Please ensure Javascript is enabled for purposes of website accessibility

The Promising Evolution of Spotify's Ad Business

By Evan Niu, CFA - Mar 5, 2020 at 9:00AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The Swedish music-streaming leader continues to develop new ad products in an effort to bolster profitability.

Offering a free, ad-supported tier has been key to Spotify (SPOT -1.87%) becoming the leader in music streaming, representing a funnel of users that the company works to convert to premium subscriptions. While that business is less profitable -- it had a 15% gross margin last year compared to the premium segment's 27% -- Spotify has an opportunity to improve profitability as its ad business continues to evolve.

In no uncertain terms, much of Spotify's financial future will hinge on the ad segment.

Reception area of Spotify headquarters

Image source: Spotify.

New ad products to drive ad sales

Spotify has been talking up the potential of its two-sided marketplace strategy for years, and the company has only recently started to really expand on that effort. One of the tools that Spotify will provide to artists trying to connect with listeners is called Marquee, which lets artists pay to promote their music, sponsor recommendations, and notify users when a new album has been released. Marquee has a minimum suggested spend of $5,000.

Importantly, this type of ad revenue would carry higher margins compared to the long-standing ad-supported tier. When free users listen to ad-supported music, Spotify has to pay the associated per-stream royalties and then monetizes that engagement with ads. These types of ads don't carry those costs, and essentially represent ad revenue that Spotify can bring in before the royalties start to kick in.

Chart showing Spotify ad revenue

Data source: SEC filings. Chart by author.

Bloomberg notes that Spotify is already pitching another similar tool to record labels and artists, although details are scarce. Spotify's licensing agreements also grant record labels a portion of all revenue, including ad revenue, according to the report. The Swedish company typically keeps key aspects of those deals close to the vest, so that revelation is quite significant to Spotify investors. The good news is that both Spotify and the labels reportedly concur that the arrangement doesn't make sense and are working toward restructuring the terms.

Spotify has even reportedly considered selling access to user listening data, which sounds similar to Twitter's data licensing business (also affectionately known as its "firehose" segment). That trove of data is one of Spotify's greatest competitive advantages because it feeds the content discovery algorithms that set it apart from rivals.

Favoring the big players?

Marquee isn't without criticisms, though. There is a fear among smaller artists and independent labels that paid promotions like Marquee will tilt the playing field in favor of larger artists and companies that have deeper pockets and can afford to pay. Dominant labels and the artists they represent could siphon engagement away from independent players, depriving them of royalty revenue in the process.

Labels have to pay Spotify $0.55 per click, according to Rolling Stone. That would translate into an additional 9,000 listeners per $5,000 spent. Spotify argues that paid promotions are already common throughout the rest of the music industry, so bringing those types of ads to its tech platform isn't some type of sea change. Spotify exec Beck Kloss told Bloomberg that approximately 25% of users who see a Marquee add choose to listen to the promoted content, calling it "one of the most effective digital marketing tools available."

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Spotify Stock Quote
$102.87 (-1.87%) $-1.96

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 07/07/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.