In its first-quarter earnings report, Spotify missed Wall Street’s earnings target by a whopping $0.53 a share, despite beating expectations for both revenue and paid subscriber growth.
The streaming service posted a net loss of $0.90 per share, compared to the consensus estimate of $0.37, even as top-line revenue grew by 33 percent year-over-year and beat the Street by 3 percent.
Part of the shortfall could be attributed to various promotion campaigns the streaming service ran during the period, which included discounted service bundles offered in partnership with Hulu. But the stark disconnect between revenue and earnings underscored a long-standing concern over Spotify’s core business model.
“The most important thing is [Libra] will enable paying for things digitally in many of the places around the world where those kind of methods just doesn’t exist. A service like Spotify, you can imagine what would happen by allowing users for instance to be able to pay artists directly,”
The licensing deals it has with the record labels, on which its business depends, are based on a percentage of its revenue rather than a fixed rate or fee. At the same time, the royalty rates it must pay to songwriters and publishers, on which its business also depends, are largely out of its hands, fixed by statute, rate court or some other external mechanism and in most cases not subject to negotiation.
All of that leaves Spotify with precious little control over its gross margin, making it difficult to translate revenue growth into commensurate earnings growth.
With a series of recent moves by the company, however, it is becoming clearer just how extensive and systematic Spotify’s efforts are — and how far it is prepared to go — to try to claw back whatever measure of control it can wherever it can.
The efforts began in earnest last year, in the wake of the company’s public listing, when it quietly began striking direct deals with unsigned, independent artists.
While Spotify has not sought to acquire any rights from those artists, which it is prohibited from doing under its deals with the labels, whatever number of plays that music is able to generate on the service dilutes the market shares of the labels that are used to calculate their payments.
The efforts picked up speed with Spotify’s aggressive move into podcasts, including the acquisitions of Gimlet Media and Anchor. As discussed in a previous post, the move into podcasting and podcast production has a significant long-term strategic component to it for Spotify. But it also clearly reflects an effort to build up a part of its business — and aggregate listening hours — not covered by its deals with the labels and where Spotify has more direct control over the margins it earns.
As also discussed in the previous post, Spotify has signed on for the launch of Facebook’s planned cryptocurrency Libra and its blockchain-powered payment system. That system, CEO Daniel Ek has now confirmed, could eventually lead to Spotify users (or Spotify itself) paying artists directly, further reducing the share of its total cost base covered by its label deals.
Meanwhile, Spotify has been equally as aggressive in looking to trim and control what it must pay songwriters and publishers.
It risked the scorn and anger of composers and publishers by leading the charge to try to try to roll back the Copyright Royalty Board’s latest rate-setting for mechanical rights, which is poised to give artists and rights owners a major pay raise between now and 2022.
Then last week, it gobsmacked the industry again by claiming that, under the same CRB ruling it is challenging in court, it “overpaid” publishers last year and is now demanding its money back.
Points for chutzpah on the last one, if nothing else.
Notably, Spotify is not demanding a lump-sum refund from publishers but said it will treat the amount it claims it is owed as recoupable advances against its royalty payments for 2019 — a clear stab at margin-management.
Whether all of those efforts — and no doubt there are more to come — will give Spotify the leverage it needs to manage its earnings effectively remains to be seen. But they will clearly further burden the already heavily freighted relationship between Spotify and the rest of the industry.
For now at least, with its 100 million paying subscribers and 217 million monthly active users, Spotify is the industry’s largest customer in what has become its most important business segment: streaming.
While the label oligopoly keeps Spotify from growing into they industry’s 800-pound gorilla, it’s still a pretty big monkey.
Most of the meaningful alternatives available to the the labels and publishers, moreover, come with their own complications. Spotify’s largest U.S. competitors are all controlled by major technology companies that are not as dependent on music for their earnings, and are therefore in a position to drive much harder bargains with rights owners if they choose to.
Artists and rights owners need need pure-play streaming services like Spotify to survive and thrive lest they be cast upon the un-tender mercies of the Silicon Valley giants.
As a publicly traded company, meanwhile, Spotify has no choice but to gain financial control over its operations. That’s not only a matter of how much it pays out and to whom. It’s a matter of whether it can gain enough predictability over its own income statement that can make realistic financial projections and not miss them by $0.53 a share.
If it can’t do that under the current arrangements it needs to make new ones.