The Ledger: Spotify Is Embracing a New Financial Metric. Can Investors?
The streaming giant is shifting focus from average revenue per user to lifetime value.
The Ledger is a weekly newsletter about the economics of the music business sent to Billboard Pro subscribers. An abbreviated version of the newsletter is published online.
Since the early days of subscription music-streaming, platforms have been measured by a single financial metric: “Average revenue per user,” or APRU. Now after a decade and a half as a business and four years as a public company, Spotify seemingly wants to take ARPU down a peg. Its replacement, judging from the company’s investor presentation in New York on Wednesday, is “lifetime value,” or LTV, which measures a user’s total contribution over time to the company’s bottom line. It’s a holistic metric that helps the company assess its decisions and guides where it invests its money.
LTV combines how long a consumer uses Spotify and how much money they either spend on a subscription or generate through advertising. To calculate LTV, take a user’s contribution margin – revenue less costs of revenue, such as music licensing fees – and discount to a single amount in today’s dollars. (It’s like the way an entire corporation or a publishing catalog is valued.) Subscription ARPU is just one aspect of LTV. Monthly churn rate also plays a key role here. As the churn rate falls, people stick around longer, listen to more podcasts, pay more subscription fees, and raise the average LTV. On the flip side, something that increases churn rate can have an adverse effect on LTV. ARPU alone can’t distinguish between the long-term implications of different decisions.
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On Wednesday, one of the most enlightening pieces of data revealed was Spotify's monthly churn rate, which fell from 5.5% in 2017 to 3.9% at the end of 2021, according to CFO Paul Vogel. It was the first time since 2018 the company released an actual churn figure. Investors also learned subscriber churn in Spotify's oldest markets averaged 2.4% at the end of 2021 — and reaches as low as 1-2% in its most mature markets. Although developing markets, where Spotify has operated for the shortest periods, have higher churn than mature markets, after three years their churn rates “historically reached the same point on the churn curve as developed markets,” said Vogel.
ARPU has an appealing simplicity, and Spotify still tracks it in its quarterly earnings reports. But it’s also more nuanced than it might initially appear. For as long as Spotify has reported its financials, ARPU fell consistently until an uptick in the last few quarters. ARPU fell from 5.53 euros ($5.82 at current conversion rates) in Q2 2017 to a low of 4.12 euros ($4.34) in Q1 2021 before steadily rising to 4.40 euros ($4.63) and 4.38 euros ($4.61) in Q4 2021 and Q1 2022, respectively. The simple interpretation is Spotify has received less from each additional subscriber over the years. But much of the decline in ARPU comes from increased adoption of student and family plans, which have lower ARPU but benefit the company by helping attract and retain subscribers. Even with a lower ARPU, the net effect of lower churn can result in a higher LTV. ARPU alone can’t capture that positive impact. That’s an important distinction when Spotify is unable or unwilling to raise subscription prices.
For Spotify, LTV is a more sensible gauge of a streaming platform's progress than ARPU because it can better measure the long-term effects of decisions. During the presentation, Tony Jebera, vp of machine learning, explained that focusing on LTV discourages Spotify from things that might improve gross profits in the short-term — such as increasing the number of ads it serves and recommending content that isn't right for them — but carry negative, long-term consequences. For example, Jebera's team runs tests to determine which podcasts generate more LTV per hour of streaming. One finding, Jebera said, was "that clickbait content manufactured to fool users and algorithms can actually decrease LTV.”
Taking a long-term view makes sense for a company that must make substantial investments before it reaps the financial benefits. Spotify's commitment to podcasting has tested investors' patience as expenses have far exceeded revenues. In 2021, podcasting generated revenues of nearly 200 million euros ($215 million) but was a 103 million-euro ($108 million) drag on gross profit — that’s a -57% gross margin. In the presentation, Spotify argued the investment will be justified because users who listen to both music and podcasts have higher LTV than those who listen to one or the other. (It expects the same dynamic to hold true with its next product expansion, audiobooks.) Additionally, Vogel cited lyrics as another example of navigating by LTV. "It's mostly an incremental expense,” he said. “However, since launching globally in November, it has quickly become one of our most used features." So, even though the lyric feature creates a short-term gross margin impact, Spotify believes it will ultimately improve LTV.
LTV is also a sensible metric for investors, although it's difficult to calculate with limited information. Over the years, Spotify had left it to analysts and investors to estimate churn numbers based on its limited public disclosures. As Billboard reported in a 2021 article about Spotify's LTV, Citi analyst Jason Bazinet believed Spotify's falling ARPU was the result of family plans, which have a lower ARPU than standard, single-person subscriptions, because they kept subscribers on the platform longer. The longer consumers stay on the platform, the more valuable they become to Spotify (and creators and rights holders). Measuring churn rate isn't straightforward, either. Spotify offers daily and weekly subscriptions in some countries in addition to the standard monthly plans available everywhere. Those short-term plans "distort" monthly churn numbers, said Vogel, and help explain why Spotify does not report churn on a quarterly basis.
Now, Spotify’s challenge is sharing the proper information with analysts and investors. LTV is a handy internal metric, but how much transparency will outsiders get? Vogel couldn't say exactly how Spotify will communicate its accomplishments but promised to provide "consistent updates" on progress to goals and the revenue and cost impacts of new product. The latest investor presentation was a good first step.
STOCKS
Through June 10, the % change over the last week, and the year-to-date change.
Universal Music Group (AS: UMG): 20.65 euros, -3.1%, -16.7% YTD
Spotify (NYSE: SPOT): $102.23, -11.9%, -56.3% YTD
Warner Music Group (Nasdaq: WMG): $27.41, -6.8%, -36.5% YTD
HYBE (KS 352820): 223,500 KRW, -2.0%, -36.0% YTD
Live Nation (NYSE: LYV): $92.27, -3.2%, -22.9% YTD
iHeartMedia (Nasdaq: IHRT): $9.78, -15.2%, -53.5% YTD
Cumulus Media (Nasdaq: CMLS): $11.50, -3.6%, +2.2% YTD
Tencent Music Entertainment (NYSE: TME): $4.39, +7.9%, -35.9% YTD
Cloud Village (HKE: 9899): 72.45 HKD, -2.0%, -53.9% YTD
Reservoir Media (Nasdaq: RSVR): $6.69, -14.3%, -15.4% YTD
NYSE Composite: 15,096.69, -0.9%, -8.0% YTD
Nasdaq: 11,340.02, -1.0%, -23.2% YTD
S&P 500: 3,900.86, -1.2%, -13.8% YTD