After subtly hinting that it has been looking at raising prices, Spotify (SPOT 0.43%) made it clear this week that price increases may play a pivotal role in growing the business going forward. The paid music-streaming leader reported third-quarter earnings yesterday that missed analyst estimates, but user growth remained strong. Spotify now has 144 million premium subscribers and 320 million monthly active users (MAUs).

Here's what the company said about the possibility of future price bumps.

Reception area in Spotify headquarters

Image source: Spotify.

Greater value can justify higher prices

Spotify has been testing price increases in certain smaller markets like Scandinavia over the past year. More recently, the Swedish company raised the price of its popular Family Plan in seven markets (Australia, Belgium, Bolivia, Switzerland, Ecuador, Peru, and Colombia), as well as the new Duo plan in Colombia.

The COVID-19 pandemic has had mixed effects on overall engagement: People aren't commuting as much but still need entertainment while staying at home, which can include both music and podcasts. As Spotify aggressively expands into podcasts with original content and exclusive partnerships -- an expensive strategy that is approaching a $1 billion price tag -- the company believes that it is significantly strengthening its overall value proposition to subscribers.

"And ​while it is still early, initial results indicate that in markets where we've tested increased prices, our users believe that Spotify remains an exceptional value and they have shown a willingness to pay more for our service," CEO Daniel Ek said on the conference call with analysts. "So as a result, you will see us further expand price increases, especially in places where we're well-positioned against the competition and our value per hour is high."

The main competition in most markets is Apple (AAPL 1.30%). Competing with the Cupertino tech giant presents several challenges. In addition to being the richest company in the world, Apple doesn't need Apple Music to be profitable since music streaming is merely a side business. If Apple Music can help sell iPhones or retain users, the service can justify itself strategically even if it isn't operating at a profit. As a pure play on music streaming, Spotify will need to eventually deliver sustainable profits for its shareholders.

Can Spotify reverse one trend but not the other?

Spotify's premium average revenue per user (ARPU) has been steadily declining for many years, which the company has long attributed to ongoing uptake of Family Plans and Student Plans. However, those plans generally enjoy much higher retention, which has driven a commensurate decline in churn.

Chart showing Spotify's churn versus average revenue per user

Data source: SEC filings. Chart by author.

The company believes that trade-off is well worth it, as low churn provides greater financial visibility while strengthening the foundation of the subscription business, which represents 90% of revenue. Churn just hit a new milestone last quarter, dipping below 4% for the first time ever. That's helping reinforce Spotify's confidence that it can justify a price increase to subscribers, and ideally the company can reverse one of the trend lines above without impacting the other too much.

"I believe an increase in value per hour is the most reliable signal we have in determining when we are able to use price as a lever to grow our business," Ek added.