Business Model Innovation – Spotify Audio Ads

Spotify built its core business model around Subscribers who wanted a better experience and selection when listening to music. Now they are becoming all things audio (podcasts, etc.), which is why we dig into the Business Model Innovation (BMi) happening around their core model.

In the original Business Model Canvas, we looked at Spotify’s trajectory with its Subscriber business model by looking at the difference between the CAC (Customer Acquisition Cost) and the ARPU (Average Revenue Per User) over time, and how this model of growth (in effect, high-growth with a tight Gross Margin) led them towards profitability in 2021.

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Business Model Canvas – Spotify

Now Spotify is the process of scaling-up its emerging Audio Ads business model. As we have seen with most other platform-based business models, opportunities can emerge outside of the core business model once a business reaches a scalable size with a ‘captive ecosystem.’

As we move further into 2022, Spotify Advertising’s mission remains the same—to modernize audio advertising globally in order to deliver greater impact for advertisers, while fueling growth for creators.

Spotify has started to open up an Advertising revenue stream, which they hope will have the dual impact of offering a new channel for advertisers and a new opportunity stream for creators.

How does the Spotify Business Model work?

Spotify reported more than 420M MAUs (Monthly Active Users) in Q1 ’22, with 182M of those being paid Subscribers. That means ~43% of Spotify’s users are paid Subscribers. For those who are not Subs, they are served Advertisements.

Spotify Q1 ’22 Results

They sit at the core of the new ‘streaming’ model that has changed the music business model for artists in particular. And not always for the good, as there are many artists and others in the industry who do not like Spotify or the streaming business model.

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But Spotify itself pays a large part of its revenue out as COGS (Cost of Goods Sold) as effectively royalties to music labels. As of the most recent quarter (Q1 ’22), you can see a relatively low Gross Margin (25.2%) and a net Operating Loss.

As a % of Revenue, however, you can see that Premium (Subscribers) represents 89.4% and Ad-Supported represents 9.6%. And there lies the opportunity for Spotify Audio Ads.

What is the Business Model Innovation in Spotify Audio Ads?

With 252M ‘Ad-Supported’ MAUs and €282M in Ad-Supported Revenue (€1.12 ARPU – Quarterly), you can see how large the discrepancy is versus 182M ‘Premium Subscribers’ and €2.4B in Premium revenue (€13.07 ARPU – Quarterly). ARPU is about 12X for Premium vs. Ad-Supported.

Audio advertising definitely could open a lot of potential as a vertical for Spotify on its own, but by bolstering the Ad-Supported side of the business, Spotify can increase ARPU on that side of the business and incentivize more users to become Subscribers.

According to eMarketer, annual U.S. digital audio advertising revenue is poised to grow to nearly $8 billion—and of that, $2.7 billion for podcast advertising alone—by 2025.

eMarketer

The company has 4 million podcasts on its platform, and 85% of new podcasts are being created on their Anchor platform. Additionally, podcast consumption rates (%) are increasing at double-digit rates and podcast consumption as a gross amount rose to all-time highs on the platform. As a result, we can see that no longer is Spotify limited to ‘music’ – Business Model Innovation (BMi) is in motion.

This quarter, Spotify launched the interactive podcast ad format: call-to-action cards in the U.S. CTA cards are clickable, interactive companion display units for podcast ads.

Spotify Advertising (Q1 ’22)

Two recent acquisitions – Chartable and Podsights – (for undisclosed sums) will help with analytics and reach measurement for podcasts help to bolster this business line, while the launch of the Spotfiy Advertising Academy will help train marketers and content creators to launch ads on the platform.

This type of education and training is essential for BMi, as they are not only changing the Value Proposition and Revenue Model, but also the Customer Relationships, Channels and Segments.

Competition & Their Business Models

Apple Music is the most oft-cited competitor to Spotify, along with other streaming platforms such as YouTube Music, Soundcloud and a variety of others.

Bandcamp (the “anti-Spotify“) and a crop of other music platforms that sell D2C music downloads, vinyl, gear and other accessories have become increasingly popular given the view that the streaming model doesn’t work for most musicians/artists.

BMi – Key Components of the Canvas

Value Proposition:

What unique value does a company’s product or service create for customers?

It is clear that Spotify was the pioneer of the streaming model around music, and as such have become a multi-billion dollar brand trading publicly under SPOT.

Now the Value Proposition is geared towards Advertisers who are interested in tapping into a new medium of advertising in the podcast era, along with potentially new segments.

Customer Segments

What group(s) of customers is a company targeting with its product or service?

In their most recent Quarterly report, Spotify claims to have seen large growth in the Gen Z audience and this may be exactly the type of demographic that advertisers want to target.

MAU growth was particularly strong in our Gen Z audience, fueled by successful product feature launches such as our Lyrics experience, as well as marketing and content initiatives.

Spotify Q1 ’22

Customer Relationships

How does a company plan to build and maintain relationships with the customers it is serving?

The magnitude of the shift in business model means that Spotify has to think carefully about how they manage their Customer Relationships with four specific customers groups:

  • Premium Subscribers – they receive no Ads, but they are drawn into the platform by the quality of the podcasters in many cases. Spotify can’t lose its top content draws because of the demands of Advertisers, the experience needs to remain ‘Premium’
  • Ad-Supported Users – this segment represents a tremendous revenue opportunity for Spotify, as discussed above, but they don’t want to saturate this audience with ads to the point where they leave the platform. Ideally, they increase ARPU for Ad-Supported MAUs and also increase the % of those who become Premium paid Subscribers
  • Podcasters and Content Creators – as we have seen with other Advertising models built around content creators, there will be monetary incentives to produce content that Advertisers can monetize, but the top content creators will not want to dilute their brand image
  • Advertisers – Spotify has had Advertising on its platform for several years, so this is not a new Customer Relationship; but they are in the process of scaling-up Audio Advertising, which means more to manage in terms of expectations and delivery

Customer Channels:

What channels does a company use to acquire, retain and continuously develop its customers?

Most of the Spotify engagement with users happens on the Spotify mobile app or browser.

For advertisers, we now see Spotify not only launching its own Advertising Academy, but also acquiring a host of other platforms where podcasts are created, produced, launched and tracked.

Revenue Streams:

How is a company pulling all of the above elements together to create a revenue stream(s) and generate cashflow?

As we saw above, Subscription revenue currently accounts for ~90% of Spotify’s revenue, whereas Advertising accounts for ~10%. We don’t know how scaled-up Audio Ads will impact the top-line yet, but it is a fair assumption that % of Advertising revenue will begin to increase over time.

The above 5 Building Blocks represent the right side of the canvas and contribute to the Revenue side of the business model.

Key Resources:

What assets and knowledge does a company possess that allow it to deliver its value to customers in ways that other companies can’t?

Spotify has a strong brand, cutting-edge technological platform, and a strong network of renowned content producers (both in podcasting and music). They are a daily destination for many of their users worldwide.

Key Activities:

What activities does a company engage in that allow it to execute its strategy and either establish a presence in the market or gain market share?

Spotify is gearing up to scale-up the Audio Ads model, which changes a lot of their Key Activities. As we have seen above, there are new Acquisitions that need to be implemented into their core product, a new Advertising Academy that needs to be managed, and a series of other initiatives and partnerships that will run in relation to Audio Ads.

Key Partnerships:

What strategic and cooperative partnerships does a company form to increase the scalability and efficiency of the business?

One example is Spotify’s new partnership with soccer (football) team FC Barcelona.

Spotify and FC Barcelona announced a first-of-its-kind partnership to bring music and football together, where Spotify will become the official audio streaming partner.

Spotify Advertising

Cost Structure:

What are the key costs associated with running the business and how can key partnerships/resources be leveraged to reduce the cost structure?

Audio Ads will definitely impact Spotify’s cost structure and probably affect Gross Margin in future quarters. Their main costs relate to Customer Acquisition (Advertisers) and the hiring of new staff to manage the various initiatives.

The remaining 4 Building Blocks come together to form the left side of the canvas, and contribute to the Cost Structure of the business model.

Business Model Analytics

Modelling – ARPU, CAC, LTV

When we looked at the Business Model Analytics related to the original Business Model Canvas, we could see the trending up of ARPU relative to CAC, giving them decent LTV (Lifetime Value) dynamics as the business scaled towards marginable profitability in 2021.

The new Audio Ads are CTA (Call To Action), which means that in addition to the general ‘awareness’ ads, conversion can be tracked.

They combine visuals and customizable text to deliver a clear, simple message, along with a first for podcast ads: a clickable call-to-action. This means that now, in addition to driving upper-funnel campaign results like awareness and recall, advertisers can drive conversions, too.

Spotify Advertising

This will be an interesting case study of Business Model Analytics to follow into the future. Advertiser success will be benchmarked against user-growth rates, both Ad-Supported and Premium.

Additional Resources

Business Model Canvas – Spotify

Business Model Toolkit