Spotify (NYSE:SPOT) has now secured sufficient licensing rights to launch in India, which it has been eyeing for quite some time. The company's strategy of acquiring users with a free, ad-supported tier before trying to convert them to premium subscribers has done wonders in other emerging markets, and Spotify hopes to replicate that success.
In this segment from Industry Focus: Tech, host Dylan Lewis and Fool.com contributor Evan Niu discuss Spotify's expansion into India.
A full transcript follows the video.
This video was recorded on Nov. 30, 2018.
Dylan Lewis: Evan, for the back half of today's show, we are going to be catching up on some news from Spotify. It's a company you follow quite a bit.
Evan Niu: We're getting reports now that they're about to launch in India. They've been eyeing that market for a long time, and really talking up the potential there. Now, it seems like they might actually be able to launch in the next six months. India is the second most populous country in the world, with 1.3 billion. There's a lot of people there to potentially address. Their prospectus for the IPO earlier this year confirmed that they had at least some office space and hired some employees. They were already laying down some groundwork. It sounds like they're getting close to moving in.
Lewis: The international expansion strategy we've seen them roll to more and more countries in the past year. They've enjoyed some good amount of success with that because they are not forcing people to pay for a product right off the bat. They have this model that lets people come in, use something on the free side, see all the benefits, then work their way up to a paid subscription model.
Niu: Right. That's been a real key to their growth in emerging markets, is the fact that they have this free ad-supported tier that they can get people on board for at no cost, then try to convert them to paid subscriptions later on. Of course, that's the opposite of what Apple does. Apple Music has no free tier, there's only a paid version, which does limit its uptake in emerging markets. Just as another interesting point here, Spotify previously said that with this model, once they successfully convert a free user to a paid user, it takes 12 or 13 months for them to break even compared to all the money they were missing out on when they were offering the free service.
Lewis: There was some speculation that they might buy into this market and acquire someone rather than expand their own platform there and start from scratch. Are you surprised that they wound up going this route?
Niu: It sounds like they just couldn't get a deal done, so they're going to go ahead and expand on their own organically. They do have a very strong brand globally. It might be a little bit trickier to build that brand from scratch in India, since there are a lot of other players there. We'll have to wait and see how that plays out.
Lewis: It's worth noting here, there are, I think, two big streaming players that are domestic market players, on top of the competition that they're going to be getting already from people using YouTube and things like that to consume content. It's not like Spotify's just going to go in there and immediately add a ton of subscribers. There's a pretty competitive market there. The local services, Gaana and Saavn, both have tens of millions of subscribers. So, a little bit of an uphill battle there for Spotify,
Niu: Right. And YouTube is by far the dominant source of music for India, specifically because it's free and there's so much music content on YouTube. The big thing here is that one of the biggest hurdles, as is often the case in the music streaming industry, is obtaining the licensing rights to be able to operate in those markets. A lot of these rights holders weren't very happy with Spotify. Over the past six months, Spotify has been inking these direct licensing deals with independent artists, which cuts record labels out of the loop. And they're not happy about that. But, of course, Spotify has always said, "Hey, we're not trying to replace labels. We're just trying to offer different models for how to do business with these smaller artists that maybe don't need that type of representation." That creates some tension and some issues. But reportedly, those have all now been resolved, and Spotify does have enough of the rights that it needs to feel comfortable with this launch.
Lewis: I think big-term, this is something that a lot of Spotify investors are probably pretty thrilled with. You mentioned before, it's the second-largest market, and it's not like China is going to become accessible. They are very walled off to a lot of foreign players. This is the remaining big fish for them to go out and really establish themselves in.
Putting this into context, understanding how this news, how this move, will start impacting the numbers that investors are looking at quarter to quarter, what I think we'll see as they get up and running is a surge in free users. What's important to note, and you and I were going back and forth before the show about this, is that this won't hit their ARPU number, even though these are free users coming on board.
Niu: Right. The ARPU number that they report is specifically related to their Premium segment. That being said, the ad-supported segment, they don't make a lot of money there. The margins are terrible, as you would expect. I think that's going to be the real big challenge here, is monetization and Premium conversion over time. India is not a rich country, most people don't have a lot of discretionary income to pay for a service like Spotify. That's going to be a challenge.
If you look super long-term, though, like decades out, India's rising middle class could help. As more and more people come into the middle class, that could change their ability and willingness to pay for a music streaming service. But that could take quite a long time. In the meantime, if Spotify can just get in there, establish a stronger presence of brand and position than Apple -- Apple has always done very poorly in the Indian market in pretty much every way -- I think it could still end up paying off.
Lewis: This is something that is more or less an extension of what we've seen from them as a strategy. It's not like this is going to be any different in terms of operating process or anything like that. And it's not like this is going to be the move that really changes the financials for this company. If anything, it might make things a little bit worse before they get better.
Niu: Right. In the near-term, I'd agree with that. But I do think it's still worth going after. There's just many people. And there's a big opening. Apple doesn't really address these emerging markets, so Spotify can really fill that void. But, again, the challenge will be building sustainable and profitable business on it.
Lewis: Yeah, always struggle.