Jeremy Deal (JDP Capital Management) & Sleepwell Capital: How does Spotify win the creators?

Jeremy Deal, JDP Capital Management & Sleepwell Capital

“Because the more Tilmans there are, the more you need Spotify to kind of sift through the data and help you find your audience.”

[00:31:48]

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Who speaks in this transcript

Jeremy Deal

Founder, JDP Capital Management

SC

Sleepwell Capital

Anonymous investor, known from Twitter

Tilman Versch

Interviewer, Good Investing

Tilman Versch [00:00:00] Welcome back to our talk on Spotify. This episode is the final episode of a three-part series. So if you want to understand the full story we are discussing here, please go back to Episode One or Episode Two to watch it and hear it. But if you already consumed those two episodes, feel free to watch the final episode now. Enjoy!

Tilman Versch [00:00:50] For the growth, what I’ve observed is that Spotify is using a lot of partners. You think about the Embed of the Spotify player for music and Facebook. You think about the possibility to go on your PayPal account and don’t get an advertisement for YouTube premium but get an advertisement for three months Spotify Premium for free. What other partners are Spotify using and how clever do you think the strategy is?

SCSleepwell Capital [00:00:58] Well the Telcos are incredibly important, especially in emerging markets, because as Jeremy mentioned, the payment side is an obstacle many times in these countries where most of the population sometimes is not even banked and has sort of alternative means to be able to pay for internet services like this so their cell phone company many times is one of those few, kind of, utilities that they’re paying for so it makes sense for Spotify to partner with these companies and be able to offer Spotify in either a bundle or an add on to their services, etc. So that’s one partnership that I think is very important for them.

Jeremy Deal [00:01:50] Yeah, just to add that to that. Thinking about how do you pay a royalty to, I don’t know, let’s say there’s a 16-year-old emerging artist in a rural part of Bolivia and somehow she recorded an amazing five or six songs and somehow they’re uploaded to Spotify. How do you track them? How does she get paid? And you think in a traditional sense, you would have a bank account and you would have a routing number and whatever but it’s not so simple in a lot of parts of the world. So the payment side is not only a big hurdle, but it’s also an enormous opportunity in emerging markets. Because it’s not just about Spotify receiving payment from local people for the premium service. It’s really about how do you pay the artists? How do you encourage more artists to get on and create, whether it’s podcasts or whatever audiobooks and how do you encourage them to get on and produce something? And then how do you pay them? And then how do you, for example, if you identify, Spotify does identify, a super fan of the 16-year-old, Bolivian, in a rural part of Bolivia that I just gave as an example.

How does she receive whatever she wants to sell to the superfan whether it’s another experience or whether it’s a concert to go to, how is that sold? So there’s a lot of opportunities, but there’s also a lot of hurdles when we think about emerging markets and Spotify seems to be really focused on unlocking that opportunity, thus the focus on expanding. And I think now they’re in 180 something some odd countries of which 85 countries came this year, but I guess the point is, it wouldn’t have as much value if it was just about simply launching and just hoping people turned on a premium subscription at some future date because I think it’s a part of a much bigger strategy to unlock value and addressable market in those in those areas.

SCSleepwell Capital [00:04:12] I was just gonna say because it’s pretty much in line with this idea of finding the right partners is also their ubiquity strategy. Being able to offer this service in potentially every device that can play music. And I think they’ve proven to be very apt at that and have partnered with most of the relevant places where you can listen to music digitally.

Tilman Versch [00:04:50] Another thing that’s more developed markets and maybe has also a bit of a Boomer cringe attachment is the Car Thing. They’ve just launched, and I don’t know if you see the Twitter feed too. Currently, they are making a lot of advertisements for listening to Spotify in the car and want to push this topic. What are they doing around the car and to widen the audience there with the Car Thing?

Jeremy Deal [00:05:15] I saw the Car Thing in New York. My brother has it. He’s got a 10-year-old Honda and which is I think he’s the target audience that they seemed to be going after. It seems to be an experiment, the way they talk about it, to understand how people use Spotify in the car more so and then I think from there, they’ll figure out what they want to do. They’ve made it clear they don’t want to be a hardware company in any way. But there is an enormous gap with people that drive a five or 10-year-old car and the stereo just can’t connect to your phone and you can’t stream Spotify in the car. So I applaud and commend Daniel Ek for taking the plunge of sending out the Car Thing to a random test group of people to see kind of what happens and maybe that’s what it takes. But the car is an enormous opportunity.

And I think we talked about this last time that the OEM, unless you have a new car, it’s hard to stream and even if you have a new car a lot of the radio stereo systems in a new car it’s like a multi-step process to connect your phone to the car every time you get in. If somebody else wants to connect their phone, it’s a whole two, process: you have to put the car in park, you have to press this button, you have to pair it. And it’s just enough of a pain in the ass where it’s a pain in the ass. And a lot of times if you’re just jumping in the car real quick, you might just hit the radio button and listen to the radio. So I think Car Thing is again a very entrepreneurial approach to kind of understanding what the job to be done is in the future of trying to crack that code of having Spotify potentially built into new cars in the audio system like it is in Teslas.

Tilman Versch [00:07:15] So you win this audience by the different initiatives and the next point is to make it sticky and keep people coming back to Spotify. One thing I personally found superior is discovering recommendations on Spotify. How would you guys rate it compared to other services?

SCSleepwell Capital [00:07:38] I think it’s great and clearly from the data, it’s much superior to any other offering that the competitors have. I mean, just the fact that not only on the engagement front, where Spotify has an advantage of two to three times versus competitors. But the time that is spent on these algorithmic and editorial playlists, is pretty high. Last we heard; it was something over 1/3 of the time. It’s probably higher nowadays. And I think Spotify to consumers is very much known for how well their recommendations are on the music side. And I think we’re going to see something similar on the podcasting side as well. We know management is very focused on that. And it’s not only the innovations that they’ve been able to achieve in the past 10 years of investing in product engineering, R&D, etc. As I said before, it’s very much an engineering lead culture at the company. But it was also the result of some interesting acquisitions.

Jeremy was talking about Pods being an important one in the next few years for podcasting. There was also a very similar acquisition that took place a couple of years ago on the music side called the Echo Nest, which basically was the backbone for Discover Weekly. So I think they’ve been, again pretty savvy in buying some of the best technology that’s out there. Discover Weekly was really the first algorithmic playlist and everything else was kind of built on top of that and there are all sorts of different recommendations that go out nowadays. And for me, it’s probably the biggest key differentiator when it comes to the engagement driver in Spotify. And data is another advantage that they have because of the size of their user base and how global it is. They’re more likely to find someone that has exactly your music taste, which another platform that’s more subscale would probably have a harder time doing.

Jeremy Deal [00:10:10] The fact that these big playlists are different for everybody is something I think people don’t grasp. So all three of us can go to our Spotify apps right now and go to the same I don’t know RapCaviar, for example, and we’re going to see three different sets. I mean there could be some overlap, but we’re going to see different things. And I think that’s just fascinating. If you think about it mathematically, the combination of options as the subscriber base grows, it’s just astounding. It just creates optionality that just didn’t exist in the past. And the recommendation engine is important because it can identify, it just improves every day. You think about how superior the Google search engine is compared to anything else that’s ever existed. And part of the reason is that it compounds on itself. As people use it, it just gets better and better and better. And I don’t think you could compare the Spotify recommendation engine to the Google search engine yet, but it has a similar characteristic and so far is it’s compounding on itself.

Jeremy Deal [00:11:30] So the more users, the more people use it, the bigger the list the more people upload. The more do-it-yourself, the more songs that are uploaded on a daily basis, the more podcasts, the more creators. All of it just compounds exponentially. And we’re never going to be able to look at a specific KPI because this is within Spotify’s secret sauce. You’re never going to be able to probably quantify that, that exponential growth. Like you can’t. You don’t really see that within Google, you just know that it’s an element of the business that becomes the second engine that just grows obviously much, much faster. Yeah, it just increases their vote. It grows a lot faster than revenue.

SCSleepwell Capital [00:12:15] And it’s the biggest switching cost I think that, for many of these consumers. It’s the first thing you’ll notice if you go to Amazon Music or Apple Music, you’re like, this thing knows absolutely nothing about me. And so it’s personal, right.

Jeremy Deal [00:12:30] Absolutely, that’s the thing with podcasts and so the more content that goes digital, the more important this is and it’s actually more obvious in podcasts how big the opportunity is because Spotify being number two in podcasts and probably going to become number one as far as the number of podcasts. They had almost no podcasts a couple of years ago and now it’s you know, two and a half or almost three, but it’s going to go probably well over 3 million in the next you know, several months, six months, or whatnot. And as that content grows, think about the number of words in a podcast and the content.

As that content grows, the value becomes in the recommendation engines and the artificial intelligence required to sift through that and make sense of all of it and summarize everything and create searchable content that has value to people and that is a really big key differentiator between Spotify and any other service because other companies may also be working on a similar problem and they may also have recommendation lists. When you sign up for YouTube Music, it asks you, do you like you know as you have to click on the titles of different artists, and it sort of tries to understand what you like. But that’s different than having many, many, many years of history. What was really important is the algorithm that’s kind of monitoring as the engagement goes up, there’s more information for them to monitor and the recommendation engine just gets better and better and better. And it’s just this virtual cycle that I think that is really underappreciated.

Tilman Versch [00:14:10] A question on the recommendation engine in music if you confirm what I’ve heard. Spotify seems to have, is not doing like, person X heard that so I recommend you this song but instead they went through the songs and distilled them to the atoms and looked for patterns that are similar with the recommendation they do. Can you confirm that they are also better on the technical side and the way they do the music discovery?

SCSleepwell Capital [00:14:45] There are different strategies that they use. It’s not only a single one. There’s definitely been some, I guess you can call it analytics on like analyzing the songs to their specific waves and sort of categorizing them to how they sound. Not only on a genre basis because the genre is one way to categorize but you can have sort of moods of a specific song as well be done with machine learning and things like that. But they definitely leverage the taste of other users. One of the ways that they do this that we’ve heard from before is by looking at your own playlists that you’ve built, and comparing those playlists to what other users may have done that is strikingly similar to what you have. So chances are your taste is going to be pretty close to that person. And if you replicate that millions and millions of times, which they can because of their massive scale, you have a much higher chance of being able to hit exactly the right song that you want to be listening to or be adding to a specific playlist, etc. So it’s a combination of different data analytics and data science that they can apply to this.

Jeremy Deal [00:16:10] And it’s also shaping the way a song is created today. Songs in the past used to be a lot longer. I don’t remember the exact numbers, but it was something like the average song used to be four minutes long or something and even had some older songs in the 70s that were seven to eight minutes long. And songs today are a lot shorter, and we now have data to be able to create songs. Artists have to have the information to create and engineer songs around certain audiences. And maybe it doesn’t sound as authentic as somebody just creating something in their bedroom. But what we have, the tools today are the potential for songs to be created that they have a higher probability of being very popular and songs that can be created. I think we’ll see songs that are created around other business models.

So a song that’s created in order to sell something specific or in order to induce a certain group of people or encourage a certain group of people to do something specific or be a part of a certain experience. Similar to maybe how a song that you hear in a movie, just sometimes it feels like it was created for that movie. And sometimes it was, but other times it wasn’t; the lyrics happen to be just a good fit. And so as the recommendation engine and the technology improves, and we really fully understand the matching of what people are interested in and trends real-time and live, that data becomes more and more valuable to all parties.

Tilman Versch [00:18:10] Coming back to the podcast experience. Can you maybe shortly describe Pods and the ongoing transcription of existing podcasts on Spotify can add as qualities to the platform?

Jeremy Deal [00:18:22] The way I research companies have changed over the last year and a half, two years, and one of the first things I do, which I never thought I would do, is I search the founder in Spotify and see if there was an interview. And I start with that. I don’t start by opening up the 10k anymore. I don’t start by doing a screen for the balance sheet and valuation. I just am interested in hearing the founder or the CEO talk and I want to kind of hear him or her and listen to what it is they’re trying to do. And then if that sounds interesting, the more financial work, the traditional work, investing research begins. And so if you extrapolate that out over how much information is being created in a podcast, I think there’s a lot of opportunities to string together important sentences and phrases or key sentences and phrases about a variety of topics that may not even be connected in a particular podcast and string them together in a format that allows people to have deep insights about a specific topic.

So, for example, in this show, we’ve covered a lot of things and there could be a sentence or two about something; maybe not Spotify specific, that could be strung together with somebody querying or looking for information about something. I don’t know, pick something. Pick one of the two or three or the four sentences that we’ve mentioned in the last hour and a half or whatever. And they string that together with maybe 1000s of other podcasts and use machine learning to pull out that information and then put it all together with references. And essentially it becomes kind of a search engine, an audio browser like they talked about, or a search engine for audio. And as far as I know, audio is kind of this elite. There’s less audio on the internet than there is visual by a magnitude, by a big factor.

So the way I understand it, Pods is the leading technology, the machine learning technology that pulls out on key pieces of the of a podcast of maybe an hour, two hours long, people are just kind of talking and it pulls out the most important essence of it and allows you to then string together things and produce queries and research in order to one: promote your podcast and find existing or really important pieces of it that could potentially be used to advertise and promote. You know, some funny sentences that you said to bring people in to listen to it or just to create research, just to give someone research about a topic. So that’s the way I understand it. And there are actually some good podcasts with the founder of Pods out there and talking about the bigger opportunity and how far advanced they were before Spotify bought them and their goals and mission and just sounds like just an incredible opportunity in general.

Tilman Versch [00:21:40] Let’s then, after looking at the audience perspective, move on to the producers and the creators, how you want to call them. I think two themes I could identify on the creative side is the reduction in friction in the production. Spotify is investing a lot in building tools. Another one is creating income sources for creators. Maybe let’s try to take a look at the initiatives they do in reducing the friction in production. There is Life Experience, Green Room there’s Anchor, which allows an easier production. What are the meanings of these tools for you that Spotify is building here and maybe what tool do you want to add?

SCSleepwell Capital [00:22:25] Yeah, I think it’s a super important part to focus on when thinking about Spotify and the strategy for the next few years. As we were talking about earlier, this shift to bring more focus to the creators recently, not just to the user base is going to help the platform a lot. So on the creator side, you obviously have to separate the music side from the podcasting side, right, because it’s a very different form of audio and there’s a lot of different intricacies and laws that surround them, etc. Maybe I’ll talk about music and then Jeremy can add some thoughts to the podcasting side. But I think that they’ve done a very nice job of helping creators, artists and songwriters make a better living as they would have, call it 10 years ago when it was practically impossible to be an independent artist. And they’ve done this in different ways. Not only by streaming, but it can also now support a decent living if you’re sort of in the right segment of an artist.

If you have 1000s of monthly listeners, it’s probably not going to do it but if you’re calling on the 200,000 to 200,000 plus listeners, you’re starting to generate up a decent amount of income from streaming and the value chain is vast and the process for a song to be from its creation to actually be put out on the platform takes a lot of logistics and there’s a lot of intermediaries, etc. And I think Spotify has tried to sort of have a place in each one of those parts. They own a company for example that’s called SoundBetter, which is basically a marketplace, who as an artist, you can find producers, sound engineers, someone to master your song maybe you need a bass player to finish recording a song and things of that nature. So on the production side, they offer some tools. And on the distribution side, is actually a place where I think they could do something else. And that’s actually one place where I think Spotify could end up doing an acquisition.

Because just to kind of take a step back for those that may not be as familiar with, but when you’ve completed recording your album and it’s ready for publishing and distribution, you don’t just go into Spotify and upload it straight to Spotify or either Apple Music or anything like that. You have to go to something called a distributor, which will then put your music out in every relevant digital service provider and they will take a cut from the sort of aggregating all the royalties that get paid out to your songs and then they pay those out to you, right. So it’s actually pretty similar to what an anchor does on the podcasting side. What I think Spotify should eventually do is buy one of these distributors and not keep those artists exclusive to Spotify in anyways because artists need to have maximum exposure.

But they can perhaps get a better rate or better terms for Spotify, for those songs that are being streamed in Spotify specifically and actually start getting more data that’s coming from all the other platforms like YouTube, Apple Music, etc. So that’s one part where I think they can make a very interesting move on the music side. People have long talked about Spotify signing, like superstars and things like that. I don’t think that’s going to happen anytime soon. But this other idea that I just mentioned, I think it’s actually quite plausible. Apple actually invested in a distributor, I think it was a couple of months ago, UnitedMasters. And a few years back, Spotify made an investment in one as well, in DistroKid. So, it wouldn’t really be that surprising if they make a move there.

Tilman Versch [00:27:35] Do you have anything to add Jeremy?

Jeremy Deal [00:27:38] No. I think that covers it. I mean that’s a lot of detail. And I think it helps that Sleep is also a musician and an artist and has a really ground floor perspective on what it’s like and the process for publishing music.

SCSleepwell Capital [00:27:58] Yeah, I would just quickly add on that one, on the artist side. The other thing that I think that they’re already working on, but we’re due to see more improvements, is kind of on the Spotify for Artists platform, which is the data analytics tool that you get as an artist and I think we’re going to be seeing more and more details that are going to be available and sort of ways for artists to connect with their fans and understand exactly who their super fans are and be able to monetize them better, etc. So those are some changes that I think we’re going to see on that side. And the same is going to apply to podcasters.

Jeremy Deal [00:28:42] And again, this is about driving engagement. Because the more opportunity that Spotify can create for the creator, the higher chance that people will engage longer with the app during the day and the higher probability that you’ll convert from freemium to premium. And I think there are other smaller flywheels within that where, for example, there’s margin opportunity in Spotify for artists and selling data, and there are a lot of ways this could go. But a lot of optionality beyond that but I think this is the focus of the company is how do we help artists make more money? How do we unlock the addressable value of the addressable market of all these small artists? Why is it that an artist has just been limited to streaming revenue and concerts? And how do we break down those barriers?

And it’s all about encouraging more people to give it a shot and find their fans and even if it’s part-time, the opportunity is better than it’s ever been. And it drives engagement and it separates Spotify from the competitors, so it’s really exciting. And I’m also very excited about Spotify for artists. Sleepwell and I were talking about it yesterday, like how do we think. We’re both kinds of taking a shot at how do we think about this financially as an item, a line item, maybe in the income statement and future? And I think he helped me also think about it in terms of more about engagement and maybe it’s margin creative because sometimes the services are traded for a lower royalty rate, like in the case of some of the bigger digital music labels like Believe. But there are other ways they could potentially charge but the more valuable the musician becomes, the better it is for Spotify’s engagement and ability to move forward with their business model.

Tilman Versch [00:31:00] And for the podcasting tools, I also have the point of reducing friction; like it’s easier to produce. You don’t have to upload it to a WordPress server somewhere, you’re allowed to embed audio snippets, you have certain rights management embedded in it so you can use popular music to play behind your podcast episode. You have advantages in data and tracking. I’ve compared different data tracking and engagement tracking tools, and Spotify is really good. YouTube is on the same level, but Spotify is really good. And also they’ve created polls and surveys. A bit like the YouTube experience where you can also ask your audience about their tastes and interests.

Jeremy Deal [00:31:48] Yeah look, the idea is, the more podcasts are created, the more quality podcasts are created, the more value accrues to the aggregator. Ben Thompson talks about this, about the aggregator theory and I think Spotify should be doing everything they can to lower the barrier to entry and help you make more money as a small podcast host, and help you grow your business. Because the more Tilmans there are, the more you need Spotify to kind of sift through the data and help you find your audience. And the more you need Spotify to, for example, apply the Pods machine, the algorithm to help you market your podcasts and be heard amongst a sea of potentially 100 billion podcasts in the next 10 years or five years.

And instead of the three or four or five million podcasts that there are today and so Spotify kind of creates its own demand for its future by helping by lowering the barriers and opening the floodgates to come in. It’s a very opposite business model of the kind of a traditional business, of a non-tech business that’s trying to put barriers up and control things and prevent people from coming in the door that isn’t paying the fee. So, it’s a different model than for example the old record labels but it’s very powerful. It really enforces the aggregator role that Spotify plays, and it enforces the value that they create; the more content there is, it’s to their advantage.

SCSleepwell Capital [00:33:50] The great thing also about podcasts is that because it’s basically a completely new market and there are no intermediaries that you really have to deal with like you would on the music side with the big labels etc., you can test out all these kind of new monetization models and see what works best. So, we already know advertising has become a very big focus for them. And the idea is not only for Spotify to be able to monetize better on the advertising side, but a lot of that will be shared with the creators who are bringing those ad dollars, similar to the YouTube model in that sense. So, it’s going to be another added advantage to the platform because creators will tend to spend more time and more focus on the platform that’s paying them the most right.

And then they also announced specific subscriptions for podcasters. So if you want to also have a premium show to kind of segregate your superfans, Tilman you could. You could have bonus episodes and Q&A for people that are paying you to know, €5 a month or something and that’s something that Spotify also has announced and is going to be rolling out over the next few months.

Jeremy Deal [00:35:15] Yeah, I think it opens the door to create. When people talk about business models being built on top of, what the need is it just allows you to kind of invent things. And let’s say Tilman, you decided that you had a request for I don’t know, think about somebody famous that you’ve interviewed or a really well-known fund manager that you’ve interviewed. You could figure out that, people would pay some amount of money to have a one on one with that person. And you could even tell that person like the look, I know you’re already successful, but if you do this, some percent, half of the proceeds will be donated to a charity or to something like a Robin Hood Foundation or there’s going to be a stock pitch that you’re going to invite, I don’t know, your top 100 listeners and users to. I mean there are just so many things you could start to potentially invent with the tools that you have; with knowing who your subscribers are and who your users are that you could leverage the platform for.

It’s not a pie in the sky idea, but it sounds pie in the sky because you’re just saying, oh, these magical business models, we don’t know what they are. But it’s really just saying look, it’s up to you to invent them and a lot of these have never been done. I mean, the podcast industry, to Sleepwell’s point, is so new, but I don’t think it’s going to take much time before we start to see one successful podcast; somebody creates an idea that hey, we could do this and somebody will copy it and entrepreneurs, people are very innovative and when they see something work, they’ll do it and I think people will become more and more creative on how they unhealed this, how they move the podcast business forward.

It won’t just be you know, selling advertising is just one option for them. And I think you know, Daniel Ek talks about that, like look, if you decide if or Gustav actually, he said if you want to monetize with advertising it’s great, but if you don’t want to monetize with advertising, you don’t have to. You can charge a fee if you want to have a special Green Room event, you can. If you want to do something completely random that you invent, you can. And that’s why I think investors have a hard time with it because it’s just something that just hasn’t happened yet.

Tilman Versch [00:37:38] The interesting thing about Green Room from the creator perspective is also that they enable recording and not only the live event you have on Twitter spaces, but you also have Clubhouse. You have to be live there otherwise it’s gone if you don’t record it yourself with some kind of tools and this is really annoying for creators because you lose the possibility to give it to the bigger audience that can’t attend the live event. That’s also the thing I think they built cleverly.

Tilman Versch [00:38:08] Maybe let us think about one thing that’s also often criticized about Spotify, the streaming income. It’s more on the music side, but many struggles about it are that people can’t live from the streams. How should we think about the streams? Is it more a commodity that enables further transactions or is it more a thing we should think of as an income?

Jeremy Deal [00:38:30] Sleepwell knows probably more about this than I do. But give it a shot and I’ll try to follow up.

SCSleepwell Capital [00:38:40] Yeah, I mean, obviously feel free to chime in with any thoughts but, this is I know, it’s a controversial topic. But you have to look at the sort of the hard data and the evidence and where the industry has come from, right because obviously 10, 15 years ago, piracy basically killed the entire industry. And now, thanks to streaming, we’re back to a pretty healthy ecosystem that’s been growing nicely. As an artist, I think you have to recognize a couple of things. The first one is that streaming is not and shouldn’t be your only income source. So there are definitely different places that you have to focus on not only on the concert side. But the most successful artists, they don’t even have to be the biggest ones. They’re the ones that are able to monetize their superfans at a higher rate. They have a very clear strategy on the merchandising side, they can do things like, they can do a clinic with their guitar player that’s teaching their fans on how the techniques that they use on the guitar.

These are things I’ve seen many artists do and be able to not only focus on their streaming income. And then I think the other important part to recognize is that it’s going to sound cruel, but it’s just the nature of the business, is not every artist deserves to make off of a living as an artist. There are just too many of them and it’s a power law. At the top of the funnel, it’s what’s driving most of the streaming income. I was actually on Twitter, this last week and I saw a random guy pop in my feed complaining that Spotify paid them, I think it was like, I don’t know $20 or $30 in the past 12 or 18 months from streaming royalties and when I went in and saw their artist profile, I think he had like, less than 100 monthly listeners and I just went back and said you know, as an artist, it’s going to sound cruel, but you just don’t deserve to be making a living off of this because there are not enough people listening to you and this is the equivalent of you selling three or four albums per year.

So that’s mainly the people that you’re going to hear complaining. If you have 50,000 or 100,000 listeners, that’s actually a pretty decent artist. And independent artists, it’s pretty common for them to have something around that. It’s pretty likely that you’re going to be generating some interesting streaming income, but you’re also going to be making some concerts that are going to be pretty profitable to you, and then at the same time you can sell merchandise, etc. so it’s not only Spotify that’s paying this out. They’re already paying over two-thirds of their revenue to all their rights holders; so it’s basically the same for Spotify and Apple and Amazon Music. These are how the deals are structured with the record labels and the distributors.

And I think as the pie keeps on growing artists will sort of naturally see that tailwind to their benefit and be making more and more and more money. And you also have price increases that have started to come in in certain places, so that’s also going to kind of benefit artists. So, 10 years down the line, I think more recently we’ve seen this is the trend; that people realize it’s not Spotify’s fault that some of these artists are not making enough money and Daniel Ek has actually been pretty vocal about this in terms of what the new business looks like. But yeah, 10 years down the line, I don’t think we’re going to be seeing much of this because people are going to be much more educated on how the business works and what the reality is, right?

Jeremy Deal [00:42:53] It’s just a tool for you to be heard. It’s not like oh, I just create something, so I uploaded and I just deserve to make money. I mean, there’s no free lunch out there and the royalty split gets a lot of publicity. But if you sign with a big label, I think the average artists get something like 10% of the royalty stream and 90% goes to the big label. Because historically the artists make money with touring. But if you’re an independent producer, if you own your own master or you are working with a modern digital label, like Believe, which takes between five and 10% cut of royalties or whatever you earn, whatever they can help you generate, then your payout as a percentage is the maximum amount.

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So without a label in the way, if you just upload direct, you’re going to get full, I don’t know, Sleepwell’s it’s 70%. And if you are owned by a label, the label is going to determine, your contract is going to determine what percentage you get of that. So a lot of the complaining that’s done is not at the fault of the streaming company. It’s at the fault of the contract that the musician has with the music label because the music label is the one who decides how much you get, not Spotify.

So I think paying out two-thirds in general as kind of a gross profit, is extremely fair. Because I mean to pay 30% for something that wouldn’t be accessible otherwise, I don’t think that’s unfair. But when you start adding up all these people in the middle that are taking their cut, I can see how it seems unfair in a way. But I think to Sleep’s point, we’re going to look up and the artists are going to realize that there’s a lot more to do than just stream music and play concerts. There are a lot more avenues to make money in a digital world when the industry is kind of fully moved online. Streaming, it’s just going to be a way for you to build your brand and your brand is going to have more value than touring. So the value Is to be unlocked.

And look, you’re gonna make more money streaming in general because music is going to be more a part of I think of the internet. There’s going to be music popping up in more places than ever before and you’ll get paid on that but the real value creation opportunity for an artist of any size is not necessarily increasing the number of streams per se, but it’s using streaming to identify your superfan and then finding other ways to monetize your superfan. I think that’s the direction from the business side of what I think it often gets missed and why Spotify and YouTube and TikTok and Peloton and even Apple Music to some degree are really powerful tools for the musician. It’s not just about streaming, it’s about finding other ways to make money with your brand.

SCSleepwell Capital [00:46:08] That’s such a good point. And I’ll just add one last quick thought there. I think a lot of people forget about a big characteristic of streaming and we finance people can probably have an easier time understanding this but sometimes you’ll see most people complaining about the specific payouts maybe like I made X amount of money in a month or in a year or something like that. But what sometimes gets lost upon that, is that this is basically a perpetual revenue stream. You almost have to think about it on a present value basis. Right? Because yeah, you can spend $10,000 making an album and promoting it, etc., and then you maybe get $500 or $1,000 in income if things go decently well but that’s basically perpetuity. So it’s gonna be a nice revenue stream that you basically don’t have to do anything about it once it’s put out. I mean, you’ll promote it when it comes out, etc. but five years down the line that’s probably going to still be making money and you won’t have to be moving a single finger to maintain that. So that’s a pretty good deal for many artists.

Tilman Versch [00:47:32] Thank you for your insights on streaming. I want to come back to the great plan Daniel Ek has to build a creator middle class and enable them with Spotify’s tools. Streaming cannot be the only source of income for this class. So, what are other initiatives Spotify has to enable this middle class? I think advertising is an interesting keyword, tipping, NFTs and banking, digital concerts, and concept planning are some of the ideas that are interesting. Maybe you want to go into detail on this?

Jeremy Deal [00:48:12] I’ve also tried to brainstorm. It’s hard because it’s like saying, well, what direction? If you go back 10 years or 15 years and you say, well, what kind of business models are going to be built on the internet? Well, there was a time in history when people maybe could envision you ordering pizza on the internet, but it didn’t go much further than that. Especially the financial community. They couldn’t have envisioned the hundreds of millions of different business models that the internet has unlocked, or that the iPhone has unlocked. It’s like saying, for example, well, what are the possibilities for the iPhone? Well, it is a lot of business models that can be built. And I think it’s just the creativity. We’re just in such an early stage. Just think about like, if you’ve never had interaction with your fans outside of a concert, and even that, I would argue is not real interaction that’s just kind of on the stage, but real interaction.

I can’t think of another industry where you have so much engagement and the artists mean so much to the fan, that there’s just no engagement and there’s no really monetization path. And so some of the stuff that’s done recently, there are sponsorship deals, which are probably the lowest hanging fruit out there where, like I’d mentioned the Bruce Springsteen and Jeep partnership, over the Superbowl or whatever. I think that was a little bit of a mess because he got a DUI or something a week afterward and they had to pull the advertisement. But there are artists promoting certain drinks or whatever. But I think you’re going to see anytime you can interact with your fan base, and you start to come up with the prior projects that are important to you, whether they’re nonprofit or for-profit or related or even not related to the music or just related to the essence of the tribe that you represent.

So listening to a song or being a super fan is about really being part of a tribe. And what does that unlock? It’s kind of, I could see almost anything being sold, but I think in the interim, and in the beginning, it’s going to be simple things like advanced merchandiser, or drinks. Like, who is the rapper famous for Vitaminwater, has a partnership with Vitaminwater; you know, five years ago 50 Cent? Yeah, I mean, I think you’ll probably see stuff like that. Sponsorship deals, and more localized concerts, and a pre-album party, pre-album access situations where you get to login and help an artist screen and decide which song to put on an album. See how they’re living their life and, in a day, ask them anything type questions.

What’s your favorite pair of sneakers? Like oh, yeah, and then next thing you know, the superfans are wearing that those sneakers or whatever. Look at Kanye. Kanye, apparently is a billionaire and he’s not a billionaire because of streaming. He’s a billionaire because he’s learned how to monetize his brand. His brand is super powerful and it’s not only that he was married to Kim Kardashian and that thing, but he has clothing lines, he has so many entrepreneurial endeavors from gospel music to all kinds of stuff that he does that he’s really been able to leverage that superfan base. So I hate to sound kind of pie in the sky here, but it’s just, the sky’s the limit on what you could do if you’ve never really been able to interact with your fan base before beyond just a concert.

SCSleepwell Capital [00:52:08] Yeah, and I mean, it does sound pie in the sky, Jeremy but we’ve also seen some evidence of this already. In terms of Spotify testing these things out, they hosted a couple of online concerts a few months ago. I think Black Keys was one and for $15 you would be able to watch them play a live concert on a specific timeframe. And I think these are things that they’re going to keep on testing. It looks like they’re also looking into actual live physical concerts as well, which they actually have some experience on. RapCaviar in the past has hosted multiple concerts, Spotify themselves as well. And I think Green Room also comes into play here and it’s a big recent for the acquisition. The way that I think about it is it’s eventually going to be a very important platform for artists to engage with their superfans.

And you mentioned some of these. But yeah, like listening parties are an example. You know, Q&A and actually having conversations with some of your biggest fans. You could have some of these be ticketed events as well, so you get yet more monetization on top of that, and everybody benefits. Obviously, the artist with connecting with their fans, and the fans get to have a better experience. And it’s probably the most natural place to do this because you already have such an immense brand recognition with both the fans as well as the artists that they know Spotify is probably one of the biggest contributors to their life as an artist. So it’s only natural for them to stay inside of that ecosystem and pursue some of these engagement initiatives.

Jeremy Deal [00:54:08] I was thinking about Travis Scott, who’s one of the top artists today; musicians today, and rapper. And you know, just looking here, Travis Scott previews, new music, and Spotify commercial. So he’s previewing, he’s basically sharing new music that he’s never shared before. And it’s becoming exclusively into a Spotify commercial. So it’s just all kinds of stuff. I mean, it’s just whatever you can kind of think of. Travis Scott also did a virtual commercial inside of a video game. So I think it’s just in the early days of thinking about these being creative people. And there’s a lot of creative people behind creative people. There are also business people and it’s also very competitive and I can’t even imagine all the ways that you could potentially make money.

I think what’s changing is you don’t necessarily have to be a top 1% musician to find a way to make a living, per se. And I think what Daniel means by that is not necessarily from streaming. But even if you have, I don’t know 20,000 fans, you don’t need to have millions and millions of fans but if you can think of a creative way to monetize those 20 fans because you can find something that everybody has in common. It’s a common interest where you can profit from that. I mean look at people can go on Instagram and have you know 30 40,000 followers and be an influencer and sell like just homeware, then an artist with 20 or 30,000 fans can find a way to make more money than they’ve probably been able to make before with their music through these tools. It’s just in a way, it’s kind of like what’s been done in Instagram only with music.

Tilman Versch [00:56:09] Followed by this, I think you don’t have an exact answer on this, but if you observe this, I have the feeling that Spotify is building an ecosystem here. How much control can they get out of this ecosystem? How can Spotify position itself in this ecosystem that it profits from the revenue streams coming through it?

Tilman Versch [00:57:13] So maybe for the end, let’s try to boil it down as an investor and to think about opportunity offers. Jeremy, in the last talk, you gave the idea of a triple opportunity. Is it still your take?

Jeremy Deal [00:57:30] One way to look at it is just the penetration of the addressable market for premium subscribers. Like I said, we think they have somewhere between three and 4% of the addressable market in premium and maybe between eight and 9% and in subscribers, so the addressable market ex-China. And there is an opportunity. Daniel Ek talks about their goal of getting to a billion-plus, getting to a billion. These guys have the biggest market share so even if 1/3 of the addressable market turned into subscribers of Spotify, even on the freemium model, that would be like something like 1.3 to 1.4 billion subscribers. And then historically, between 40 and 45% of those freemium subscribers convert to or are premium subscribers. So that’s more or less how you get to someday, a premium penetration rate that’s in the hundreds of millions.

What that could be worth? Well, it depends on the engagement. But if you look at something, you know, how much maybe Netflix earns or how much other subscription services earn for sub and mature markets and try to extrapolate a version of that. I think the opportunity is in the 10s of billions as far as gross profit; in the 10s of billions greater than where they are today. I mean, like I said earlier, currently, they only earned about 50 cents a month in gross profit per subscriber, that’s total subscribers. But it doesn’t seem like very much relative to the value that they offer for every subscriber, even the freemium subscribers. So you can go down the list. Podcast advertising is still in its very early infancy and that drops straight to the bottom line. In any incremental growth that we’re seeing in podcast advertising, is a 75 plus percent gross margin. I mean, the infrastructure is already built out so when they grow, it just kind of drops right, your gross profit if it’s depending on what split with the labels and how that negotiation moves forward.

But Spotify for artists, the two-sided marketplace you know, other little incremental opportunities to sell data, maybe but the bigger picture is probably just the competition with radio and taking more market share from radio and the conversion of freemium to premium subs. Oh, and by the way, the new win with Apple I think is a big deal because they’ve talked about how if they could only be able to subscribe, they could only have a link to allow people to subscribe directly within the app that it would reduce churn quite a bit. And so now they’ll be able to get that with the new Apple rules. In the App Store that apply to them starting at the beginning of the year. So all that is helpful.

So how big could it be? I mean, it seems like we’re in very early days and I see you know, it could be Daniel Ek talks about the company being five to 7x bigger within what he’s willing and able to talk about publicly and what they can see today. And if you just multiply that out, you get to 60, 70 billion in revenue, and maybe a 35% gross margin. It’s a much, much bigger company than it is today. So sure, a double. I can also see, over a long enough period of time a 10 bagger. I don’t think that’s out of the question at all. It’s a 40, 42 billion enterprise value business. It just isn’t that big relative to the size of the opportunity and where they are.

Tilman Versch [01:01:30] Do you agree or disagree, Sleepwell?

SCSleepwell Capital [01:01:35] That’s a very similar line of thought, when I try to think about the valuation call it 10 years down the road. Another very simplistic way of thinking about it, for me, is I try to look at just the kind of entire universe of technology, large technology companies that’s out there and I can’t really see any other company that has some of the attributes that we’re seeing here. In terms of being the largest, the only pure-play, it’s scaled, as well. It has a highly engaged user base. It has an actual real shot of getting to billion-plus users. And it’s basically going for a 40 ish, billion enterprise value. And I don’t think there are many other companies like that are out there.

And, again, going back to sort of the metrics that we’re focusing on, I think that the user growth and the engagement and the innovation, those are the three more most important ones for me and if we get to where management thinks they can get to in the next 10 years, the stock price is basically going to work itself out.

Tilman Versch [01:02:53] Do you have anything to add for the end of our interview? Anything we haven’t thought about in the context of Spotify and the music market?

Jeremy Deal [01:03:05] I mean, there’s probably a lot of other topics. Blockchain, for example, payments, the partnership with DM, being on the DM Association and centralized kind of blockchain and the impact that a stable coin will have on their ability to do business in parts of the world where it was prohibitive otherwise, and there’s a lot of other facets of it.

Tilman Versch [01:03:32] What was the impact in short?

Jeremy Deal [01:03:35] Well, you don’t need a bank. I mean, in a perfect world, if they’re using a stable coin or crypto to make a payment you get to circumvent the bank, and in a lot of these countries, and also manages payments in a really efficient way that isn’t done analysis. I think there’s a lot of other pieces, just greater that as the company evolves, the company just gets better and better. And it’s not really core to the thesis today, but there’s just so many little optionality elements to the story that outside of just the core business of, you know, just growing subscriptions, that just is fascinating. It’s a rare case where you just have so many ways you can win and the downside, I know three and a half, four times next year’s revenue on US dollar terms, just seems relevant. It seems like a very different valuation proposition than a lot of large tech companies.

Tilman Versch [01:04:40] What optionality are you thinking of?

Jeremy Deal [01:04:42] Use the app. Everybody should use the app. I think people that are critical of it, don’t necessarily use the app and if they use the app, they just use it to listen to a playlist or something. But I encourage people to really play with the app. Really get into podcasting, really use podcasting as a tool to do research on whatever topic, really get into the recommendations, and just start playing around with it. They’re going to be introducing eBooks before the end of the year. I’m really excited to see what that looks like. And try to participate.

Try to buy a concert ticket. I bought a concert ticket last month to a small band, a small group that I love that happens to be coming to Europe in March next year. So buy a concert ticket. Click on your favorite artists and look for the next time they’re going to be playing in your city and buy a ticket. And use the app to learn more about your favorite artists. There’s a section on there that talks about the artists where they have a history of how the band got together. Just kind of play with the app and really get into it. And I think comparing that to what else is out there, it helps somebody to understand what this is and what the bigger opportunity is and monetizing it.

Tilman Versch [01:06:05] Sleep, do you have anything to add?

SCSleepwell Capital [01:06:10] I think the only other thing I would add that I thought was super interesting was that they announced a $1 billion buyback recently which is not that common for a company at this stage but they’re overcapitalized and they’ve been pretty vocal with the fact that they think their stock is cheap. The last time they did something like this a couple of years ago, they bought back a bunch of stock in the 130s so it proved to be pretty timely. And we know Daniel Ek has bought warrants in the past as well from his own pocket. So management is thinking about the stock price as attractive here if that’s indicative of anything. I think it’s interesting.

Jeremy Deal [01:06:52] Yeah, they’ve got some three and a half billion in cash, I mean, it’s more than enough. And Paul Vogel, the CFO, talked about it on the last, they did a Bank of America sell-side call and he talked about their priorities for capital allocation. The buyback is kind of the third priority but it is nonetheless, just a question of pure opportunity where they really believe their stock is undervalued, and I do as well. And I think if hey, if they’re investing like a billion a year in R&D, so if they’re fully invested in R&D, and they’re fully invested in podcast content or whatnot, and then they happen to have a billion-plus leftover of that three and a half and their stock is trading at what they believe to be, you know, a 25 cent dollar, why not buy a couple 100 to 300 million worth of it? And it’s an asset they know pretty well so I think it’s great.

Tilman Versch [01:07:46] Thank you very much for coming to Good Investing Talks and having this great talk about Spotify.

Jeremy Deal [01:07:54] Thank you for having us.

SCSleepwell Capital [01:07:55] Thank you, it was fun.

Tilman Versch [01:07:58] I was great insights. And thank you for the audience for listening to this talk. And hope to see you in the next episode. And for this, bye-bye.

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Jeremy Deal

Founder

JDP Capital Management

jdpcap.com

Sleepwell Capital

Anonymous investor, known from Twitter

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