Two Commodity Tech Players, Two Very Different Stories

In this week's episode of Industry Focus: Tech, Fool analysts Dylan Lewis and Evan Niu catch listeners up on some recent tech news. First, rumors abound that Grubhub (GRUB) is seriously considering shopping itself around, and companies like Walmart and Amazon might be interested in taking it in. How did Grubhub get to this point, and what comes next for the food delivery company?

Then a look at Spotify's (SPOT -7.28%) new podcast advertising technology and why this could be a game-changing innovation for the streaming company that's struggled against variable costs for so long. Could Spotify even overtake Apple (AAPL 1.27%), the creator of podcasts, in this growing new medium? Tune in to learn more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Jan. 9, 2020.

Dylan Lewis: It's Friday, January 10th. I'm your host, Dylan Lewis, and we're doing a rundown of some major tech news. I've got fool.com's Evan Niu with me on Skype. Evan, we haven't chatted in a while. What's on tap for you and 2020?

Evan Niu: I don't really have any big plans. Have you been having a good year so far?

Lewis: Yeah, I am. I didn't think I was going to be buying a house in 2020, but I might be in a position where I'm buying a house, unexpectedly.

Niu: Really?

Lewis: Yeah. I'm exploring a little bit of a fixer-upper type situation. A family friend has a house that might be up for sale, and I might be scooping it up. If any of our listeners have any DIY horror stories or tips when it comes to buying a house that needs significant work, please let me know. I'm still in that phase where I'm looking for someone to talk me out of it. But it checks a lot of the boxes for what I want in a place in D.C.

Austin Morgan: If there's an oak tree, don't buy it.

Lewis: Yeah? That sounds like a story from experience there, Austin.

Morgan: I have two of them. I also have tens of thousands of acorns every year.

Lewis: That's the thing. You live in Virginia. This is a house in Washington, D.C. We don't really have lawns in Washington D.C. in the same way.

Morgan: That's true!

Lewis: I'll keep that in mind, although for this property in particular, not so much of an issue. I've got enough space for a grill and a smoker and a couple chairs out on that patio. But I will keep you posted. If you see me slowly spiraling over the course of 2020, you'll know exactly how that decision has gone, guys.

Niu: I will not be buying any houses this year, despite my wife constantly wanting to buy new houses.

Lewis: Well, you guys are settled up at this point. You've got the recording studio in the basement, Evan. You're good to go.

Niu: Yeah, she's kind of constantly looking at houses. It's like a hobby for her, looking at houses.

Lewis: In fairness, I remember being on vacation as a kid with my parents -- I'm an only child, so you're always hanging out with your parents. I remember my dad was always looking at the real estate circulars for all of these areas that you would be vacationing in. And I never got it. Now, as an adult, I totally get it. You're doing the math in your head, you're trying to arbitrage the rent and mortgage and stuff like that. The idle fantasies of buying houses is something that I can appreciate now in a way that I couldn't have possibly done back then, so I can understand where your wife's coming from, Evan.

Anyways, long tangent. Listeners, write in if you have any ideas for DIY or house stuff. I would appreciate it. But we are not talking about that today. We are talking about some tech news. We're going to specifically talk about Grubhub and Spotify, two companies with some pretty big news that came out. Grubhub got a lot of the headlines this week because the Wall Street Journal reported that the company has hired an external advisors to explore strategic options, including a possible sale. Anytime you see that kind of news, it's naturally going to stoke a lot of interest in a company, Evan.

Niu: Right. Strategic options is just a euphemism for "we might be trying to sell ourselves." Of course, they denied it, they came out with this statement saying there's unequivocally no process in place, we're not trying to sell the company. But I don't know how much I buy those types of PR responses. I could see Grubhub trying to find a buyer, because they've been on the ropes the past few months. I think there is a case to be made that this industry needs to consolidate a little bit more.

Lewis: Yeah, I feel like that's the PR team's job, almost. You're almost always going to get some answer kind of like that, especially if it's early on in the process of potentially selling. Just to follow on to what we got from the Wall Street Journal, we also got something, I think from the New York Post, saying that Walmart and several other grocers have expressed interest in buying Grubhub. So, even if it's not true that Grubhub is shopping itself, it seems as though there is some interest in that company. We're going to explore why. This is the leader in food delivery. They've got a ton of partnerships with restaurants and a really big entrenched user base. They're one of the first movers in food delivery. But I think we need to rewind a little bit and look at the most recent quarterly results that we have for Grubhub. There was one narrative for the stock for most of last year, and that came to a screeching halt in the fall of 2019.

Niu: Right. Last quarter, when they reported in October, stock, absolute tanked. I think it dropped like 40% or something. Revenue came in under estimates. I think it was $322 million versus $330 million of the consensus estimates. Daily active grubs, which is their term for orders, was up only 10%, which was at the low end of their guidance. Then they cut their full-year guidance quite a bit. I think it was down by about $60 million because a lot of people just aren't ordering as much as they used to, and people are not particularly loyal to the platform. So, they had baked higher expectations into them having all these new diners coming in, new users on the platform. And they basically expected these new users to have a certain level of order rates based on their observed history of cohorts in the past. And then, these new diners simply were not ordering as much as they had thought they were going to.

Lewis: Yeah. You kind of go through different phases as a disrupter. You go through the early phases, where you are enjoying having created a space. I think they were in that space for quite some time. And then at a certain point, other people realize that there's a pretty good opportunity there, and they start entering the market, too. And really, the key there is, can you maintain your market share? Can you maintain loyalty with your customers? If so, you've got a really successful business. If not, you're going to run into some of the issues that Grubhub currently has.

Niu: Right. At the end of the day, to me, I see a lot of parallels with this food delivery service and ridesharing, which we've talked about quite a bit, obviously, on the show. As I've mentioned before, I'm not a big fan of the ride-sharing industry for a lot of reasons. It's commoditized, the drivers don't make good money, they're treated as contractors. There's a big overlap in terms of the drivers that do ridesharing as well as food delivery. Of course, you have Uber Eats, which is very much the same network of drivers as doing food delivery as well as ridesharing. So, if you look at Grubhub, it's the same thing. It's really leaning on these gig economy contract drivers. You have these two platforms that are competing very heavily for users. They're both discounting very aggressively for a commoditized service, which is just not an appealing business to me.

Lewis: The pull quote for me from the management commentary when they released those earnings that were disappointing was from their CEO, who said, "Online diners are becoming more promiscuous," which I think is kind of a funny word to use. But it really gets at the idea that you aren't just going to be a Grubhub user. If you're in an environment where there are all these competitors, they're all going to be competing, and they're going to be offering pretty compelling deals, whether it's discounts or referral codes or things like that. That's going to eat into their profitability. And that's where you get that promiscuity that customers seem to be demonstrating. It's more of a customer's market than a business' market.

Niu: Right. It just boils down to price. Particularly when you have these coupons for free delivery or whatever, that's all you care about. I mean, Grubhub has some advantages, I think. They have a lot of integrations with restaurant POS, point of sale systems, as well as integrating menus into their apps. They have a couple of these things. But at the same time, as a consumer, do you care about that over the price? The price is still like the most important thing. And that's why these companies keep having to spend so much money on these incentives and promotions and discounts.

Lewis: Yeah. At the end of the day, you want your food and you want the food delivered to be as cheap as possible. And you're going to stack those options against each other. And management has made the point before that they believe, and have generally believed, that the business cannot generate significant profits on just the logistics side of what they do, and that's the getting the food from A to B, because it is a commodity service. So, I think for them as a company, the key is going to be proving value to restaurants, building out that huge network, and making it even more dominant, making it the go-to place. Continuing to work with enterprise customers, you can bring in a lot of business that way. And then, basically proving out to customers that they deserve to be the only app for them, which is a tough sell.

Niu: Right. And on top of that, you and I have also talked about how Grubhub has done a bunch of shady things to take more money from the restaurants, in terms of redirecting phone calls and internet traffic to these websites that look like restaurant websites, but they're really operated by Grubhub. Basically, the net effect is that Grubhub inflates their commissions. I think that's really shady, and they're hurting all these local businesses that are their big partners. And that's one of their solutions, to your point of not being able to make money just on the delivery side of it. But then, if they're going to try to take more money out of the restaurants' pockets, that's not great, either.

Lewis: Yeah. I think that this company does face some existential threats. You mentioned a lot of the gig economy things before. I think that they are going to be under the microscope for regulators for quite some time just because of all these things that have come out, and deservedly so. I think a lot of these headlines don't look particularly good, especially when you're talking about relationships with more mom and pop type restaurants and less local chains or national chains.

Niu: Right. Everything's cutthroat here. DoorDash overtook Grubhub last year in the U.S. to become the No. 1 food delivery platform. Grubhub is now No. 2, Uber Eats is No. 3. DoorDash has also had a bunch of controversy and criticism around its tipping policies and how much of that actually goes to the driver. This whole industry is rife with a bunch of cracks and flaws that really undermine the sustainability of it becoming a long-term, profitable business for any of these companies. I think that's where some of the speculation about acquisitions and consolidation is coming from.

Lewis: And you certainly would expect it when you see a business that generally is in a market-leading position go on sale. For them to have sold off so much -- they've retraced some of those losses, but they are at a discount to where they have been in the past -- I think that naturally invites some of the speculation about who these buyers might be. We mentioned before, Walmart could be interested. I think there are some other e-commerce companies that could make good use of the network that Grubhub has.

Niu: Right. There's some analysts saying that Amazon actually would be a well-suited buyer. Amazon has been sending some mixed signals. Last year, they invested in UK-based Deliveroo. I'm probably pronouncing that wrong. But, it's a local food delivery service company. Regulators are looking at that investment, and all this stuff. Then, a couple months later, they announced they're closing Amazon Restaurants, which was their competing service in the U.S. So, some mixed signals there. But I think long-term, Amazon is still very interested in the space. I think they were having a hard time building their own service from scratch. But at the same time, they have so much money, they could go buy their way in as a No. 2. There's a lot of ways that makes sense. They're increasingly relying on the same gig economy, contract drivers, for the Amazon Flex program, which is their last-mile delivery network. That's really been ramping up quite a bit. They've been doing a lot more food delivery from Whole Foods, like grocery delivery. So, I think there is a case to be made that Amazon could make sense as a buyer for Grubhub. But I guess we'll see.

Lewis: Yeah, and this is a company that's committed to trying to bring more and more grocery purchases online. You look at most conventional measures of e-commerce, and it tends to focus on the retail side of things. Amazon is absolutely dominant there. Most of the overall spending that is not happening online via e-commerce is more in the buckets of buying gas and buying groceries. So, you saw that Whole Foods acquisition. And they clearly prize that market. You could see a very good integration coming with Grubhub as well.

Niu: Right. And they just recently made Amazon Fresh, which was the grocery delivery -- there used to be an extra fee you'd pay on top of Prime. Now it's included for free in Prime. It does show me that they are still pretty interested in scaling that out, which is where a local restaurant delivery service could come into play.

Lewis: OK, we're going to talk about some recent news for Spotify that could be a game-changer for the business. But before we do, I want to remind our listeners that if you're looking for stock ideas, we have a special Stock Advisor offer for our Industry Focus listeners. Head over to if.fool.com and get one year of unlimited access for $99. That's if.fool.com.

OK, Evan, we talked about how Grubhub was a company facing some core business issues, with the idea that they are in a commodity business, and they are trying to figure out how to make the numbers work as competition comes into play. I think you could probably say that some of those things are also true for Spotify. One of the big issues this company has faced is that they don't have a ton of control over their cost structure because they are in a business where the costs are decided by music royalties, and they don't have a lot of pricing power because there are a lot of streaming options out there.

Niu: Right, so they are getting pinched there. The biggest challenge, to your point, is that royalties are variable costs. The more people listen, the more Spotify has to pay. They're charging the same price every month. They're not charging you based on how much you listen. That does make it really hard for this company to scale. But they're starting to show some signs of it, including with some of the podcast stuff they've been doing.

Lewis: Yeah, they had an interesting 2019, because they made this huge acquisition buying Gimlet Media, one of these podcasting giants, and showing that they are interested in getting into programming outside of just music. I think that's smart because there's really not a lot separating Spotify from Apple Music. They are very good with their Discover Weekly playlists. I think the Spotify Wrapped at the year-end is fantastic. But at the end of the day, both of those platforms allow you to stream music. There's not a lot of exclusivity there. So, they made all these podcast acquisitions with the idea that they are going to be providing exclusive content, kind of like a Netflix for audio type pitch.

Niu: Right. It's worth remembering that their outgoing CFO used to be the CFO of Netflix back when Netflix started its whole original content strategy. So, there is a lot of cross-pollination of strategy there. But, yeah, Spotify CEO Daniel Ek has made a point that Spotify is not just about music, it's really about all of audio, which can include things like podcasts. They made three acquisitions, including Gimlet, like you mentioned, last year. They spent about $400 million total. It's a pretty big bet on podcasts. And podcasts, in contrast to music -- if you're funding original content in terms of podcasts, it's a fixed cost that you can scale up as you monetize that across your base. So, that incrementing will help their cost structure, and really give them a little bit more optionality.

Lewis: Yeah. what we're seeing with some news from this week is the next step in that process for them. We got some news that at the Consumer Electronics Show, Spotify announced streaming ad insertion, which will be the company's proprietary ad technology. I look at this and I think it's huge for so many reasons, Evan. We are in a place where podcast advertising is still pretty primitive. We have reads that are done by us, the hosts, and they are generally hard-coded onto the episodes. There's some data that advertisers get in terms of downloads, demographic, if the shows have polled their audience and they have a good feel for who's listening. But you don't get the granularity that you get with a lot of digital media. When we were doing prep for the show, I remember you had a really good analog for how to explain where podcasts are at now.

Niu: Yeah, it reminds me a lot of linear TV advertising versus digital TV advertising. In traditional TV broadcasting, advertisers don't really know who's watching. They don't have data on how many times their ad is being viewed. They have to look at these third-party ratings from companies, and they get a general sense of, "Oh, this demographic tends to like this type of show. We want to go after that demographic, so we're going to broadcast our ad out there." But you don't have the detailed measurement and analytics that digital platforms do. So, if you think in comparison to streaming TV like Hulu or Roku, those companies that are really capitalizing on cord-cutting and all that, advertising moving over to the digital side. There, you have lots of analytics, you have much more granular detail. Who's listening, how many times an ad is being seen, ad impressions, all sorts of stuff.

Lewis: So, this is a really compelling pitch for advertisers whom at the end of the day, are the customers for Spotify. But I think if you're looking at Spotify's financials and just trying to figure out how this company can really make it work long-term, this could be a pretty big deal, because it does give them ownership over their cost structure in a way that royalties kind of don't right now. And -- we've talked about it plenty on the show before -- digital advertising is such a lucrative market to be in.

Niu: Right. And with them rolling out these tools, of course, they're going to entitle themselves to a cut of ad revenue, and some type of revenue-sharing agreement with content creators. Unlike the current state of it, which, for example, Apple's always been the top player in podcasts. If you're reading an ad on a podcast, Apple has no idea, they're not getting a cut, and they don't really care. They're happy enough as it is. But I would say that innovation in podcast advertising has been stagnant over the past 20 years, for the most part. Even though it's growing, there's not a lot of new stuff coming out, because Apple has never cared to take the lead on innovating on this front.

Lewis: Yeah, I think that's a curious element of all this. Apple was really first in podcasts. I mean, the reason we call a podcast a podcast is because of the iPod, right? That's the etymology of that word. And I think there's probably a whole generation of people who are now listening to podcasts who never owned an iPod and are wondering why we call it that. [laughs] We're almost so removed from it. But, the source of it was Apple, and they haven't really done all that much to advance podcasts or advance advertising in podcasts over the last couple years. Evan, how or why do you think Spotify is beating them here?

Niu: Well, I think there's a couple of things going on. They were happy to sit on their laurels. There wasn't a lot of competition to spur them into putting any effort into it. So, I think it is a little embarrassing, but at the same time, it's also pretty expected, because Apple hates advertising businesses. They have this utter disdain for it. When you're using user data to target ads, there are inherent privacy compromises, and Apple just doesn't want to compromise on that front at all. They're not willing to budge. Spotify, Daniel Ek has mentioned that Spotify is a logged-in environment. You're logged in, the platform knows who you are, they know where you're located, how old you are, your tastes, what content you like to consume on the platforms. They have a lot of information they can use to target ads to you. I think that's going to end up being a pretty powerful advantage, particularly when you acknowledge that Apple is not interested in this advertising stuff. On the music side of the business, Spotify has the ad-supported tier that's free. Apple Music does not. I don't think Apple is going to really follow them here. I don't see Apple getting into this podcast advertising stuff in the same way the Spotify is. If Apple is going to basically sit still, Spotify has a big opportunity here.

Lewis: Yeah. It will be something that I think dramatically shapes this business over the next five or 10 years if it's done right. You mentioned that they have the ad-supported model. That part of their business does about 16% gross margins. Their premium business, where people are paying, does about 26% gross margins. That does not leave a ton left over to pay all the other bills. But if you have a business that's doing somewhere in the neighborhood of 40% or 50% margins, you have way more control over the costs, and it scales so well. I could see this being a real game-changer for them over the next decade. And when you look at some of the estimates for podcast advertising, I saw one that was saying over $1 billion by 2021. If Spotify is able to get a slice of that with some high-margin revenue coming in, it could be huge.

Niu: Right, and there are so many ways it plays into Spotify's broader service. They've said that people that are listening to podcasts are having strong conversion rates from free users to paid users. The ad insertion technology that we're talking about is really based on the same technology they already use on the music side of the business. So, there's a lot of efficiencies there. They're just deploying the same type of technology into the podcast. They just really feed into each other, because they've also said there's much higher levels of engagement. It all makes a lot of sense. If you look at Daniel Ek's vision that he laid out when he announced that they were making this big move into it, it just makes a lot of sense. To your point, I think the next decade is going to be pretty exciting for Spotify.

Lewis: I think the pitch to podcasters is pretty good, too. We don't really run into this quite as much with The Motley Fool podcasts because so much of what we do is talking about the news of the market, we're talking about earnings results. So, we're kind bound in time to what we're discussing. And a lot of the stuff that we do, because we're doing things daily, is only relevant for so long. But there are a lot of programs out there that have come out five years ago and still have tens or hundreds of thousands of people that are listening. I could see a compelling case for having dynamic ad insertion in there, and allowing you to update the ads that are in, and continue to monetize that content in a way that is fresh and relevant for marketers.

Niu: Right, because they can really drag out the useful life of this content, much in the way that Netflix amortizes their content over many, many years, because they know they can get such good use out of it. It's the exact same thing with Spotify. They've fund these these podcasts, they can use those for many, many years, and, as you mentioned, keep monetizing them with ads that are dynamic and targeted. As opposed to like the same manually read ads in every podcast. [laughs]

Lewis: [laughs] Yeah. Evan, I remember when were first talking about Spotify. I think we were Slacking about it. And you said, "My thesis is, this company is too big for it to not be relevant and make some money at some point," basically. Like, someone needs to make money in streaming music, because the music industry needs streaming music to be successful. Spotify is basically first in the race there. You're also an Apple shareholder, so you also have bets on both there. I understood that thesis back then. I think that this business and this development is a great kicker to a business that's already in a market-leading position.

Niu: Right. I think there are huge implications for the cost structure. Even though I invested in Spotify, my biggest concern has always been this cost structure stuff we've been talking about with the scalability and the royalties. I just figured, as you mentioned, the music industry is so reliant on streaming. Streaming is driving this renaissance. Even though they do have to pay these huge costs to the record labels, record labels need them, too, so there has to be some middle ground where Spotify can make some money. And, at the same time, now that they're expanding into podcasts, that has a huge, whole new horizon of possibility in terms of costs and profitability.

Lewis: Before we get too excited, Spotify is rolling us out with its original and exclusive shows. They're going to be starting there. I think this is something where, if you see success, and you see it being rolled out to more and more shows, and advertisers really gravitating toward it, it's a sign that this business is going to be taking off. For me, this shoots up on the watch list, because it makes something that I think users love -- I don't know anyone who hates Spotify. So, they have a product that people love. [laughs] Austin Morgan behind the glass just raised his hand, but he's a Pandora subscriber, so take that with a grain of salt. I don't know anyone who really does not like Spotify. And if you can build a good business financially that complements a business that customers love, then you've really got something.

Niu: Right. I agree that they're somewhat commoditized, but I actually think that their content discovery technology is better than Apple's currently. I do think that is a pretty big advantage for the time being. But whether Apple can catch up on the discovery side remains to be seen. But these companies are both evolving very quickly. They're both playing off each other. It's kind of funny, because Spotify is first to streaming, and then Apple followed them with Apple Music in 2015. Now, Spotify is turning the tables. Apple's always been on podcasts, and Spotify is coming to podcasts. They're both heading in the same direction. So, I think this competition will be interesting to watch.

Lewis: Well, since you mentioned Apple, Evan, I've got two iTunes reviews of the show. As folks that have been listening over the last couple weeks might remember, anyone who drops us a five-star review on iTunes, I will give you a shout out at the end of the show. If you have any questions in the review, I'll be happy to answer them. This week, I've got two.

I've got one from Matt G, who says, "Because of The Motley Fool podcasts, I've gone from someone who knew nothing about investing to feeling confident about helping my family live a smarter, happier, and richer life in less than two years. Thank you all." That's awesome. I love to hear that. Matt, we're learning right alongside you. I think much of what we do, the joy of this is getting to talk about new companies and continuing to learn about the evolving landscape with investing. So, thank you for joining us in that journey. Let me tell you, I'm learning every single day. I love hearing from people that are enjoying doing it over on the listener side.

Our second review, from ebunny, wrote, "Hey, guys. Longtime listener, first time reviewer, Love the show, very informative. A lot of the other finance business shows I listen to can be a little dry, but these guys keep it upbeat and entertaining. I guess all that talk about the housing stuff is what really gets people. Keep up the good work. The only problem I have is with the new opening. Woof, is that bad or what?" [laughs] I will say to ebunny, there's a lot of great compliments in there; I think I like us being challenged a little bit on the intro. Some backstory on how we arrived at that. We knew that it was time for a facelift. We wanted to do something that gave a sense of all of the different people that are contributing to the show, all the different things that we talk about on a week-to-week basis. We tested it out internally. People seemed to like it. We've been getting some pretty polarizing reactions, though. Isn't that the case, Austin? [laughs]

Morgan: Oh, yeah. People either love it or they hate it. But I can tell you this, there's a little button the bottom right hand corner, skips forward 30 seconds. The intro is exactly 27 seconds long. So, if you don't care what day of the week it is, you can just tap that button, you'll be right in there.

Lewis: So, there's a pro tip. If you don't like our new intro, you can just skip ahead. I'm hoping that this is a situation where, like when Facebook rolls out a new interface, and everyone freaks out, there are some people that love it, there are some people who swear it off --

Morgan: People don't like change.

Lewis: People don't like change. Especially for something that you're used to listening to all the time and hearing in the same way. So, I'm hoping that some of the folks that don't like it will come around. I will say, though, it was fun to have Austin render a couple different versions of the intro. Who knows, maybe we'll mix it up a little bit.

My favorite part of the new intro -- I don't know if this is something that all of our listeners have caught -- is the It's Always Sunny in Philadelphia reference that's embedded in there with the Wildcard. If you are a fan of the show and know what I'm talking about, there's your little Easter egg. If you're not, check it out. It's not a family-friendly show in any way. I would never watch that with kids. But it's a very fun show if you're an adult. I think we're going to wrap things up there. Evan, Austin, thank you guys so much for hopping in!

Niu: Thanks for having me!

Lewis: Of course. Listeners, that's going to do it for this episode of Industry Focus. If you have any questions or you want to reach out and say hey, shoot us an email over at [email protected], or tweet us @MFIndustryFocus. If you want more of our stuff, subscribe on iTunes or Spotify or wherever you get your podcasts.

As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for all his work behind the glass today, and all of his work making that new intro. If listeners do like it, I'm sure Austin would like to hear about that, too, on Twitter or via email. If you're enjoying the new introduction, feel free to write in. For Evan Niu, I'm Dylan Lewis, thanks for listening and Fool on!