Sleepwell Capital & Jeremy Deal (JDP Capital Management): How does Spotify become the audio platform?

Sleepwell Capital & Jeremy Deal, JDP Capital Management

“It’s not only a music service as it was if you look back as short as four years ago. But it’s really going after the entire audio market nowadays.”

[00:00:41]

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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] Dear audience, it’s great to have you all back for the second episode of our talk on Spotify. Today, we are doing a deep dive into the company. And I’m very happy to welcome Jeremy Deal and Sleepwell Capital. It’s great to have you on guys.

Jeremy Deal [00:00:16] It’s great to be here.

SCSleepwell Capital [00:00:17] Thank you, Tilman. Thanks for having us back on again.

Tilman Versch [00:00:22] It’s great that you’re back.

Tilman Versch [00:00:24] So maybe, let us start with the question: what kind of animal is Spotify in your eyes and try to define what Spotify is as a business? Is it a streaming service? Is it a platform? Is it something else? What is your definition of Spotify?

SCSleepwell Capital [00:00:41] Sure, so maybe I’ll start. It’s not the easiest question, especially because as we, most of us that have been following it for the past couple of years now, it’s been evolving at a rather rapid pace in terms of its of its strategy. But I guess the most recent definition in my head, and the way I think about it is the only focused and scaled audio platform in the world. That’s kind of the one-liner for me. It’s not only a music service as it was if you look back as short as four years ago. But it’s really going after the entire audio market nowadays. So its strategy has changed a lot and I expected it might look something different if we think five years from now.

Jeremy Deal [00:01:36] Yeah, I would echo that. I would say that where it started, how people know the company, maybe four or five years ago is kind of behind. I mean, it’s evolved, like all great companies, it started one place and leveraged itself into a very different place. So as an audio platform, that transitioned from just a music streaming business, to truly an audio platform is a really important differentiator because it becomes a really important tool for the creator. And also, just kind of a must-have for consumers around the world because it’s an enabler for the creator and the fan to interact in a way that wasn’t really possible before.

Tilman Versch [00:02:27] So to try to summarize your answer you miss a lot if you define Spotify, just as a play on music, or?

SCSleepwell Capital [00:02:38] Yeah, absolutely. I would say that. To be clear, if you look, sort of the total listening hours, the majority of that shares is still in music. But as we’ve seen, from the recent investments and shifting in narrative and focus, it’s much wider than that; not only podcasting, but we’ve also seen them going to live audio, also known as interactive audio. So I think we’ll see them attacking new frontiers when it comes to the audio market globally.

Jeremy Deal [00:03:17] Yeah, not that there’s anything wrong with the music side. I think music could potentially be, will continue to be, you know, a really important part of their business. But on the music side, it’s easy to say, oh, look at this other business they’re getting into, and just look at it as an audio business, but the music side has an enormous opportunity. So it’s not necessarily that music is sort of at maturity. It’s just that music and the prior way that it was used, the prior way we think about monetization of music is what’s changing quickly. So yes, Spotify is more than just music, but just looking at the music side, there’s an enormous opportunity. So I think that’s important as well.

Tilman Versch [00:04:11] You already mentioned it, Sleep, that Spotify is unique. How unique are they and how are you both thinking about the competitive landscape of Spotify? Who are they competing with?

Jeremy Deal [00:04:25] I think the biggest competitor is radio. I mean, Daniel Ek talks about that, and I see that when I travel around and get in Ubers in different countries. I was just in New York for 24 hours and I took a series of Ubers and every Uber I was in was listening to the radio. I mean it’s the radio you can think of as having almost 100% market share everywhere in the world. There was a study done recently where they looked at the radio listening hours in 21 countries was something like 2.4 hours a day. So in places like the US, it could be higher. Radio is by far the biggest competitor to Spotify and to streaming in general.

SCSleepwell Capital [00:05:12] Yeah, I think that’s actually a very interesting way to think about it, Jeremy, and perhaps not the most intuitive one. But absolutely, I agree with you, when it comes to the big prize, or the opportunity when it comes to the total share of audio, radio is still on a global basis, the biggest, what’s capturing a lot of that share. So in that sense, it makes sense for them to go after that, and do as much as they can to bring all those or as most of those listeners as they can online. On the other hand, when it comes to, sort of pure music streaming companies.

SCSleepwell Capital [00:06:00] Naturally, there are competitors that offer similar products to Spotify. The biggest ones being the, you know, the big tech companies that we’re all very familiar with, obviously, Apple with Apple Music is the second player. Just to be clear, Spotify does lead with roughly a third of the market share, when we look at music, so music subscription streaming, specifically. So you have Apple after that.

And then, closely followed by Amazon, and then Google with YouTube Music. And then you have a bunch of much smaller players, most of them scattered across different regions. And if you look at India, for example, there are a lot of players that are very strong locally, but then have no presence in their countries, etc. So it’s a very, varied competitive landscape especially when you take up the big tech companies. But I think there are a couple of things to keep in mind when we compare Spotify to these other players. The first one is that, as I mentioned, in the beginning, Spotify is really the only global one that’s purely focused on not just music, but also audio. So, there’s no really a pure-play competitor, that’s doing something like Spotify out there. For the tech companies, in my opinion, music is pretty much a distraction. And they don’t really have or seem to have any intentions to make much money from that part of the business. It just served as an additional service for sort of a greater bundle.

In the case of Apple Music. I know we were talking about this yesterday, Jeremy, I thought you had a very good point in talking about cloud and storage where they’re basically bundling music and arcade and news, with a more sort of relevant offering when it comes to iPhone users. So in the case of Apple, I think that’s very relevant. In the case of YouTube, people are really just focusing on the video. And if you look at the statistics that Spotify has talked about in terms of engagement, they say it’s usually anywhere from two as much as three times higher than the competitors. So the evidence points to the Spotify product being much superior to what the competitors are offering. And I think those numbers are pretty compelling as well as the fact that they’re a lot bigger as well. And they’ve started to increase prices without much or without any impact to their business.

Jeremy Deal [00:08:55] Yeah, I’ll just echo that. One of the reasons I think you don’t see the numbers broken out, for example for Apple Music, is because I don’t really know if you can break them out in the same way. So Apple, what you get when you upgrade when you buy storage, so let’s say you get that famous warning that says you’re almost out of storage. And people might look at that and say, well, if I don’t buy storage, I’m going to lose these important videos or pictures or whatever. Maybe you don’t have time to go through them and so there’s this constant reminder that you’re almost out of storage and over time, people are buying more and more storage for their phones. And with that iCloud service, you get bundled in music and other things.

So what we don’t really know is, we don’t have a truly standalone product to compare, for example, Apple Music or Spotify or the same with YouTube. When you watch YouTube, anybody that watches YouTube and doesn’t have the premium service is familiar with the screen that pops up every single time you open the browser and it says subscribe for one month, you know, free trial, whatever for the premium service. And with that premium service for YouTube Video, you get access to music, you get YouTube Music, as well. So it is a different animal.

For these other companies, it’s an auxiliary product, it’s just a feature and they’re streaming catalogs. And I encourage anybody that doesn’t use Spotify to just download Apple Music and play with it and compare it to the selection and the interactiveness of Spotify, the recommendation list. When you see on Spotify, some of the music lists, for example, the lists you see are going to be different for each person. So the recommendation engine is getting more and more superior as time goes on kind of like Google Search gets better and better every time somebody uses it. And that recommendation engine is becoming more and more important, as the number of music increases. And so as to more do-it-yourself artists, DIY artists emerge, because costs come down to publish, and the same with podcasting as the tools to produce an excellent podcast come down in cost, the more contents added and the more important that discovery feature is. And not only the discovery feature but the ability for the artist to be able to find identify their fan base and figure out how they want to monetize them.

And that’s a fundamentally different value proposition overall than just a music catalog where you can type in your favorite artist and have it play like for example with other streaming services. So yeah, the competitive landscape is when you really play with the different products. Maybe you’re somebody that just says I only want to listen to the same YouTube song every single day for the rest of my life, well then maybe you wouldn’t see a big difference. But if you interact with artists, if you interact with music, if you interact with, if you’re interested in music, and you’re open to listening to new things, and you’re interested in the discovery feature, Spotify becomes a tool that it’s hard to live without.

Tilman Versch [00:12:40] Is there any competitor, Spotify has to fear in your eyes?

SCSleepwell Capital [00:12:45] Yeah, maybe. There are two that come to mind. Because obviously, in any business, you always have to be cognizant about the competition and really understand what they’re doing and what local landscape, right? So when it comes to the big tech companies, it’s not something I worry about a lot, especially when I look at Amazon and Apple. But YouTube I think is definitely one to watch closely. Because in some ways, it’s the biggest music app in the world. There are over 2 billion monthly active users globally. And I think the last stat we heard was something like 25% of them engage in music listening or it could be even higher. So you’re definitely looking at a platform that’s very much associated with music. What makes me comfortable as it is right now is the fact that I don’t think they have prioritized their strategy in any way to become an audio platform.

Their number one priority is still video, and it makes a lot of sense for them as well, because it’s much higher monetization when you think about it in terms of advertising and things like that. So if they do end up shifting their strategy to become more focused on capturing the audio share, that’s something I would watch very, very closely. So, for example, if you open the YouTube app, on your phone and you’re not a paying subscriber, as soon as you close that, if you’re listening to something, it’s gonna stop, right. And I think that’s a way for them to try to make you pay for it. But if they really wanted to go after this market, they would just give that out for free and sort of try to change that consumer habit and even end up competing more directly with Spotify. So those are kind of some of the things that I watch for, for YouTube specifically.

But again, we haven’t really seen much evidence that they’re shifting their strategy in any major form. The other one I like to keep an eye on, especially given how disruptive they’ve been in the social media space these past couple of years is TikTok. A lot of people obviously associate TikTok with music, I don’t think of TikTok as purely a music consumption application. But it is a very important music discovery tool and obviously, music is a big part of their platform in general. They did launch a streaming service this year, I think, earlier this year or last year, but it basically launched in three markets. And we haven’t seen any more recent updates. It’s supposed to be a little bit more social and focused on the social aspects of music, something that Spotify has lacked historically. But again, that’s just something to watch closely for me and I haven’t really seen that many updates to it or any incremental evidence that they’ve started gaining a lot of shares or gaining traction in important markets, etc.

Jeremy Deal [00:16:40] I’d echo that, I would agree with all that. I would agree with everything you said. I would also point out that one of the things that I look at or think about, if there was something that kind of kept me up at night, it would be just this general leakage of audio and the internet, and not necessarily all going just to Spotify, or any of these big tech people. I think there are some things that, you know, as audio becomes more and more a part of the internet in general, the things you watch as audio gets integrated more into your daily life and things that you see on the internet; and Daniel Ek talked about this concept in a recent interview with Patrick O’Shaughnessy, his five year anniversary a few days ago. But I think he’s right, that is something I’ve thought about too, is that maybe the bigger threat is that they just can’t grow like they think they can. And so although it may be a superior product and service leaps and bounds in quality ahead of some of the others, there could just be some natural leakage, just in audio, the internet in general, and there’s so much attention.

There’s only so much time in a day. And it’s really competition for your attention, and then the ability to monetize that. So as audio becomes more prevalent on the internet, including the spoken word versus video, that that is a form of competition, which people may not be thinking about. But it’s on my mind as well. But I guess speaking just to the big tech companies, I mean, when I play with the app, of course, I’m biased, but the way I use Spotify for research and podcasts and the way we use it at home for baby music and discovery and stories and listening to interviews with actors or movies that are coming out. And if we think about the way we use it as a family, not just to stream like some curated music list, I just don’t see a lot of competition there. I think it’s just there’s a big gap between what I see as far as quality. It’s like comparing an entry-level car with a supercar.

But maybe the threat comes from just the sheer competition just from more and more things, more and more music and audio going online and permeating throughout everything we do. Maybe it’s Peloton and it’s a combination of Peloton and TikTok and YouTube and whoever else is out there, small services in different countries. There’s decentralized stuff that’s popping up. It doesn’t have the same ease of use. But I think as time goes on, the ways we consume audio online, the different ways that you can consume audio online are going to grow exponentially.

Tilman Versch [00:20:00] You mentioned the word bias, and maybe it’s time for disclosure. We are all meanwhile, all three invested on Spotify. So we’re are all a bit biased. But coming back to the questions, what are three words that come to your mind when I would say the phrase or the idea of the culture of Spotify? How would you describe it in three words?

Tilman Versch [00:21:08] What are the management and Daniel Ek adding to the company?

Jeremy Deal [00:21:12] Daniel Ek seems to be somebody that is very inspirational, somebody that keeps everybody on track, and who keeps everybody focused and has a vision. And that vision is to have all audio available on Spotify. So keeping people innovating and focused on that single purpose. Because, and again, these are just listening to interviews with different people in the company. If you can maintain that goal, if you could, in a perfect world, I mean, of course, you’re not going to have every single piece of audio on Spotify. But having that as a goal allows for a lot of creative freedom to figure out what does it take and what are the incentives to get big pieces of audio that are not on Spotify to Spotify. An example of that was the OAP, the Spotify Open Access Platform. So we talked about that in the last podcast, but that’s an example of a team sitting around thinking, okay, we have to find a way to get iHeart content, for example, a big podcasts competitor on to Spotify. And how do we do that in a way where there’s a win for everybody?

And that’s a very different approach, I think than some of the competitors who are not as focused on this, or do not necessarily have, they have more of a winner-take-most mindset versus how do we have to do to get everybody on the platform? And then how much value does that add to our subscribers and to the creators, by having everybody on the platform, we’ll figure that out later the best ways to monetize that. But this vision and this drive to stay focused on the goal, even when the goal seems sort of simple, but it’s actually a very, very difficult goal. And I think he’s done a great job of keeping people focused on that. So that would be my takeaway on Daniel Ek.

SCSleepwell Capital [00:23:35] In my mind, I mean, I think he’s an incredible CEO, and more recently, has started to be noticed by more and more people, as his track record grows, etc. And I think he will keep on becoming more and more public over the years. The visionary part is, is obvious, right? But again, I don’t think it can be understated what he’s been able to achieve so far and what his long-term goal is.

Arguably the company single-handedly bailed out the music industry. That’s one way that you could think about it. By having been able to combat not only the labels and convince them to take on this completely new, unproven business model, but at the same time you were competing against a product that was completely free. So I mean, they were battling all over the place. It was such an incredibly challenging endeavor that they took on. And I think it’s been amazing what they’ve been able to achieve.

I heard a very apt description of him as a CEO. I think it was last week, there was a podcast on the Music Business. The Music Business Worldwide podcast interviewed Troy Carter. He’s a music executive, he was the manager of Lady Gaga for a number of years. He also worked at Spotify for a little bit. And when he was asked about Daniel Ek, he said, he’s always 10 years ahead of everyone in terms of the industry and where he’s thinking. And I thought that was such a simple but powerful way to think about it. And most people nowadays, most of us that are involved in the stock market, we’re very used to thinking about the next quarter, maybe the next year or something. But this is a guy that’s truly thinking about where things are going to be in 10 years and spends most of his days thinking about that. And that’s in, in many ways, similar to the kind of the Jeff Bezos way of thinking. And I think that’s a super important attribute to have when you’re managing a company of this nature.

So in terms of his vision, I think that’s a good way to explain it. He also seems to be an extremely patient individual. And in his own way, he has a very firm vision, but at the same time, I think he strikes a balance of having the right flexibility in terms of how to get there. I don’t think he knew exactly how it was gonna happen. So you can’t really trace that path from day one and know exactly how you’re going to get there, you need to have also that that flexibility in your mind and sort of change course when you have to. And I think we’ve seen this already with the change in strategy as they implemented podcasting into their business model the last couple of years, and we’ll see more and more examples of this going forward.

Jeremy Deal [00:27:10] Yeah, I would just echo that. He’s not afraid to take really big risks before anyone. They have been the trendsetter. Their entrance into it podcasting was really a first. They went in in a really big way and I think what he saw as far as the future of audio and then that pivot away from just being a music streaming company was, I think we’ll look back someday and see that that was just a brilliant move. Kind of similar to what Reed Hastings of Netflix saw when they moved away from the CD and went to streaming and saw a future where all video would be streamed someday. And so that vision of transitioning away just from music to the bigger audio space, it sounds may be trivial, but in fact, nobody had done it. And he was a first and I think you’ll continue to see the company, make big, big first-mover decisions ahead of everybody else, and then there’ll be caught up by the competition that comes in.

And it seems to me that in the industry in the last 10 years, or 15 years, or since Spotify has been around, it’s always been about Spotify making a big decision, strategic decision, and then everybody else trying to catch up. And Daniel Ek has said, multiple times that Spotify is not for sale. That he wanted to build a company with Lorentzon I think is his name, the co-founder. Yeah, Lorentzon said that they wouldn’t need to sell. And I really admire that mindset. The company was not built to be sold, the company was built as a living organism to grow and to be as absolutely as big and important as it could possibly be. And he’s slowly building his own life work and painting it in the public, eye. He doesn’t take a salary, he’s fully aligned with the common shareholder as the largest shareholder.

And when you invest in Spotify, you are getting Daniel Ek essentially, for free. I mean, you’re not paying him a fee. There’s no special equity class that he benefits from that the minority shareholders don’t. You probably won’t look up one day and have crazy capital allocation decisions made that were short-term oriented. For example, just to pump the quarter or whatever like you would potentially at other companies. And you also don’t see him taking shortcuts like you do at a lot of other big tech companies. There are several big tech companies that I’ve noticed taking really big shortcuts that have built products and services, really more for the advertiser and not for the consumer. And so the short-term mindset leads to problems down the way. So this idea of giving more than you’re taking and building something to stand the test of time, for as long as possible, that’s the kind of company I want to be invested in because I can be fully aligned with some of the best people and one of the best CEOs and entrepreneurs in the world.

Tilman Versch [00:30:25] Daniel Ek is a friend of Mark Zuckerberg. That was disclosed in one of the podcasts of Patrick. And, you know, from Facebook, they have the strategy, if they see something interesting coming up somewhere in the world and new trends, they buy it or build something and use the leverage they have with their users on the platform to fight against the competition, do you see something like this ability or this acting also at Spotify, that when they see something that’s taking off, they also copy it or try to buy it?

Jeremy Deal [00:31:05] Yeah, absolutely. I mean, the acquisitions they’ve made just in the last 12 months have been, not only incredibly strategic and valuable, I think, but they’ve been done on a value basis, these are relatively small companies. I mean, just the acquisition of the Green Room. I guess, technically, they could have gone out and tried to buy Clubhouse for many billions of dollars. But instead, they found the Green Room, which is incredible, and did a deal with them that was small enough to where it doesn’t have to be disclosed. If that tells you something probably. I heard something around 50 million-plus in earn-out, but who knows.

The acquisition of Pods. I mean, probably we’re gonna look back at the acquisition of Pods and think that it was probably one of the most important acquisitions that they’ve made. And that was also done for that amount of money, small enough that it didn’t have to be disclosed. So we’re talking about capital allocation and discipline. Looking at everything, they bought Anchor, all the big podcast stuff, including the investments and the Joe Rogan Experience and the exclusive content. It seems to be a real strong focus on payback and maximizing what they buy and not spending as much as maybe some of the bigger companies like Facebook, for example, in order to deliver something really important, as far as a strategic fit for the company’s next step up.

SCSleepwell Capital [00:32:50] Yeah, I’ve been pretty impressed with their capital allocation strategies and track record, the more I’ve been following the company. I think it’s very clear for them when it makes sense to buy something versus to build it. And a lot of it comes down to how time-sensitive it is to make a move on something. So could they have built Green Room on their own? I mean, yeah, probably they could have done that, maybe in six to 12 months, but instead, they decided to buy Locker Room and in less than three months, they have rebranded the entire product and relaunched it. So live audio had become viral in many ways at a very quick pace.

I mean, Clubhouse; everybody started hearing about Clubhouse in February. So it wasn’t really that long ago, and Spotify moved promptly in a matter of a month or two after everyone was talking about Clubhouse. So I think that was the right strategy. And as Jeremy said, we’ve seen various examples of that in different parts of the value chain, not only on the podcasting side and live audio, but also on the music side. And I think we’ll keep on seeing more and more of that.

Jeremy Deal [00:34:20] Yeah, and they’ve in the past, talked about free cash flow. They talked about the number of days of free cash flow used to pay for something. I think they realize too, it seems to be that they realize that they want to buy things that enhance the broader vision and enhance their bigger strategy. And so by default, that means they’re not necessarily buying an entrance into, they’re not using one company to completely enter something new but more buying companies that just enhance the existing value proposition of what they already have.

So it would have been a mistake, for example, to buy Clubhouse because they didn’t necessarily need to buy that user base, they just needed the basic technology of live streaming to plug into their existing user base, and their existing podcast ecosystem. So from that perspective, the technology itself was the driver more so than the brand because Locker Room was rebranded. Locker Room originally was Betty Labs and something. But it was rebranded to Green Room. So it was really the technology, which meant that they could pay a much lower price because it was much less developed as a business and more developed on the tech side.

And I think you see that with Pods, too. Which, again, I talked about it before, but I think we’ll look back at one of the most brilliant acquisitions that they’ve made. Pods had, it seemed like a very developed tech that was much further ahead of anyone else of the competition, and in the quest to kind of figure out how to monetize the spoken word and socialize the spoken word. But the tech was built up, but the business itself really wasn’t. So it was a perfect match.

And I would assume that the sellers because they’re staying on and they’re helping to be a part of a much bigger repositioning of Spotify and be a bigger part of that future that they’re there, they have an earn-out that allows them to feel like they’re made whole and not regret selling the company too early because of the importance of that tech and the distance that tech can go within Spotify versus a standalone business. It’s a different capital allocation strategy than buying massive companies for 10s of billions.

SCSleepwell Capital [00:36:58] Yeah, so it’s definitely been shifting to Spotify’s favor if we think five years ago versus today. And I think the trend still holds if we look out for the next five years. So back in 2016, the labels had a lot of or most of the power when it came to negotiating these very complex deals. The payouts were much higher, so Spotify’s gross margins were much lower than they are today. Before the IPO, I think it was in early 2018, they were able to negotiate higher payouts right before going public. The next step in sort of the evolution of this relationship, which as it stands today, I think it’s very symbiotic. So you know, they basically need each other and they’re not going to do anything to hurt each other. But that doesn’t mean that the negotiations are easy, though. They’re still very, very tough and complex. But I think what Spotify will be able to do over the next few years is to start bringing some of the label expenses over to their income statement, basically.

And we’ve already seen some of this with the two-sided marketplace strategy where the labels will be spending some marketing dollars on Spotify, basically, at very high gross margins. And we can see this develop in different ways and eventually even start monetizing some of the data that Spotify is providing the labels. So not necessarily directly changing the percentage of payouts that they’re giving out to these to these right holders, but find more creative ways that can sort of grow the pie for everyone and everyone’s gonna benefit from it. The other option that comes to mind there as well is price increases, where Spotify can find ways to get a better sort of payout structure for every incremental dollar that they’re able to increase prices on.

Jeremy Deal [00:39:32] I think there’s been this mindset in the market that it’s this tug of war and this fight over have a finite dollar amount, a very finite margin that they’re fighting over. And I don’t think that’s true. I think that what’s going to happen in five years is that Spotify’s margins will definitely go up and the relationship with the labels will absolutely favor Spotify more and more as time goes on. But the labels have their own really unique opportunities to grow. And they also have their own margin expansion opportunities as well. So I like to think of it as the industry is just so small.

The addressable market and the way we’ve thought about music in the past is really limited, the addressable market. And as we go forward, the addressable market will just expand. I think the opportunity in the addressable market is really the bigger story. And there’s room for everybody to make a lot more money. The way that labels conduct themselves and grow an emerging artist or even an established artist is changing really rapidly. And they’re depending more and more on digital marketplaces and digital tools. The kind of person that would have been successful at a record label or would have been hired at a record label 20 years ago is probably very different than the person that they would hire today.

The job to be done today, to use Daniel Ek’s terminology, on the record label is probably maximizing the brand value of an artist on different digital formats and engaging, finding new businesses and new ways to engage with the fan base. First of all, identifying the superfan base all over the world and then finding ways to engage with them beyond just selling them advertising or selling concert tickets. And the skill set required to do that is very different. And so there are a lot of changes happening that do favor the larger platforms or a digital mindset in general. But that doesn’t mean that the labels lose, and Spotify wins. I think they all kind of win. And to Sleepwell’s point, the balance of power, though, feels like it’s shifting much more to the benefit of the digital platform, which is where the new sources of revenue are going to come from, and where new business models are being built on top of the data that platforms like Spotify are able to generate.

Tilman Versch [00:42:20] Do you have any rough estimate about the TAM growth? What is the TAM now at a total addressable market?

Jeremy Deal [00:42:21] The TAM now? Recorded music is something like 31, 32 billion a year and there’s some debate on that number. From what I’ve read, a lot of times numbers are counted twice and there’s overlap, but the actual number is somewhere around 31 billion in recorded music, and podcast advertising revenue is less than a billion, which is kind of crazy to think about. So the old way of the music was brought, the traditional way that music was brought to consumers is completely changed. It was controlled by a handful of people and the opportunity just for a musician or for a creator, whether it’s a podcast host or an audiobook owner or even maybe a medium that we don’t necessarily have is mainstream today, to make money by maximizing the brand value of the artist is what is not in the addressable market today. So the addressable market today is essentially just streaming revenue and maybe on the other side concerts, and maybe a little bit of merchandise or something.

And that’s really when you think about what is the value of a superfan? I don’t know if you’ve ever really fallen in love with a band or had a song really move you and get you through hard times or have a memory or really important life moment anchored on a song or a group. You don’t have to go further than high school to see certain kids you know what music does with certain groups it determines the way you dress, the way you think, it’s friends who hang out with it. And as you get older it also has more value just beyond background music in a grocery store or something. So think about what does a country concert means for the two hours you’re at a country concert? It’s Americana. It’s tailgating. It’s barbecue. It’s all those things. What does a U2 concert feel like for those two hours? It’s the rush of the experience, but it’s also what does it stand for and what else could Bono and U2 sell to their superfans beyond just a concert every two or three years. And I think we’re just now starting to explore what that means whether it’s individual experiences with the band or just the feeling of what it means to be a part of that tribe; whatever that represents.

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You think about the advertisement that Bruce Springsteen did or the Superbowl for Jeep. And the Bruce Springsteen kind of person, the way he dresses, the car, the Jeep drives. It’s a lifestyle, it’s a way of thinking, the genre, it’s the topics that he sings about, for example. To think that the only value in Bruce Springsteen or Bruce Springsteen’s value is just limited to how many concerts he can sing, or the number of streams he can get on platforms is kind of ridiculous. It feels like we’re just scratching the surface of what’s possible between a creator and the superfan. So I don’t know, I don’t know what the answer is, but it’s definitely bigger than 31 billion.

Tilman Versch [00:46:00] It reminds me a bit of a scene I saw from the documentary about Rammstein and their global success. They went to Mexico for a concert, they were there for the first time and they then discovered outside of the concert there’s a whole ecosystem where they sell Rammstein products with many different things. You have bottle openers, keys, whatever, with the Rammstein logo, and they didn’t even know about it. So it transformed us into a digital world.

Jeremy Deal [00:46:28] Daniel Ek has talked about this before. Spotify is essentially morphing into just a toolset for a creator to identify a way that they want to make money. So some creators, maybe it’s, you know, give everything away for free and or just sell concert tickets. For other creators, it’s selling something really exclusive. So the first step is to identify your fan base, and that fan base is constantly evolving over time; it’s not a stagnant thing. It’s constantly in motion and moving and evolving and identifying who those people are and their tolerance for what they’re actually worth, to the artist and building that interaction and that feedback between the two. Whether it’s a podcast host, whether it’s unlocking data and information that’s discussed in a podcast to unlocking the brand value of a startup, you know, young rapper coming out of some ghetto in a poor country in Latin America, for example, and connecting with an audience maybe in Norway, I don’t know. So there’s just a lot to can that can be done.

I mean, it feels a lot like the early days of the internet. It’s one of the industries that has not really evolved financially, with the internet, kind of like what other industries have. So when you talk about the TAM, I just think it’s, unfortunately, something that you have to corral into thinking about maybe Spotify’s opportunity to sell premium subscriptions and advertising and podcasts and stuff like that. And that opportunity is probably 10s of billions more than it is today, a longer-term. But as far as the entire industry is concerned, I mean, just think about the value of putting more music, finding ways to put more music and on the internet alone and spoken word on the internet alone. It’s just got to be enormous.

And to take a stab at it, it would have been like taking a stab at what is streaming video worth. 20 years ago, or 15 years ago, people thought that Netflix didn’t have any value, would be forced to sell to a bigger competitor, or to a big movie studio because the consensus was that the video streaming addressable market was maybe 1 billion and fast forward today and we still don’t know what the addressable market is for video streaming. It’s just going to continue to grow and grow. But we know it’s definitely a lot bigger than 1 billion. So it’s an incredible runway to invest in.

SCSleepwell Capital [00:49:20] I think about it in different ways. And any way you look at it points to just how under-monetized the market is and how large the opportunity is. I think we can go anywhere from four maybe even five times as big as we are today in 10 years’ time. If you think about streaming penetration right now, you have around 440 million paying subscribers globally. There are roughly 4 billion smartphones, which is consistently growing at a rate of maybe six to 7%. So naturally, you get a tailwind from that as well. But just by getting higher penetration from streaming on a global basis, which I think is a natural thing to happen in the next couple of years, as we’ve proven how much of a superior value this product is for every consumer out there. And then, on the other hand, you have the monetization side, which can also improve. So when you combine those and put those two together, it’s not hard to see how this market can quadruple in the next 10 years.

Jeremy Deal [00:50:45] And to your point, Sleepwell, by our calculations, there’s something like 4.3 to 4.4 billion people between the ages of 15 and 64, that’s kind of a potential demographic to be a premium subscriber in the world, ex-China. So just exclude China because China has Tencent Music, and they have their own regulations and rules. And so just forgetting China, the rest of world ex-China is about, let’s call it a similar number to what you’re just talking with smartphones. So let’s call it maybe even 4.3, 4.2 billion, billion people, and a lot of markets may have 20% of that, but it’s still very, very underpenetrated. So globally, I think of 165 million paying premium subscribers, maybe they have, by our calculation, less than 4%, or they penetrate something like three and a half to 3.8% of the market. And including the freemium subscribers, you’re still at like eight point something, 8.5% of 15 to 64-year old’s, ex-China, which is pretty incredible.

And just looking at the US numbers. And again, it’s hard to think about Spotify is by far the market leader, and it’s still yet such a small company in terms of percentage of market share, compared to radio. But in places like Europe, where Spotify, Spotify is a Swedish company, and I’d say, Europe is probably more saturated or more evolved in terms of streaming than other places. But Spotify still only has a little over 20% penetration with users of 66 million premium subscribers, which is about the population of France. So no matter how you look at it, whether it’s Africa of a billion-plus people between 15 and 64, whether it’s the rest of Asia, whether it’s Latin America with 400 and something million people between the ages of 15 and 64. There’s just an enormous opportunity, whether it’s freemium, or premium. And we’re just scratching the surface.

Tilman Versch [00:53:15] In your eyes, what are the top five growth drivers for Spotify, like the five forces that can bring growth?

Jeremy Deal [00:53:22] Sleepwell and I had a great talk yesterday, and he had a really interesting way of framing the flywheel. So maybe that’s something to talk about.

SCSleepwell Capital [00:53:33] Yeah, I think it makes sense, especially given there has been a subtle shift in their management’s narrative and way of explaining the company where we’ve seen a more recent focus on the creator side. It used to be a lot more focused on the user experience but I think now there’s more of a balance between being able to help out creators and work towards their goal of eventually achieving; 1 million creators being able to live off of their craft, and at the same time serving a billion users.

SCSleepwell Capital [00:54:15] And I think these two sorts of supply and demand components really feed off each other a lot because if you give creators the best tools to monetize and connect with all their fans and offer them the best platform to exemplify and show off their work, it’s naturally going to bring a lot more users to the platform.

And at the same time, you get the classic flywheel effect that the more users you bring, the more likely creators are going to be attracted to your platform. So I think it makes a lot of sense for Spotify to pursue this strategy of attacking both sides of this supply and demand curve. And that’s going to be a very big driver of their growth going forward. So if we translate that to sort of more KPI metrics, obviously, we’re looking at both MAUs and premium subscribers, but then you also have to pay attention to what management is saying, in terms of how many creators they have in the platform. I think the most recent number we heard was somewhere in the 6 million figure if you count. This obviously includes artists and podcasters. We’ve heard management say they can probably double this number in the next couple of years and eventually reach a figure as high as 50 million creators, which I think is incredible.

So these two, I think are the most important metrics to keep a close eye on as we go forward and the strategy develops. The other one that comes to mind, for me, that’s super important is engagement. And there are different ways to think about this and sort of understanding how much of the listening share is coming from podcasts. And if that’s increasing overall music consumption, as well, and increasing the overall time spent on the platform, and also comparing how much time is being spent on Spotify versus the competition. So those are some of the big ones that I like to focus on.

Jeremy Deal [00:56:55] And I think just to chime in on that, the engagement is key. So the more time, whatever Spotify can do to increase the engagement is probably the most important investment they can make. So the engagement drives. The success of the model is that most people start they come in as a free user freemium, and then they convert to a premium over time. So the more somebody is engaged, the more subscribers engage with the service, the higher likelihood that they will convert to a premium subscriber. And so the business model is around increasing that engagement. So it’s not good enough, for example, to you know, I think, and Sleepwell tell me if I’m wrong on this, but I think that the average engagement is something like 25 or 30 hours a month, they’re probably a lot higher now.

SCSleepwell Capital [00:57:56] Last we heard, yes. But I think that might be higher now with podcasts. This figure was like for three years ago or something.

Jeremy Deal [00:58:05] Okay, so let’s say it’s, I don’t know, 30% higher than that. And so the more they can do to increase engagement, so let’s say, by focusing on the artist and building value for the artist, by default, it builds value for the subscriber and it encourages the subscriber to engage more which increases the chance that they’ll flip to the premium service which also over time increases the chance that they’ll pay more for that premium subscription. So if you think about Netflix, where there was a point in the past where the number, the selection wasn’t that great going back 10 years or eight years but today, the selection is so great and it’s become such an integral part of people’s video streaming life that the engagement is so high, it’s easier for Netflix to raise prices. And I think you’ll see that with Spotify, as the engagement increases because you have access to some events or more engagement with artists. Let’s say you get an invitation to do a behind-the-scenes or pre-album engagement with the artist before the concert.

Or you get Patrick O’Shaughnessy who says hey, my top fans get to ask one-on-one questions with the person I’m going to interview, right after the show. Things like that are gonna cause you to engage more and I think they’re just working on so many different ways of focusing on that engagement and increasing that engagement. One of the things they talk about is becoming the audio browser. And the audio browser, for example, in podcasts could be really valuable to be able to do more and more research and search things out through podcasts.

And so I can see a future where you just can’t live without, well you can, but a future where it becomes normal for most people to have a subscription to Spotify, a paid subscription to Spotify. Just like you think of Netflix today, it’s relatively normal for most people in the developed world at least, to have a subscription to Netflix. And they’re going about that by doing whatever they can to increase engagement and providing much more value than they’re asking you to pay.

Tilman Versch [01:00:32] Maybe let’s walk a bit through the puzzle pieces they are building to increase engagement. One big puzzle piece is the widening of the market with the offer of the service to emerging markets; they released at the last capital markets. How are they going about emerging markets, Spotify?

Jeremy Deal [01:00:52] They launched in 85 five markets this year, right?

SCSleepwell Capital [01:00:58] Yeah, I mean, first off, when it comes to these markets, versus launching in markets where they actually had a very big head start. Like Latin America is known to have been a massive success because they were pretty early on, on the process and the brand was already very well-known in the region. So they’re very much the undisputed leader in the entire region. And but these newer markets, most mostly were in, countries like in Southeast Asia, Africa, the Middle East, a handful of other countries in other regions but basically, most of them were centered in these regions. I think it’s not a surprise because we know, they’re going after basically the entire world, excluding China. And we know that the most recent quarter results weren’t as impressive as maybe some people would have expected them to be. But I think there are a couple of things to keep in mind when it comes to these newer, more sort of developing countries.

The first one is that a lot of them are very much dominated by piracy, right? So you’re working towards competing with completely free products, and sort of educating the consumers about this superior product that you can also have for free, and eventually, it would make sense to pay. Obviously, you have to offer it at a much lower price point compared to any other market that has higher incomes. And at the same time, in many of these markets, you’re competing with local players that they have been around for maybe three or five years, so those already had a head start. And the marketing spend in these in these launches is very important. And something that they actually cut down in the last couple of months because of COVID restrictions that came back in certain places.

So I think it’s very important to follow these newer markets and see what the traction is like. I think it will take time. I don’t expect them to get millions and millions of new MAUs and subscribers overnight. But it’s definitely the right strategy. And I also think they had to move fast because again, you already had some competition with a local presence. YouTube is another big player in many of these countries that have been around for a long time. So time was definitely of the essence and they had to move fast in that sense.

Jeremy Deal [01:04:02] And the monetization; I just keep coming back to something it’s just a really basic fact is that as of last quarter, the company was earning something like 50 cents, US cents per subscriber in gross profit. So the opportunity is there. That gross profit per total subscriber has continued to grow, it’s kegged in the mid-20s for the last five years but there will be a point where that grows. I think it has the potential to grow just exponentially. And a lot of it has to do with them figuring out how to most effectively open up these markets that they’re just now getting into.

So if you think about some of the less obvious opportunities, in developing countries, one of the markets they talked about was Tunisia that they opened in. What is the opportunity in Tunisia? Do you think that everybody is going to start paying $10, $15 a month for a subscription in Tunisia? Probably not. But if you think about the opportunity for the artist, for artists that didn’t have an opportunity before, they didn’t have an audience, before. There is a natural pull-through where a local artist now feels like they can be heard that they can upload their music through, like a digital label, like Believe, for example, and build a fanbase.

And that has two things. First of all, that that helps create engagement with the existing Spotify user base that might be interested in that music. And secondly, it drives new users in that country and for that type of that music as well. So if you discover a new musician, in Tunisia, for example, and that guy says, hey, or that girl says, hey, you know, I’m on Spotify. There’s a higher probability that that word will spread, and that the audience or the fans of that artist will at least have listened to the freemium model and Spotify to listen to that artist.

And as the tools get built out, which are really there to either compensate that artist in different ways, or book a concert or sell merchandise or support them in a certain way, as those tools become more and more prevalent, with the combination of I think, a maybe a blockchain solution, and payments that maybe we’ll talk about later through the DM Association; you start to open up away or different paths to monetize those markets in a way that I think the markets not necessarily thinking about. That will be a little bit different from just the obvious of expecting that everybody’s going to have a premium subscription.

Tilman Versch [01:07:04] Now it’s time for a break. As our episode on Spotify was really long, we decided to split it into two episodes. You will find more on Spotify in an upcoming podcast on this channel, so please subscribe. Thank you.

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Jeremy Deal

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JDP Capital Management

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Sleepwell Capital

Anonymous investor, known from Twitter

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