At least one analyst has called Spotify's (NYSE:SPOT) podcasting strategy into question recently, pointing to a lack of premium subscriber growth and app downloads tied to podcast investments. But management aimed to set the record straight with its fourth-quarter earnings release. "We are confident that podcast usage has been a factor in the accelerated net additions," management wrote in its letter to shareholders.

Management provided additional insights into how podcast listening is progressing on its platform and what it has planned for the future within the letter and on the company's fourth-quarter earnings call.

Daniel Ek giving a presentation

Spotify CEO Daniel Ek. Image source: Spotify.

Podcasts on Spotify exploded in 2020

Spotify ended 2020 with 2.2 million podcasts on its platform. That's more than three times the number of episodes on the platform at the end of 2019. Total podcast listening hours doubled last year, after tripling in 2019. The percentage of active users who listen to podcasts increased to 25% from 16% a year ago -- that's about double the number of total listeners on an absolute basis.

Not only are more people listening to podcasts, but Spotify's starting to generate meaningful revenue from the format. Management says podcast revenue grew more than 100% year over year. The company also pointed to a "favorable revenue mix shift toward podcasts" as a reason for its gross margin expansion. Its ad-supported gross margin in the seasonally strong fourth quarter improved to 10.8%, versus 0.6% in the third quarter. Spotify's recent acquisition of Megaphone could lead to greater podcast monetization in the future.

Most importantly, at least for the near term, management reiterated that its user data shows podcasts improve its listener retention and customer lifetime value. Management also said it's a factor in gross additions based on data showing podcast listenership for new signups. Spotify will aim to build on those factors in 2021.

What's next for Spotify's podcast strategy?

During the earnings call, CEO Daniel Ek said the focus of its podcast strategy thus far has been to grow listenership among its existing users. While exclusive podcasts have been a factor in driving listeners to its app over competitors, the company mostly wants to get its existing user base to diversify its listening.

That has two effects on its business. First, it creates more engagement, which gives Spotify more opportunities to monetize its listener base either through higher retention for premium subscribers or more advertising for ad-supported listeners. Second, it diversifies its revenue to potentially higher margin podcast advertising. Spotify can leverage fixed costs with podcasts since it doesn't have to pay out a percentage of revenue to music labels.

Going forward, the focus will shift in two ways. 

First, Spotify will aim to attract more listeners to its platform with new podcast content. This could be a major test of its theory that podcasts are driving new sign-ups. Spotify's exclusive deal with Joe Rogan, which went live in December, is one such effort to convert listeners from other platforms to Spotify users.

Second, Ek says the focus is moving from acquisition to leveraging the assets it's already acquired in the podcasting space. "Most of our strategy going forward, while we don't exclude any further acquisitions, it is about ramping the ability of our own production capabilities that we now have through all the studios that we have acquired," he said on the fourth-quarter earnings call.

As Spotify faces increased competition for podcast acquisitions, focusing on developing content in-house becomes a more efficient use of cash. In-house productions will still come with a lot of overhead expenses, though. Ek says it will have 1,000 people working on podcast productions in 2021, compared to just 30 people three years ago.

But as CFO Paul Vogel said on the earnings call, "The more we invest, the more you can have some confidence that the good news we are seeing through Spotify and the benefits we're seeing are going to continue." The potential margin on podcast content for Spotify is a key in the growth stock's path toward consistent profitability.

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