Why podcasts won't save Spotify

By: Kenny Ning

Published: 2020-07-31

Spotify has spent $650 million acquiring podcast content and tech companies over the last year, including Gimlet Media, Anchor, Parcast and most recently The Ringer. In the past few months alone, the publicly-traded company has amped up its content spending spree even more, landing an exclusive licensing deal with Joe Rogan for over $100 million and additional deals with former First Lady Michelle Obama and TikTok star Addison Rae for who knows how much.

How has Wall Street responded? They are loving it.

Narratives in support of Spotify’s bold podcast gambits generally consist of three kinds of arguments:

Improve revenue, bring in more subscribers and reduce content costs? If you take these assumptions at face value, podcasts really do sound like a silver bullet. However, upon closer inspection of each of these assumptions, they start to look dicier.

The revenue argument

Assumption: Spotify will be the major player in podcast distribution and thus be able to capture most of ad marketing spend.

In early July, Omnicom Media Group pledged $20 million in podcast ad spending on Spotify for the second half of 2020. Assuming all of this money will go to Spotify-owned podcast content, we can use this figure as a lower bound for projecting the streaming service’s 2020 podcast ad revenue.

Let’s be generous and say that Spotify nets $80 million in ad revenue across all of 2020, which would be around 10% of the podcast ad market (using data from PwC and the Interactive Advertising Bureau for total U.S. podcast ad revenues). Let’s be even more generous for 2021 and say that Spotify doubles its market share and makes $209 million (based on a 20% market share of a theoretical $1.045 billion ad market, according to the PwC/IAB projections).

Here are the numbers side-by-side:

$209 million… a seemingly impressive number. Problem is, Spotify has already spent 20% more than this on acquiring The Ringer alone. And at their current clip of podcast acquisitions, Spotify will continue to outspend their podcast ad revenue growth chasing new deals.

Frankly, Spotify’s current ad revenue on podcasts today is probably close to $0. Their podcast ad platform still seems to be in beta, suggesting they haven’t really sold anything other than bespoke test deals.

Also, the Joe Rogan deal explicitly states that Spotify will not sell or receive ad revenue from his placements. In the short term, Spotify will have to make do selling ads only on their original properties, which altogether have basically zero market share. (Can you even name one Spotify original podcast that was not an acquisition?)

The user argument

Assumption: High-profile podcasters bring in new subscribers

To illustrate how this argument could work, let’s focus on Spotify’s highest-profile podcast exclusive to date: Joe Rogan.

Billboard recently published a piece on how many new subscribers Joe Rogan alone would have to bring in for Spotify to break even on their $100 million deal (summary graphic below).

Let’s say Rogan’s monthly listener count is around 10 million — somewhere between his number of YouTube subscribers (9 million) and his number of monthly podcast downloads (11 million). These listeners probably already skew young and internet-savvy, so I would expect them to have an above-average likelihood of already being a Spotify Premium subscriber. Let’s say that number is 50%.

This leaves around 5 million potential customers on the table for Spotify from Rogan’s fan base alone, of which they would need to attract between 20% and 40% to break even (based on the lower and upper estimates from the Billboard table above).

I think the extent to which Spotify can pull off this conversion is solely dependent on how “exclusive” plays out in practice for Rogan. And if the past is any indication, “exclusive” hasn’t really been as “exclusive” as we might think, because it has taken on one of the following three forms:

Joe Rogan has claimed that both audio and “some” video will be exclusive to Spotify “after the end of the year,” making this the most “exclusive” deal for Spotify to date. However, it’s still not really a full exclusive:

If we look at similarly high-profile podcast acquisitions that Spotify made before their Rogan deal, we’ll see these podcasts both have smaller audiences and are even less “exclusive”:

Michelle Obama’s and Addison Rae’s podcasts represent truer exclusive content for Spotify. Though their respective clout is huge, they are first-time podcasters and it’s much more uncertain as to how their shows will perform, so we will leave them out of our calculations at this time.

Finally, to peg some numbers for the sake of argument, let’s assume Rogan brings in one million new subs, or 10% of his YouTube subs, to Spotify. We can use the ratio of each of the above “high-profile” podcast brands’ follower bases to that of Rogan on YouTube and Apple Podcasts to estimate how many new subs these brands would collectively bring to the table:

To be clear, this is a gross overestimate of new subs attributed to high-profile podcast acquisitions:

But, hey, let’s be generous and give this 1.3 million new-subscriber number to Spotify. We will revisit this in the conclusion.

The cost argument

Assumption: Unlike music, podcasts are a fixed cost and will drive Spotify’s total cost of content down.

I’m not going into the gory details of how Spotify pays music rights holders. But at a high level, Spotify has to pay out around 70% of its revenue to music rights holders as part of their licensing agreements. What this means is that no matter how successful Spotify is at generating revenue, their profit margin will stay stubbornly low.

The most common misconception I hear around streams for podcasts and other non-music content is that they somehow “dilute” the pool of total streams and reduce Spotify’s total payout to labels. This is incorrect. Revenue-share calculations have almost always excluded non-music streams, so there is no dilution or improved economics for Spotify.

Let’s look at a hypothetical example. Say in a given month, Spotify earns $100 in premium off of 100 streams; 80 of those streams are for Universal Music Group catalog, with the remaining 20 going to Warner Music Group catalog. In the music-only world, based on the 30/70 Spotify/rights-holder split, Spotify would keep $30, Universal would get $56 and Warner would get $14.

Now what if Spotify had an additional 10 streams of non-music content? A reasonable person might expect that this would “dilute” both Universal and Warner’s market share of rights holder payouts. In other words, Universal’s new market share would decrease to 73% (instead of 80%) and Warner’s would go down to 18% (instead of 20%). In this scenario, Spotify just made an extra $6 in profit off the back of 10 non-music streams.

But to reiterate: This dilution does not happen, because Spotify actually uses the first framework for its revenue-share calculations with music rights holders. Dilution used to be on the table in the early stages of Spotify’s non-music strategy, but record labels were smart enough to figure this out early on and have explicit non-music exclusions carved out in their contracts.

I believe the only way that Spotify can enjoy the upside of fixed costs for podcasts is if they offer a premium add-on (e.g. an additional $2 or more a month) to stream their exclusive podcast catalog, much like how Hulu does this for HBO. This incremental revenue would be outside the scope of labels’ revenue share, so Spotify could enjoy 100% of the resulting margin on incremental podcast subscribers.

But wait… A paid subscription service for premium-quality podcasts? That sounds familiar and — spoiler alert — that business model doesn’t really work, either.

Wrapping this up

Let’s conclude with looking at the most generous outcome — namely, that all the above assumptions for why podcasts are a silver bullet actually become true, not false:

In this situation, what is the actual return on investment (ROI) for Spotify?

Below is a rough breakdown:

Even in the rosiest of scenarios, Spotify will have already spent more than double their maximum theoretical podcast-related revenue on acquisitions alone.

One quick note on churn: You could argue, as Spotify has hinted at in recent earnings calls, that an expanded podcast catalog could help reduce subscriber churn. I’m sure this happens to some degree, but I doubt it’s material. Just take it from Spotify’s own dicey language on this topic from their 2019 Q3 earnings:

“For music listeners who do engage in podcasts, we are seeing increased engagement and increased conversion from Ad-Supported to Premium. Some of the increases are extraordinary, almost too good to be true. We’re working to clean up the data to prove causality, not just correlation. Still, our intuition is the data is more right than wrong, and that we’re onto something special. So expect us to lean into our early success with podcasting and to share more insights with you when we’ve established causality.”

They’ve since dropped associating podcast consumption and retention in their latest earnings.

You could also argue that the $650 million Spotify has spent on acquisitions is a fixed cost just to bootstrap their owned catalog. However, there’s one more argument I will make for why Spotify will never financially reign itself in.

I used to go to a lot of label showcases, where more than 90% of the crowd consisted of people who worked in the music business. Every person I met had the same introduction:

In the music and media businesses, your career capital is based on the famous people with whom you rub shoulders. You don’t get your next job because you, say, slashed costs by 20%. You get your next job because you worked on a digital marketing campaign with Bruno Mars once.

For this reason, content leadership is not necessarily interested in making Spotify profitable. They’re more interested in signing flashy deals so that they can go to their next employer and say, “I brought Joe Rogan to Spotify.” I’m sure the only time “ROI impact” comes into the strategic discussion is a 10pm email titled “urgent” to the content analytics team after the deal was just verbally agreed on so that it looks like they did their homework.

But, hey, the stock price is soaring and growth is up 31% year-over-year, so podcasts must be working, right?