Why Spotify Should Ditch Its Free Tier, Add Streaming Fees

Spotify hand changing free to fee
Cheyne Gateley/Variety

Spotify’s financials for the year 2016 highlight the company’s split personality. On the one hand, there is a rapidly growing subscription business that generates decent gross margins and 90% of its revenues. On the other is an unprofitable and small ad-based service. It’s time for Spotify to ditch the free tier and go all in on paid streaming.

Whereas paid subs generate the lion’s share of Spotify’s revenue and have a 15%-20% gross margin, the company’s free users generate just 10% of revenue and have negative 10%-20% gross margins. The ad-based tier accounts for more than 60% of Spotify’s total users, helping it to surpass 100 million total users, but it generates minimal revenue and loses money even before operating costs are taken into account.

More important, the free tier is a point of friction in Spotify’s relationships with the major labels, which see free streaming as unsustainable. As such, dumping free streaming would not only lighten Spotify’s profit-and-loss statement but also ameliorate its relationships with major stakeholders and partners. Apple Music has a paid tier only, and has much better relationships with artists and labels as a result.

sources: Spotify financial filings, jackdaw research analysis

Spotify’s renegotiated deal with Universal Music forced it to consider more windowing of new music through its paid service, breaking its long-held principle that both tiers should get access at the same time. The model is starting to crumble, and Spotify should kill off ad-supported streaming as it prepares for its IPO, which would also improve the company’s financial prospects.

Why wouldn’t Spotify eliminate the free tier, given all this evidence? The biggest reason is that the tier is the company’s entry point for winning paid subscribers. The barrier to the streaming music market is extremely low for that free tier, but it demonstrates the value of subscription streaming, while the frequent ads slowly push at least some users to eventually pay.

sources: Spotify financial filings, jackdaw research analysis

Yet Spotify already spends nearly half a billion dollars a year on sales and marketing, so it’s not as if the free tier provides all the promotion the company needs — indeed, it spends more on traditional marketing than it earns in revenue through free streaming, so it could simply divert some of the money it uses to prop up the free tier into more traditional marketing and still come out ahead. It’s already signing partnerships left and right with everyone including wireless carriers to sell discounted subscriptions.

And Spotify isn’t even the largest in free streaming -— that would be YouTube, whose 2016 revenues from the ad-supported stream were more than four times Spotify’s. If Spotify cuts off its free service, it would put more pressure on YouTube to play nice with the labels, which could even shift the industry balance of power toward Spotify.

Jan Dawson is the founder and chief analyst at Jackdaw Research, an advisory firm for the consumer technology market.

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    1. bryan says:

      It would be useful if Nick would say why he believes Nilsy and dustbin loads of other freeloaders, should get all the music in the world for nothing.
      Nilsy claims he is poor and therefor everything should be handed to him. Back in the 60’s 70’s 80’s you had to hand over your hard earned cash for music. In the 90’s and beyond, a new type of person started to appear. Someone who believed stealing, as in illegal downloads was the honourable thing to do. Now we have streaming and the free tier side of it. If any Spotify use has a shred of decency about them, they will contribute the minuscule amount of money that is asked of them.
      I would lay a pound to a penny, that Nilsy and the dustbin loads of other freeloaders out there, all consume alcohol, some will smoke, others will have the latest trainers, many will have more than one mobile phone, tablet or laptop. they will regularly buy crisps, sweets, chips, magazines, take away food etc etc.
      Don’t ever tell me that these people cannot afford Spotify. Anyone in a first world country is not truly poor.
      Now for the revelation that will shock some readers here. I believe that with the arrival of Apple and all of the other companies who made music listening machines, Nano, Sony’s efforts, etc etc, along with the internet and all of its capabilities, the gathering or getting or amassing of music became very simple and easy to do. People with no TRUE interest in music, suddenly could gather it together at no real cost to themselves and then wander around the streets, showing off, shouting things like, i’ve got four thousand tracks on my machine, how many have you got.
      These people are not music fans. they simply look like fans, If you were to ask them pay, as was the case in the past, for each and every record, you would find a sudden disinterest and they would very quickly find themselves something else to do.
      Music has been dumbed down, with the arrival of the internet, downloading and streaming. The fun has gone. The charm has gone. Making it easier and free to get at, does music and real music fans no favours
      I still love music, but I have to navigate the sewers and try to remember how to do it properly, so the thrill of the musical experience remains as exhilarating as it ever was.

    2. Nick White says:

      Wish I could delete that last comment of mine. I was just angry about the assumptive reply by Bryan. I therefore responded in kind and made a fool of myself. For that, I apologize and I respect the different views we have. However, I do disagree most strongly with his reply to Nilsy. Goodnight!

    3. Nilsy Dorantis says:

      Why you trying to make us poor people pay. Just let spotify do what they want too

      • bryan says:

        Freeloaders like you Nilsy, is exactly what is wrong with the world…

        • Nick White says:

          If you assume, you’re “making an ass out of you and me”! Enough said. There are SEVERAL reasons why someone doesn’t pay for streaming, but I can’t expect a corporate shithead like you to understand.

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