Spotify goes wild

On Wednesday, the Swedish giant Spotify reported a 29% rise in MAUs to 207M, their first-ever quarter with positive operating profit, net income and free cash flow but misses on Q4 revenues.

Think that’s wild?

They also announced the acquisition of Gimlet and Anchor, two podcasting companies, and confirmed they plan to spend up to $500 million on acquisitions this year.

Here’s what this means: the long-awaited “year of podcasts” we’ve all been predicting for a couple of years is here, and Spotify will lead the charge:

“I’m proud of what we’ve accomplished, but what I didn’t know when we launched to consumers in 2008 was that audio — not just music — would be the future of Spotify.” - Daniel Ek, CEO, Spotify

The real question is why.

Gimlet and the moat problem

Spotify has a Netflix problem. Music inventory isn’t a fixed cost. The more people listen to music, the more royalties they need to pay artists and record labels.

On top of that, Spotify has no way to differentiate itself from competing services. You can listen to Justin Bieber on Apple Music.

In the long term, this is an expensive game with extremely low margins because you need to pay more for acquisition, and subscribers have no reason to stay.

That’s where Gimlet comes in.

Gimlet is one of the best content creators in the world, and has the potential to turn Spotify into the Netflix of audio. Producing original audio content can drive new subscriptions, reduce churn and create a unique value proposition.

Spotify won’t be just an aggregator anymore – they’ll have content that it does not have to pay for on a marginal cost basis which translate into a healthy bottom line.

How do we know?

“The existing shows will not be made exclusive to Spotify. They will continue ... you’ll continue to get them where you get them now. And yeah, going forward, I think it’s going to be a mix.”  -  Alex Blumberg, CEO, Gimlet

The key in all this is Gimlet’s CEO telling us that “... going forward, I think it’s going to be a mix” of exclusive and non-exclusive content.

If the content is good enough, it builds a higher moat around the business, the same way The Ranch does for Netflix.

Problem is, it’s too small.

Anchor as a driver for podcasting growth

While music generated $8.7 billion in revenue in the U.S. in 2017, podcasts generated only around $300 million in the U.S.

That’s where Anchor comes in.

Anchor is startup that makes it easier for people to record, distribute and monetize their own podcasts.

Yes, podcasting is still small, but it’s growing, and it’ll only continue to grow because it’s perfect for on-demand, personal content binge consumption, which users have become accustomed to from other media.

Ad revenue is growing rapidly (+72% in 2016 vs 2015, +85% 2017 vs. 2016, +80% 2018 vs. 2017, and +50% 2019 vs. 2018.), which in turn attracts higher cost talent and quality production to the format.

Million dollar businesss around long form convesations like Joe Rogan or The Tim Ferriss Show can only be built around podcasting because there’s enough value to capture.

Spotify hopes that the tools Anchor is building will bring nearly all the audio creators to them because it has better tools and a larger audience.

To put it another way, Anchor is a means of generating audio supply, without the marginal costs of producing music hits.

But Spotify is not Netflix, it’s Adsense

Here’s the twist.

Everyone saying Spotify will become Netflix, and in a sense, it will. They will use original content as a moat. But Spotify will also become Adsense.

In the early 2000s, Google launched Adsense, the first centralized place to buy advertising, and ad spend on the internet skyrocketed.

Podcast advertising is cumbersome because it requires a lot of individual conversations to scale. Managing all that can be exhausting, and is only worth it if the lifetime value of the customer justifies it.

But the moment you reduce friction and make the experience worth it (in podcasting, more targeted, scalable and profitable) people will flock to it.

Think Uber and taxis.

To this day, Google makes most of its revenue from advertising. The bulk of Google’s $110.8 billion revenue in 2017 came from its proprietary advertising service.

I believe Spotify will drive the growth of the podcast industry, centralize creation and monetization under one roof, and build sophisticated advertising tools similar to Facebook.

As a result, advertisers will increasingly buy from Spotify, and move away from working directly with podcast creators, so podcast creators will gravitate towards Spotify.

This creates a virtuous cycle that we'll have a hard time competing against.