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Spotify Price Increases Are Working

By Adam Levy - Apr 29, 2021 at 11:15AM

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Price hikes are an important next step for Spotify to keep growing.

Spotify (SPOT 0.73%) started raising prices in select markets in the fourth quarter last year. It expanded on those early price increases in February with hikes in 25 more markets, and once again earlier this week with increases in key markets like the U.S., U.K., and Brazil.

Raising prices, particularly for its multi-user plans, is a big point of leverage for the streaming company, which has seen its average revenue per user decline considerably over the last few years.

A reception desk with Spotify logo on the wall behind it.

Image source: Spotify.

Stabilizing revenue per user

Here's a look at the declines in average revenue per user, or ARPU, over the last four quarters adjusted for changes in foreign exchange rates.

Quarter

Q2 2020

Q3 2020

Q4 2020

Q1 2021

Change in ARPU

-7%

-6%

-3%

-1%

Data source: Spotify earnings releases.

Historically, management has pointed to "product mix" as the driver of the declines in ARPU. In other words, a growing percentage of users are subscribed to a plan that allows multiple listener accounts like Duo (two users) or Family (up to six users).

The stabilizing ARPU, however, may not be a reflection of its price increases for those plans. Rather, it's a stabilization of that product mix. Remember, most of the price increases didn't go into effect until the last month of the first quarter. Likewise, price increases announced just ahead of the earnings release won't have much effect on the second-quarter results.

With product mix stabilizing, it suggests the multi-user discount isn't driving outsized growth in new premium users. So, if family plans aren't going to be accretive to revenue through faster user growth, Spotify needs to grow through higher pricing.

Users don't mind paying more

Spotify needs to be very conservative as it looks to raise prices. Unlike the video streaming space where each competitor has unique content, the core product for every subscription music streaming service is the same: Access to millions of songs on demand. Apple's (AAPL 2.14%) Apple Music, for example, has the same 60 million songs as Spotify.

Spotify aims to differentiate itself from the competition in a few ways: Personalization, features, and a library of original and exclusive podcasts. Those are the areas it leans on to attract new users and convert them into paid subscribers. "Look at our expansion of these price increases as that we see the strategy working," CEO Daniel Ek said during Spotify's first-quarter earnings call.

Importantly, management has noted on multiple occasions that the price increases have had minimal effect on gross additions or subscriber churn. In other words, Spotify's proving it's built a product and a network of users that allows it to charge a premium over competitors.

Increasing ARPU to expand gross margin

There may be an opportunity for Spotify to expand gross margin by increasing prices. Certain expenses like payment processing and content delivery have fixed costs that don't change based on Spotify's pricing. More importantly, there may also be some leverage in Spotify's contracts with music labels.

Earlier in April, Apple shared that it only pays out 52% of revenue to music labels for Apple Music. By comparison, Spotify's premium gross margin was 27.9% during the first quarter. That suggests there's a lot of room for improvement in what percentage of revenue Spotify pays to music owners if it can get its average revenue per user headed in the right direction. 

The early results from Spotify's price increases have been positive, and investors should look for ARPU to start trending toward growth in the second half of the year. Gross margin expansion could follow as the company renegotiates its deals with record labels.

Adam Levy owns shares of Apple. The Motley Fool owns shares of and recommends Apple and Spotify Technology. The Motley Fool recommends the following options: long March 2023 $120.0 calls on Apple and short March 2023 $130.0 calls on Apple. The Motley Fool has a disclosure policy.

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