Spotify’s customer acquisition involves adding free users into the top of the funnel, then engaging those users so much they choose to pay for the product:

The creation of Competitive Advantage

Over time, Spotify will begin to aggregate demand for audio content.

Risks

There are many, the most obvious of which are:

  • Your competitors are the most successful tech companies in the world, who have enormous war chests of cash, with an in-built hardware advantage, who can use audio as a loss leader for their existing products and services. I’m comfortable with this risk because this has been the case for years now, and Spotify through focus and execution has maintained its market share in music and gained market share in podcasts from these competitors.
  • The podcast advertising market today is tiny ($500m annually) so you’re betting that with a significantly better ad product and the expansion of podcasting to include all forms of streamed audio (news, sport, education) you can both increase the size of the podcast advertising market to look more like the radio advertising market, and use the new listening hours as a tool to convert users into paid subscribers.
  • Spotify is just starting a long journey, and this pivot doesn’t work they’re left with a bad business model that probably won’t spit out free cash flow as it scales.

Valuation

Many people think Spotify is over-valued today, but if you have a long-term time horizon and think even some of the above is possible, the potential for revenue, earnings and multiple expansion allows for considerable upside.

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