Spotify (NYSE:SPOT) added 8 million paid subscribers in the second quarter, bringing its total to 138 million, the top end of the company's guidance provided in April. And while Spotify is doing a great job adding new subscribers to its platform, the amount those subscribers are paying, on average, has fallen considerably over the last few years. Last quarter, average revenue per user (ARPU) declined 9% on a constant currency basis, or 6% when adjusting for revenue adjustments and foreign exchange headwinds.
Premium subscribers paid just 4.41 euros per month on average in the second quarter. Three years ago, Spotify's ARPU was 5.53 euros per month during the same period. While Spotify has expanded to emerging markets with lower pricing, the bulk of the ARPU pressure comes from a shift to family plans and other bundles. In fact, Spotify said product mix shift was the dominant factor in its decline this quarter, without even mentioning geographic mix.
Spotify has experimented with raising prices in the past, but none of those experiments resulted in global price increases. It actually made it easier for some subscribers to lower the price at the start of the third quarter. The company expanded its two-person Duo plan, offering a price between individual and family plans, to more markets.
The metric Spotify cares about most
Spotify's management says its primary measuring stick of success is the ratio between subscriber lifetime value and subscriber acquisition costs. There are several factors that go into that metric, including ARPU. But factors such as subscriber retention and marketing expenses must be considered as well.
To that end, multi-person plans are some of the best ways to reduce subscriber churn and a cost-effective means of adding incremental subscribers. The same strategy is prevalent in the wireless phone service industry, as the incremental cost of adding a line to a family plan is far lower than that of the first plan. That's because doing so makes it harder to switch. While Spotify has built a more differentiated experience than other streaming competitors through its playlists and podcasts, switching costs are still relatively low for individual subscribers.
Meanwhile, family plans can be an effective marketing tool for Spotify. Existing users bring on family members (or friends) to subscribe as part of their family plan. That may create incremental revenue as a subscriber moves from an individual plan to a higher-priced plan, but even if it doesn't, it still feeds into Spotify's other primary motive.
Spotify is all about taking market share
Spotify wants to grow its user base as large as possible while maintaining positive trends in lifetime value. It wants a greater market share of overall audio listening across recorded music, radio, or streaming.
With 299 million total listeners, it's quite a massive user base already, but during the second-quarter earnings call, CEO Daniel Ek said: "There are still billions of people who have yet to discover on-demand music streaming or listen to a podcast."
Ek believes a larger scale will actually reduce subscriber acquisition costs, improving the ratio in the key metric management uses to measure success. He said scale produces a virtuous cycle, particularly in podcast listening, where listeners tell friends about the things they're listening to and it invites more users to try Spotify. At the same time, more listeners drive more creators to want to be on Spotify's platform, improving selection, and driving more listenership.
Scale is also key to Spotify's two-sided marketplace strategy, which is just starting to show promise. A larger listener base makes Spotify more valuable to record labels and creators on a relative basis, and it could more easily expand the fan base for artists. Greater scale should improve its negotiating leverage with media companies and improve uptake of its two-sided marketplace products.
Expect the trend to change direction at some point
Management doesn't expect ARPU to continue falling forever. "I think over long-term, our expectation is that ARPU will moderate in terms of declines and start to move higher," CFO Barry McCarthy said during the earnings call.
Ek added: "Japan and the U.S. have shown before, there are existing audio products that are monetized at much higher ARPUs than Spotify in those marketplaces." He says that as Spotify improves, the company should be able to exhibit pricing power. So as long as it manages subscriber churn if and when it finally raises prices, it should steadily improve the lifetime value to a subscriber acquisition ratio management holds as most important.