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Spotify's Virtuous Cycle Is Just Getting Started

By Adam Levy – Aug 4, 2020 at 11:03AM

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Spotify has reached a point in its development where it sounds a lot like Netflix circa 2013.

Spotify (SPOT -2.54%) CEO Daniel Ek described a virtuous cycle around podcasts on several occasions during the company's second-quarter earnings call. Ek's outlook around podcasts echoes comments from its video analog, Netflix (NFLX -1.53%).

In 2013, Netflix executives said they'd view long-term success as "having substantially larger revenue [versus competitors] and therefore sustainable increasing content, tech, and marketing spending, leading to further growth, and a virtuous cycle."

Indeed, Netflix has proven that cycle works very well over the last seven years, growing its subscriber base while increasing pricing. Spotify is hoping podcasting will create a similar virtuous cycle as it attracts listeners and creators while improving its monetization.

A reception area inside Spotify's Stockholm headquarters.

Spotify's headquarters in Stockholm, Sweden. Image source: Spotify.

How Daniel Ek describes the virtuous cycle

Ek says Spotify is still at the very beginning of its flywheel. "Every piece of content that we're adding on the service, that we're successfully serving to our consumer, we're creating more engagement," Ek told analysts. "Now that we have almost 300 million monthly active users on the platform, these users are also sharing [when they find great shows] on social media and other forums to other consumers, as well, driving this virtuous cycle where more and more people are learning about what's going on on Spotify and more and more creators want to be on Spotify."

Much like how Netflix subscribers might find a great new (or old) show on the service and tell their friends about it, Ek expects the same thing to happen with Spotify. It's investing heavily in podcast content, and has seen great success so far. Podcast listeners have grown from 14% of Spotify's user base in the third quarter last year to 21% last quarter. Total podcast hours consumed grew over 100% year over year.

That's only going to keep improving. The company is launching several high-profile podcasts in the second half of the year. It launched The Michelle Obama Podcast last month. It has content coming from Kim Kardashian West and DC Comics. And the Joe Rogan Experience, the most-searched-for podcast on Spotify, will become an exclusive later this year. "We want to create more and more original programming that only exists on Spotify," Ek noted.

Spotify can grow really fast

Spotify has grown -- and can continue to grow -- really fast. Its total user base increased 29% year over year from a base of 232 million users. That's because there's practically no barrier to entry. Spotify has basically removed any objection a consumer might have to listen to a friends' recommendation.

For one, Spotify's exclusive podcasts aren't behind a paywall. So, if a user comes to Spotify because they heard about Michelle Obama's podcast, for example, they're immediately drawn into the platform without any friction. Additionally, Spotify's available on a growing number of platforms. Beyond desktop computers and mobile devices, Spotify's also available on the major smart speaker and connected-TV platforms.

A growing audience gives Spotify leverage in negotiations with media companies to bring more exclusive content or participate in its two-sided marketplace. It generates more interest from creators to get their content on Spotify and use its tools to expand their audience. And those results, in turn, improve engagement among existing listeners and bring new listeners onto the platform. More listeners and better contracts with media companies will grow revenue and give management more money to reinvest in content. 

That's exactly the Netflix playbook.

Spotify's adding tens of millions of new listeners to the platform every year, and Ek believes the total addressable market is billions of people. As its user base and podcast content library grow, they ought to fuel each other -- just as Netflix's subscriber base and content catalog have over the last seven years.

Adam Levy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Netflix and Spotify Technology. The Motley Fool has a disclosure policy.

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