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Putting Growth on Repeat

Spotify, headquartered in Stockholm, Sweden, is one of the world's largest music streaming service providers, with hundreds of millions of total listeners. The firm monetizes its users through both a paid subscription model, referred to as its premium service, and an ad-based model, referred to as its ad-supported service.

Spotify aims to unlock the potential of human creativity – by giving those the opportunity to make a living off their craft and for others to enjoy it. Providing access to over 75 million songs and over 2.6 million podcast titles, Spotify is the go-to for audio streaming services.


Braden Dennis







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Where Are We Now

Updated on: 11/7/2021

Conviction Score


Spotify is an audio beast, plain and simple. Spotify is the place where the world’s best creators upload their content to be enjoyed by millions of listeners worldwide. We think Spotify today is extremely attractive. The powerful network effects from the massive global listener, artist, and creator base will only enhance the variety and quality of content uploaded onto Spotify.

  • The Spotify user base continues to swell. The company recently surpassed 380 million active users, up 19% since last year. By the end of 2021, Spotify expects this number to be north of 400 million.

  • The potential podcast, music streaming, live audio, and concert distribution consumption is outlandish. Spotify is working on capturing these markets. Today, we think Spotify is best positioned to grow with these trends.

Investment Thesis

  1. Spotify owns the largest market share in the audio streaming business. Providing a product that people love, providing useful insights and listening recommendations, the founder-led business has market leading engagement rate and continues to post impressive growth of paid and ad-supported users.

  2. To create a paid user acquisition channel, Spotify can be used completely for free with advertisements. To go ad-free, or “Premium”, users pay an ongoing subscription. This model creates a powerful user acquisition model and high conversion rates to users eventually becoming paid subscribers.

  3. Spotify is building a powerful network effect in audio streaming allowing for collaborative listening and live audio.

  4. The business is well positioned to capture the enormous and growing total addressable markets of music streaming, podcasting, live audio and concert distribution.

  5. Spotify as a platform is very sticky for users as their listening experience improves with listening data, recommendations and playlist creation. Eventually, a business like Spotify with low churn and high growth will produce exceptional operating leverage and profitability.

  6. Spotify is executing an exclusive content creation model with creators that will drive more users to the platform and widen the gap between them and competition.

The Basics

Spotify transformed the way people listen and access to everyday music and podcasts. Spotify reinvented the wheel by shifting from the old pay-per-track or pay-per-album models to a consumer-friendly, access-based subscription model.

Spotify provides users access to millions of songs and podcasts at their fingertips for a low monthly fee. Although this business model appears simple, it is a lot more complicated under the surface (more on this later). Nonetheless, Spotify has warped a network of millions of people in one huge virtual location where everyone has an interest in one of two things — music and podcasts.

Spotify's user base makes up a classic freemium business model with two tiers of users:

  • Ad-supported

  • Premium

The company makes money from both types of subscribers, but the sources of the revenue earned are entirely different.

Spotify User Segments (Q3 2021)

Source: Spotify Investor Relations

Ad-Supported Service

Free users do not pay any fee to access Spotify. However, they only have limited access to Spotify's music and podcast libraries. These limitations largely include the inability to:

  • skip more than 6 songs per hour

  • access playlists beyond the 15 select playlists provided

  • pick a song without shuffling the playlist

  • listen to music ad-free

Spotify generates revenue from these users by selling ad space to agencies that represent advertisers (i.e., clients).

As of late, Spotify has begun piloting a less restrictive ad-supported service for about $1 per month. This new tier would bridge the gap between the Ad-Supported and Premium Services by allowing listeners to pick songs but still play ads.


Spotify's Premium Service provides listeners with unlimited, ad-free access to millions of songs and podcasts from their favourite artists and creators.

Spotify Premium can be accessed through smart devices, computers, tablets, and mobile devices and could be played through a myriad of systems.

Subscribers can choose one of four Premium pricing plans:

  • Individual

  • Duo

  • Family

  • Student

The following plan specifics are based on Spotify US plans:

Spotify's Pricing PlansSource: spotify.com

Premium subscribers are captured primarily from the Ad-Supported Service. Therefore, the freemium model is a key driver and funnel of Premium subscriptions. It showcases a wonderful example of how a freemium model should generally work.

Licensing Overview

Put simply, Spotify is in the business of selling music to you, the listener, music and other audio you crave through a subscription model. In order to deliver music and podcasts to your devices and through your speakers and headphones, Spotify must pay for the rights to stream the audio composition to users.

For recorded songs, Spotify obtains one of two general classes of licenses:

  1. Sound Recording License Agreements ("recording license")

  2. Musical Composition License Agreements ("composition license")

Music Ownership Explained

Before delving into the two music licensing classes, it is crucial to understand exactly who owns any given song and what rights they have with respect to a song or an album.

There are three general parties involved when it comes to recorded music:

  • Songwriter

  • Performer

  • Publisher

Songwriting is self-explanatory — it refers to an individual or group of individuals who write songs. Songwriters themselves might also be the performers — the person or group actually recording the song in studio — of the song, or they might not be.

There are many popular hits out there that were not written by your favourite artist. For example:

  • Party in the U.S.A. by Miley Cyrus was written by Jessie J

  • Sia wrote Diamonds by Rihanna

  • Pink wrote Adam Lambert's hit, Whataya Want From Me

It's important to note that "ghostwriters" do not receive the same credit as songwriters do. Ghostwriters are typically obligated to remain a "ghost" and will usually receive a one-time payment as consideration rather than royalties.

The performer of a song, as you probably now know, is the individual or group of individuals that perform and record a song or album in studio. Using the examples above, Miley Cyrus, Rihanna, and Adam Lambert would be considered the performers of the song, not Jessie J, Sia, or Pink.

Lastly, music publishing, in its simplest form, refers to the promotion and monetization of a song or album. There are two main rights or assets related to a song:

  • composition (lyrics, notes, music)

  • sound recording (i.e., "master", or the recorded version of the song)

A songwriter can either publish their song entirely on their own or through a music publishing company. If a songwriter is also the performer of the song, they would have rights to both the composition and the sound recording, or master. If a songwriter does not perform the song, they would only have rights to the composition.

Oftentimes, it is slightly more complicated than that. In most cases, songwriters do not pitch songs to the performer on their own.

They usually work with a music publishing company to get their musical compositions in front of artists. The music publisher serves as the intermediary between a streaming medium — like Spotify — and the songwriter. More specifically, the publisher looks out for a songwriter's music rights and earned royalties and seeks to promote their work and source great artists.

Sound Recording License Agreements

Recording licenses are agreements that Spotify has in place with the major three labels — Universal Music Group, Warner Group, and Sony Music Entertainment Group. Similarly, Spotify also has deals with Merlin and other independent record labels. These licenses represent the rights to the actual recordings or songs themselves.

To compensate these groups for the art they have created, Spotify pays royalties and in some cases, minimum guaranteed payments, on the songs owned by the songwriters or their agents. At Spotify, almost 80% of the music streams played through the platform have a recording license agreement in place.

Musical Composition License Agreements

Composition licenses are not exactly a single type of license. It is an umbrella term for two other types of licenses Spotify generally has to obtain prior to making music available on the platform:

  1. Performance rights

  2. Mechanical royalties

Spotify pays performance rights to the publisher of a song when it is streamed. In general, these royalties are paid when a song is performed in public. Streaming meets this definition.

Spotify also pays mechanical royalties. These royalties are meant to compensate a songwriter any time their song is "reproduced" (i.e. played). In the US, mechanical royalty rates are set by the Copyright Royalty Board based on a proportion of a platform's streaming revenue or total content costs. These must be agreed upon by all parties involved.

How does the music industry make money?

Spotify certainly has a lot of parties to pay when it comes to streaming music. This is the company's largest cost, eating up about 75% of revenues. However, this is an improvement versus the last several years when licensing costs ate up more than 80% of revenues, producing fairly low gross margins.

The Story of the Misheard

Daniel Ek and Martin Lorentzon were both successful Swedish entrepreneurs when they met in 2005. Ek was the CTO of Stardoll, a fashion-based video game company, and Lorentzon was the co-founder of Tradedoubler, a digital marketing company.

One day while trying to browse Ek’s home theatre computer for media, the duo found it troublesome and awkward. So, they built a solution themselves. This was the beginning of the now-known multibillion dollar company, Spotify

Now you may think — where does the name Spotify come from? Surprisingly, it was a misheard term.

While Lorentzon was shouting random idea names to Ek, they took the words “spot” and “identify” to make Spotify.

Since the start of the company in 2006, Spotify has grown tremendously while helping transition the music distribution industry into a whole new dynamic — streaming-based services.

From partnering with Google Home to provide services through Smart Homes to the end-of-year “Spotify Wrapped” campaign, Spotify has a knack for getting its product in front of consumers. 

Artists’ successes have also been attributed to the growth of the company. In the last few years, artists have taken the platform by storm hitting record numbers.

If you remember:

  • Drake’s “One Dance” became the first song to hit 1 billion streams

  • Drake was also the first artist to surpass 50 billion streams 

  • Ed Sheeran was the first artist to hit 80 million followers on Spotify

Competitive Advantages

Two-Sided Marketplace

Spotify's main competitive advantage over traditional audio platforms (i.e., radio, CDs, etc.) is the ability to connect millions of listeners with millions of creators and artists.

Listeners have easy, quick, and convenient access to all their favourite songs and podcasts without having to pay $1.29 / track or go through the bulky effort of finding a high-quality free version online.

That's the "buyer" side, but "sellers" also have many reasons to place their content onto Spotify for consumption by their fans. Artists and labels are enjoying a revival in recorded music revenues following a structural decline from the late '90s until 2014 / 2015. Without streaming services, particularly Spotify, we struggle to find a reason why recorded music revenues would not continue their decline over time. For this reason, we think labels and artists are optimistic overall on what Spotify has done and will do to the audio industry.

Global Recorded Music Revenue ($B)

Source: Statista

As Spotify grows in prominence and continues to take share away from traditional listening media, we think labels and artists will be more inclined to sign deals that increasingly favour Spotify. As it stands today, labels still have a fair bit of leverage over Spotify as the gatekeepers to recorded music.

Should Spotify's MAU base surpass 1 billion and beyond, we think there is a high chance the (negotiation) tables turn in favour of Spotify. If streaming services become the main medium for listeners to access music and podcasts, how much power would labels really have despite being the gatekeepers to recorded music? Quite little, in our humble opinion.

Millions of Songs, Tons of Data

A remarkable side effect any technology company with millions of users experiences is the amount of user data that can be tracked, fed into algorithms, and ultimately spewed back to the consumer as a higher value product.

For a two-sided marketplace like Spotify, trackable user data benefits both buyers (i.e., listeners) and sellers (i.e., labels and artists).

Spotify helps labels and artists reach their target audience more effectively than traditional media by identifying who listens to what music and when they tend to listen to it most.

Listeners also benefit immensely from Spotify's algorithms. Spotify literally listens to what users listen to through algorithms. These algorithms chew up the data and then spit out high-quality, personalized playlists for the user to enjoy.

How Spotify's algorithm worksSource: miro.medium.com
Spotify's "Made for You" PlaylistsSource: engaiodigital
Spotify's Personalized PlaylistsSource: HBS Digital Initiative

Spotify is the dual-threat platform that listeners and labels both never had. Listeners hear more of what they like in a significantly more convenient and cheap platform. Labels and artists reach listeners from around the world in seconds. Even small independent artists making music in a niche subgenre can reach their specific audience in no time.

From the two-sided marketplace comes a wide variety of benefits for all parties involved. Spotify is winning and we expect it to continue to do so.

The World of Audio Streaming

What made Spotify special was its introduction to the idea of audio streaming. Before its time, the main way to access music was to purchase tracks on iTunes or walk down to your local shop to get CDs. With Spotify’s audio streaming platform, users could sit in the comfort of their home and have access to millions of songs, all for one price.

US Music Industry Share by Source

Source: RIAA

In addition to music streaming, Spotify helped shine a light into the world of podcasts. With over 300 million listeners around the world, Spotify provides services to encourage people to use the platform. They introduced a program called Spotify for Podcasters which allows users to share their libraries easier, along with a tool to help generate advertisements to embed in the podcast itself.

US Music Sales Distribution graphedSource: RIAA

Their main goal is to try and encourage more and more people to use their platform for distribution.

In May 2020, Joe Rogan signed a deal with Spotify worth $100 million, to host his show, “The Joe Rogan Experience”, exclusively on Spotify.

Building a Community of Listeners

Spotify’s main stream of revenue comes from their monthly active users. Premium users can pay a monthly fee to gain access to a plethora of upgraded features.

Since it is a SaaS (software as a service) company, they opted for a freemium model. This is a strategy to give users a taste of how platform works with very little friction. This is not to be mistaken with a free trial, which has a time limit and then an obligation to purchase the premium product.

Spotify Monthly Active Users (M) (Q3 2021)

Source: Spotify Investor Relations

The freemium model is a strong way to gain customers’ trust and pique their interest. Spotify has used this model successfully by drawing in millions of new subscribers each quarter.

Spotify also has the highest conversion rate across SaaS companies, sitting at nearly 27%. Just to put into perspective, companies like Dropbox and Evernote have a 4% conversion rate.

How does Spotify grow their MAUs so quickly? By creating a community of listeners. 

Spotify’s marketing structure is always striving for the idea of a community. Whether it be shared playlists with friends, seeing what your circle is listening to, or even purchasing a Family subscription plan, Spotify is always helping you build a community.

Spotify Revenue (€M) (Q3 2021)

An Experience Catered to You

Aside from building a community, what helps bring in more MAUs every year is Spotify’s ability to make your listening experience about you. Their use of Artificial Intelligence helps to cater specific songs, podcasts, and ads to your liking. This is what keeps users on the platform, converting to premium, and keeping churn low.

Spotify took a new approach on ads in podcasts. Hosts now have the ability to insert dynamic ads, which are different for every user. Based on their preferences, every individual gets a different ad in that specific time slot, ensuring people get ads catered to them.

On top of the spot-on recommendations, the end of year Spotify Wrapped campaign is what puts the icing on the cake. The campaign helps users appreciate their music tastes, regardless of if they are a freemium or premium user. Statistically, daily average users (DAUs) increase by 20% every year when Wrapped comes out.

It is creative, fun, and even embarrassing experience to keep users engaged and wanting to come back.

(We know Nickelback was your top artist)

At the end of the day, this is the biggest reason why users join Spotify, convert to premium, and stay on the platform. You aren’t just paying for a bunch of music and podcasts; you are getting a service that appeals to who you are as a listener.

 Bad Bunny Spotify UnwrappedSource: Spotify Wrapped

Let's "Talk" About Podcasts

Perhaps the most exciting part about Spotify’s growth has yet to come.

As previously mentioned, Spotify is putting more and more resources into podcasts, with dynamic ads, and dealing with Joe Rogan. They also recently acquired 3 podcasting companies, Gimlet Media, Anchor, and Megaphone, for over $600 million. These acquisitions are intended to help the platform dominate the podcast market. Spotify now has the ability to make more profit off of ads, while having exclusive shows on their platform.

 As Spotify continues to be more active in the podcast industry, they will be able to take down the current podcast baron: Apple. Since 2018, Spotify transformed the way people listen and access to everyday music and podcasts.

Spotify recognizes podcasting is big business and they are pursuing it aggressively with acquisitions of exclusive content and podcasting software platforms.

Owning the advertising ecosystem could be on of the most wise moves in the opportunity of podcasting that exists today.

"Audio is ours to win." - Daniel Ek, Spotify's Co-Founder and CEO

They recognize that the opportunity set is much larger than just music.


Labels in Control

Although it's clear the world loves streaming services through mass adoption over the last five years, there are parties that still may dictate the future of these services.

In the case of Spotify, labels are still very much in control today. Speculation aside, labels are the gatekeepers to music rights. Spotify has no choice but to compress its margins substantially to get content onto its platform. Without this content, Spotify has nothing.

Although we think Spotify (and other streaming services) will continue to eat up market share from traditional music media (i.e., sources of revenue to music labels) and labels will be increasingly inclined to sign deals in Spotify's favour, we absolutely cannot be certain as to the timing, extent, and magnitude of such deals.

In simpler terms, we do not know how much negotiating room labels would be willing to give in an extreme theoretical situation where Spotify has 100% market share over audio media and platforms. Although Spotify would have much more negotiating room, labels would still remain the gatekeepers and benefit substantially from the growth of Spotify.

Spotify's gross margins are certainly the largest area of contention over the long run when investors think about Spotify's mature, steady-state margins.

Fierce Competition

Spotify may be in first place, but many of its large competitors have one advantage that Spotify may struggle to compete with over time.

Apple Music or Amazon Music hold about 30% of the market and they have no intention of achieving a near-term profit target with the services. These music services are merely value-added services for other services they provide.

Spotify is adversely impacted by the existence of these services for two main reasons:

  1. These services provide a viable alternative to Spotify that caps Spotify's pricing power now and in the future.

  2. If audio platform providers like Apple and Amazon are not as concerned with obtaining music rights and the costs associated with them, labels can maintain their leverage at the negotiating table with Spotify.

Apple, Google, Tencent, and Amazon are all highly profitable companies with or without their streaming services. Their mere existence could severely limit Spotify's negotiating leverage, margins, and pricing power capabilities. Spotify's growth profile could also be severely impaired if any of these services decide to cut prices to drive adoption of these companies' platform ecosystems.

Global Streaming Music Subscriber Market Share (Q1 2021)

Sources: MIDiA Research Music Model, routenote.com

Suppressed Pricing Power

Spotify is a highly sticky service that customers undeniably love (ourselves included). However, the structure of Spotify's royalty-based deals with labels implies that price increases may not fall directly to the bottom line. In fact, price increases may see commensurate increases in music rights costs, eliminating any benefit from the top line.

Shareholders may feel uneasy with the nature of these unit economics. While Spotify likely has lots of room to expand its top line, it might take substantial price increases to show up meaningfully in the bottom line. If this is at the expense of what a listener believes is a reasonable price for the service, Spotify may be limited in its true pricing power.

A mitigating factor for this is Spotify pioneering the monetization of podcasting, which completely circumvents having to sit face-to-face with a label and negotiate contracts with them. If Spotify can pull this off well, it may set itself up for massive success.

Spotify Content Payment StructureSource: Spotify 2020 10-K

Bottom Line

Spotify is trying to be the center piece of all things audio. They have revolutionized the music distribution scene in addition to popularize the idea of podcasts. From your favourite music to the podcasts you listen to while studying, Spotify has it all.

By the numbers, Spotify is growing tremendously, averaging 15 million more MAUs per quarter.

Their advancements in Artificial Intelligence are what make people come back for more. They cater sounds to you, and help you find new music that you would enjoy.

Spotify is just hitting the tip of the iceberg right now with audio streaming and advertisements. In the upcoming years, there is potential to delve into other markets such as concert and ticket distribution along with music production.

Despite not yet being profitable, investors should consider that Spotify is investing in the business to drive growth.

Spotify has been an impressive growth in the music streaming business. Their future upside in gaining market share, domination in the podcast market, and emphasis on user experience is what will help put the company’s growth on repeat.

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