Why Losing Free Customers is a Good Thing for Spotify’s Business Model

In my Future Music Forum keynote last week I discussed some Spotify metrics which were picked up by Paid Content and have stirred up a bit of a debate.  Here is a little more context to those numbers.

The headline statistic is that in 2011 Spotify had to acquire approximately 1.8 million users per month to retain just 400,000 a month (i.e. ‘losing’ 1.4 million a month), resulting in a total monthly churn rate of approximately 20%.  These estimates are based upon the following reported numbers:

• Spotify’s end of year accounts for 2011 reported a total of 32.8 million registered users.
• In December 2011 Spotify reported 10 million active users on its developer blog.
• In March 2011 Spotify reported 1 million paying subscribers, representing 15% of active users, which put the active user count at 6.7 million.
• In September 2010 Spotify held a press event to announce 10 million registered users.

The headline numbers give a ‘gap’ of 22.8 million between registered users and active users at the end of 2011.  Using all of the reported numbers and applying flat rate growth assumptions for intervening months we can calculate the total number of active and registered user gains throughout calendar year 2011 (see figure 1).  All of which gives approximately 1.8 million new registered users per month but only 400,000 active users per month.

Figure 1

Now of course there will be monthly and seasonal variations in those numbers so the exact count will be different for each calendar month.  Also many of those 1.4 million new monthly inactive users (i.e. the gap between new registered and new active) may well become active later in the year.  But the headline trend remains that Spotify has to gain a lot more users than it holds onto (or at least did in 2011 – though I would expect similar metrics to apply in 2012).

Losing Low-Value Free Users Actually Helps Spotify’s Business Model

None of this is necessarily a reflection of a flawed business model for Spotify.  In fact, in my view, it reflects positively.  Let me explain.  Spotify’s business is all about selling premium subscriptions.  That’s where the money is for Spotify, labels, publishers and artists alike. The free tier of its business is simply a marketing funnel.  Ultimately it doesn’t actually matter that much how many of those free users stay on board as free users, what matters is how many convert to paid.  In fact, it benefits Spotify if those users who have no intention of paying churn out early on from the free service as it means less cost to Spotify’s bottom line.  As challenging a path towards profitability as Spotify may find itself on, it would be a dramatically more difficult road if all of those 32.8 million users were active.  So Spotify’s business model and margins actually benefit from the majority of those new free users churning out of the service early, allowing Spotify to focus on migrating the remaining engaged free users to paid.

Figure 2

Free Churn Does However Raise Questions About the Wider Streaming Market

All in all Spotify has brought a huge amount of value to the digital music market and has achieved many credit-worthy milestones (see figure 2).  But as much sense as the free-user-leakage makes sense to Spotify’s business model, it does raise challenging questions about the streaming model more broadly.

For so many users (two thirds of Spotify’s 2011 total) to effectively say “no to free” indicates that streaming audio, even when free, does not resonate strongly enough with mass market music fans.  There are multiple potential reasons that Spotify free users churn out, such as: usage caps, advertising, being PC only, not being able to burn to CD, even just being a stream rather than a download.  Many of those can be fixed with a 9.99 subscription, but the simple fact is that most consumers do not spend that kind of money on music.  9.99 is actually the average monthly spend of the top 20% of music buyers. So it is a price point for the aficionados not the mainstream, which means that most consumers will never get a proper taste of the ‘complete’ streaming audio experience.  Which is why I continue to argue strongly that subsidized subscriptions and cheaper price points are the crucial routes to the mainstream music fan that need pursuing with haste.

Spotify, Rhapsody, Deezer, rDio etc are all doing a great job of trying to take premium subscriptions to the masses, but until they can work out a way to get cost-to-consumer price points down, the addressable audience remains a subset of that top 20% of music buyers.

The Elephant in the Room

And all of their cases are challenged further by an uneven playing field.  While all those music services have to charge for mobile access and have some gaps in their catalogues, YouTube provides unlimited access, on all mobile devices, with the world’s largest music catalogue, with video, for absolutely no cost at all to the consumer.  As far as streaming goes, there is one rule for YouTube, and another for the rest.  Until that anomaly is fixed, the rest will be swimming against the tide.