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Why Did It Take So Long for Spotify to Turn a Profit?


Here's some good news for Spotify (NYSE: SPOT) investors: The company actually made some money! It posted an operating profit of 94 million euros in the fourth quarter of 2018. Net income and free cash flow were also positive for the first time in company history.

It may seem strange that a company that investors value at roughly $25 billion ( market capitalization ) is just now making money after more than a dozen years in business, but such are the oddities of the world of finance. Stranger still, Spotify expects to dip back into the red next quarter, predicting an operating loss of between 50 million and 120 million euros. So what's going on? Why has the world's most popular music streaming service had such trouble turning profits?

Year 2013 2014 2015 2016 2017 2018
Net loss (in euros)
63 million 188 million 230 million 539 million 1,235 million 78 million

DAta SOURCE: SPOTIFY.

Music is expensive

Spotify pays billions to rights holders, and its payments are tied to metrics like play counts and revenues, which means those payments grow with Spotify's success.  A powerful music lobby has successfully kept Congress on its side as it seeks to extend copyrights and keep royalty payment systems lucrative, which is bad news for Spotify and the rest of the music streaming crowd.

It's also worth noting that musicians are not earning much from Spotify. One estimate is that artists make about $0.001 per play. That's not exactly good news for Spotify, because it means that musicians will only want royalty payments to go up.

Original content and its limitations

Spotify isn't the first streaming company to confront the frustrations of pricey content. The high cost of streaming content was the main driver of Netflix 's (NASDAQ: NFLX) decision to focus on original content . Netflix's original content strategy is brilliant: Though the up-front costs of producing original content are high, Netflix saves money in the long run by not having to pay outside companies for their content.

A woman sits on a couch, wearing headphones, looking at a smartphone in her hand, and smiling.

Image source: Getty Images.

Music streaming services do not seem likely to sign bands and compete with record labels anytime soon, but Spotify has emulated the Netflix strategy in the podcast world. Spotify's planned purchase of two podcasting companies signals that the company will seek to produce original content to keep costs down. But Spotify's original content strategy won't work exactly like Netflix's.

Since some of Spotify's expenses are per-play payments, it can save money whenever users choose Spotify originals. Every minute that Spotify users spend streaming Spotify original podcasts instead of Ariana Grande is a minute that Spotify does not have to pay the owners of Ariana Grande's music for. Netflix's content deals virtually never include per-play bonuses, so a Netflix user who opts for originals over something Netflix bought from someone else does not immediately save Netflix any money.

But Netflix's original content strategy offers a more powerful way to save. If Netflix's originals are popular enough, the company can afford to pass on pricey licensed content. Subscribers are OK with the service not offering everything. Spotify can't really do this as a big part of the appeal of a service like Spotify is that it offers a comprehensive library. Spotify can't use the popularity of a podcast to justify dropping Ariana Grande from its service.

The price of competition

Looking at Spotify's bottom line, one could conclude that Spotify customers are not paying enough, but Spotify is understandably reluctant to raise prices. Spotify is in the lead with 96 million premium subscribers, but competitors like Apple 's Apple Music and Alphabet 's Google Play Music or YouTube Music are still threats. And the major music streaming services are all charging similar prices: Spotify is $9.99 per month, Apple Music is $9.99 per month, and Google Play Music is -- you guessed it -- $9.99 per month. Amazon 's Amazon Music Unlimited is also $9.99 per month, though it's available for $7.99 per month to Amazon Prime subscribers. Some services offer cheaper annual subscriptions.

Is anyone making money on music like this? Probably not. We know that Spotify isn't, while the bigger companies have the ability to absorb losses while waiting for competitors to fail. A service that raises prices before the competitive field slims could be the one that loses out.

Spotify's long path to profitability

Spotify has taken a long time to make a profit, and it expects to soon be unprofitable again. The company is clearly taking a long-term view, and is not keen to give an inch to the competition by raising prices. There may come a day when there are just a couple of music streaming services, and both of them raise prices. Or maybe music streaming services will begin to raise prices more or less in unison when losses become intolerable -- something that has begun to happen in the similarly profit-starved and competitor-packed live TV streaming market . Whatever the case, high costs and competitive pressure seem destined to keep Spotify profits down and force the company to focus on a bright future rather than a near-term payday.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Stephen Lovely owns shares of Apple. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy .

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This article appears in: Personal Finance , Stocks
Referenced Symbols: SPOT , NFLX




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