Spotify (SPOT -4.62%) has seen some positive trends around its investments in podcasting. Podcast listening more than tripled year over year in the fourth quarter, and more than 16% of its 271 million monthly active users (MAUs) listened to podcasts.

Spotify plans on doubling down on its investments this year. "We have gained even more confidence in the data, particularly around the benefits from podcasts, and as a result, 2020 will be an investment year," management wrote in its fourth-quarter letter to shareholders.

Its first investment was buying The Ringer, a podcast-centric media company with a strong presence in sports. "I think we bought the next ESPN," CEO Daniel Ek said on the earnings call.

Spotify has already seen a positive impact from podcasting on its music-streaming business, and it has the potential to provide another source of revenue and expand gross margin over the long run.

Spotify CEO Daniel Ek giving a presentation.

Spotify CEO Daniel Ek. Image source: Spotify.

The early data on podcasts

There are two primary metrics for investors to pay attention to when it comes to how podcasts impact listenership on Spotify: retention and conversion.

Retention measures the percentage of users that stay active from month to month or maintain their subscription. "We have seen benefits to retention on the order of several hundred basis points, which is a material change on a retention curve, for users that engage with spoken word content relative to those that haven't," management wrote.

Additionally, those users are more likely to upgrade their account to a premium subscription over time, management says. Interestingly, the percentage of MAUs that subscribe to premium has declined slightly over the last year. Management isn't concerned, however, noting strong growth in total MAU has historically translated into strong premium subscriber growth over time. 

Spotify's seen accelerating MAU net additions in each of the last three quarters. That may be an indication that podcasts are also working to attract new users to the platform. Spotify is creating more and more podcasts that it keeps exclusive to its service, which may lead to more sign-ups over time.

The company's strategy with The Ringer may follow that of previous acquisitions like Gimlet and Parcast. Existing podcasts will remain available across all podcast-listening apps, but new series may be exclusive to Spotify. Using cross-promotional strategies for series on podcast networks could lead more listeners to sign up to Spotify for the exclusives.

The new revenue opportunities

Spotify's revenue from podcasting remains a tiny sliver of its total. It currently only generates revenue from its own podcasts on the platform, and despite the size and popularity of podcast companies like Gimlet and The Ringer, they generate relatively little in revenue compared to Spotify's overall business. The Ringer generated about $15 million in ad revenue in 2018, according to The Wall Street Journal. That compares to about $7.4 billion in revenue for Spotify in 2019. That said, only about 10% of that revenue came from advertising.

The long-term opportunity is much more interesting for Spotify and investors. "We haven't added internet-level monetization yet to audio. So, all the things that you've come to expect in video and display in terms of measurability, in terms of just targeting, a lot of that is lacking in podcast today," Ek said on the earnings call. He continued:

And you've seen it time and time again. As you add those capabilities, you generally can raise [price per ad impressions] across the board, because advertisers feel more certain about the results that they're getting. And if we do that, that's going to be a tremendous benefit for all the podcasting creators, but it's also going to be a tremendous benefit for Spotify.

Spotify took the first step toward that goal with the release of its Spotify Podcast Ads using streaming audio insertion. The company is leveraging its programmatic ad-buying platform to extend dynamic ad insertion into podcast listening, so instead of every listener hearing the same advertisements read by the host, Spotify can offer a more tailored approach. That service is currently limited to Spotify's owned podcasts, but it plans to expand the service to all podcasters on its platform over time.

Importantly, Spotify Podcast Ads ought to produce relatively high gross margin for Spotify. It's built on existing technology, and it doesn't have to pay royalty fees for content. It's merely acting as a middleman for podcasters to fill their ad inventory.

Drawing in new podcast listeners with big media company acquisitions like The Ringer is essential to building a listener base. By some measures, Spotify already has the biggest podcast listener base of any company. Long-term, podcast listening could be massive, and Spotify's potential to partake in the economics of the business should pay off handsomely.