After years of anticipation, the world’s largest music streaming service Spotify finally went public on Wednesday. As opposed to most other companies going public, Spotify
chose not to raise capital in a traditional IPO but to be listed directly on the New York Stock Exchange instead. “Normally, companies ring bells. Normally, companies spend their day doing interviews on the trading floor touting why their stock is a good investment. Normally, companies don’t pursue a direct listing”, the company’s founder and CEO Daniel Ek said in a statement
on Monday, adding that “our focus isn’t on the initial splash. Instead, we will be working on trying to build, plan, and imagine for the long term”.
If the company wants to be successful over the long term, it needs to solve the riddle that all streaming companies are facing in their quest to become profitable: balancing revenue and content acquisition costs. For every song a user streams on Spotify, the company has to 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 2017, Spotify’s cost of revenue, consisting primarily of royalty payments to record companies, amounted to $3.24 billion or roughly 80 percent of the company’s revenue. That leaves a gross margin of just above 20 percent 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 34 percent last year, up from 24 percent 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.