Spotify is still missing the high notes on profitability

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Strong subscriber growth and an upbeat outlook for this year sent shares in Swedish music streaming group Spotify up 5 per cent on Tuesday. The market capitalisation has almost doubled over the past 12 months to $46bn. 

The sharp run-up reflects Spotify’s steady growth and dominant position in the audio streaming market. But the 18-year old company’s lack of profitability should not get lost in the noise.

There was plenty to like in Spotify’s fourth quarter. The company ended the year with 602mn monthly active users (MAU), a 23 per cent increase from the year ago period. Within this, the number of paid subscribers was up 15 per cent to 236mn. Momentum has continued this year. Spotify expects MAU to reach 618mn in the first quarter and paid subscribers to grow to 239mn.

Yet profit remains elusive. Price increases and a growing ad business helped Spotify pull in €13.2bn in revenue last year, a 13 per cent jump from the prior year. But costs are growing more quickly. Full-year losses widened to €532mn, from €430mn. 

Spotify is cutting costs. It has pared back investments in podcasts and announced in December plans to lay off 17 per cent of its workforce. None of that addresses the 700lb elephant on its balance sheet: song royalties and fees that eat up the bulk of revenue. Cost of revenue — a proxy for payments to record labels — rose by over €1bn to €9.8bn last year. It was equal to about three-quarters of total revenue. Meanwhile, spending on research and development, sales and marketing and administration make up about 29 per cent of sales. 

With just three major record labels controlling most of the music industry, Spotify has little leeway to bring down these costs. The move by Universal Music to pull its song catalogue from TikTok after a breakdown in negotiations over payment underscores the power imbalance. Spotify’s gross margin of 26.7 per cent remains some way off its long-term target of 30 to 35 per cent.

Spotify can raise prices further. The risk is that customers will defect to rival music streaming services run by cash rich tech heavyweights. The company’s market valuation reflects hopes of significant future profits. Record label payments mean investors could be waiting a long time.