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Why Spotify is Falling Short in Their 2016 Financial Report

At 140 million subscribers, Spotify has quickly grown into the world’s largest music streaming service, outshining Apple Music, Tidal, YouTube, and others. Their 2016 financial report, which they released last week, revealed many of their successes from the year. According to the report, the app brought in $3.3 billion worldwide. Already an impressive number, it’s even moreso when you consider that it’s a 52% increase from 2015 ($2.15 billion), and a near 300% increase from 2014 ($1.2 billion). In addition to revenue, Spotify has grown from 20 million paid subscribers to 50 million in less than two years. This kind of consistent growth over the last two years looks very promising for Spotify, especially as they plan to go public in the next year. Spotify’s major growth has lifted the sales of the entire music industry, even helping lower piracy worldwide.

While the report reveals major growth for Spotify in 2016, one should not assume that things are going perfectly in the music streaming industry. While revenues and subscribers increase, so does debt. Spotify lost $601 million last year, a 133% increase from 2015, when the loss was only $258 million. Spotify also acknowledged an accounting error that understated the losses in previous years. The core of these major losses lies in two arenas: subscribers and royalties. At 50 million, Spotify’s paid subscribers only account for about 35% of their usership. And given that paying subscribers already account for 90% of the company’s sales, this seems to be the untapped area that Spotify needs to build upon if they want to continue to be successful.

On the opposite side of their users lies the music studios. Already, Spotify has committed to paying $2.2 billion in royalties to music studios over the next two years. In addition to that, Spotify is still negotiating new long-term deals with Warner Music Group and Sony Music Entertainment which will only add to the payout.

This then begs a question: Why does Spotify struggle while other streaming services, such as Netflix, find success? In their 2016 Q4 report, Netflix announced that they had 5.8 million net new paid subscribers, totalling their subscriber base at 89.1 million. And although both companies have experienced sustained growth, Netflix experienced a 18.5% streaming margin in 2016, while Spotify had a margin of -9%, according to a study done by Midia. This radical difference highlights the issues of streaming music over television. Minimum Revenue Guarantees (MRGs) are a key factor in music streaming. This means that the service, such as Spotify, guarantees a payment based on anticipated subscriber growth. They are always paying against tomorrow’s numbers.

However, one of the main reasons Netflix is successful is their ability to produce and own their own content. Spotify, who has not yet produced anything music of their own, must co-rent their content. And given the differences between the music and TV industries, it’s not so simple for Spotify to begin producing their own content. Record labels are wary of streaming services becoming labels themselves, but this might be Spotify’s key to making a profit.

Things are ramping up for Spotify as they plan to go public on Wall Street later this year or early next year. Valued at $13 billion, Spotify will carry out a direct listing, as opposed to an IPO, so that employees can cash out their holdings without the company having to pay the fees traditionally involved in an IPO. It’s a big year for Spotify as users and investors alike wait to see what the streaming service will do next to turn a profit.

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June 22, 2017
By Alex Moersen

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