Spo­tify’s up­hill bat­tle against roy­alty costs

By Fe­lix Richter

Financial Mirror (Cyprus) - - MARKETS -

De­spite re­port­ing third quar­ter re­sults that were largely in line with or even ahead of ex­pec­ta­tions, Spo­tify’s share price dropped by more than 6% in the af­ter­math of its earn­ings re­lease on Thurs­day. The drop was largely driven by fears of slow­ing user growth and the com­pany’s plans to “ac­cel­er­ate the pace of in­vest­ment in R&D and Con­tent in 2019”, which would likely re­duce op­er­at­ing mar­gins for the “fore­see­able fu­ture”.

Like all stream­ing com­pa­nies, Spo­tify is fac­ing an up­hill climb to­wards prof­itabil­ity as it needs to find a way of max­imis­ing rev­enue while keep­ing con­tent ac­qui­si­tion costs at bay. For every song a user streams on Spo­tify, the com­pany must pay a cer­tain amount to the record com­pany own­ing the rights to that song. While the rate per in­di­vid­ual stream is very small (so small that many artists feel treated un­fairly), the costs quickly pile up when mil­lions of users stream bil­lions and bil­lions of songs.

In the first nine months of 2018, Spo­tify’s cost of rev­enue, con­sist­ing pri­mar­ily of roy­alty pay­ments to record com­pa­nies, amounted to $2.8 bln or roughly 75% of the com­pany’s rev­enue. While that is al­ready a sig­nif­i­cant improve­ment over past years, it still leaves just 25% of rev­enues to cover all other ex­penses (in­clud­ing sales and mar­ket­ing, re­search and de­vel­op­ment as well as gen­eral and ad­min­is­tra­tive costs), mak­ing

it in­cred­i­bly hard to turn a profit.

Net­flix has solved that rid­dle by pro­duc­ing more and more orig­i­nal con­tent and bow­ing out of un­prof­itable li­cens­ing agree­ments with movie stu­dios in or­der to im­prove its mar­gins. The world’s lead­ing video stream­ing com­pany had a gross mar­gin of 40% through the first three quar­ters of 2018, up from 24% five years ear­lier. Un­for­tu­nately for Spo­tify, this model isn’t eas­ily con­verted to the mu­sic stream­ing busi­ness, where users ex­pect to find all mu­sic past and present in­stead of a se­lec­tion of orig­i­nal con­tent to choose from. In­stead, Spo­tify needs to con­stantly ne­go­ti­ate with record la­bels in or­der to im­prove its li­cens­ing terms and bring down con­tent costs. The com­pany reached new agree­ments with Uni­ver­sal Mu­sic Group, Sony Mu­sic En­ter­tain­ment, Warner Mu­sic Group and oth­ers last year, but it re­mains to be seen whether these agree­ments will be good enough for Spo­tify to ac­tu­ally turn a profit any­time soon. (Source: Statista)

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