Reference no: EM133982150

Assignment

Part I

(Based loosely on as 'Spotify Plays for Growth, Not Profit.' Appeared in the March 27, 2018, print edition of WSJ)

Spotify is rapidly gaining users and expanding into new markets, but it is uncertain when the company will become profitable. Spotify prioritizes growth over profit, and this strategy will make the business more valuable in the long run, according to the company. Despite reporting net losses every year since its inception in 2008, Spotify has been approaching profitability on an operating basis since 2016, as evidenced by its positive free cash flow. In 2020, Spotify generated $134.7 million in free cash flow. The company is set to make its debut on the New York Stock Exchange next Tuesday through an unusual direct listing, which is being closely watched by Wall Street.

"Becoming the world's largest music-streaming subscription service has been expensive," said finance chief Barry McCarthy during the company's first investor presentation earlier this month. "But the trend toward profitability is clearly apparent."

On Monday, Spotify announced its 2018 outlook, forecasting an increase in revenue by up to 30% and a boost in premium subscribers by up to 36% year-over-year. Although this represents substantial growth, it is a slower rate compared to previous years. Spotify is the global leader in a rapidly expanding market, with U.S. consumer spending on music streaming services projected to rise 29% to $6.6 billion in 2018, according to the Consumer Technology Association. Subscriptions, which generate more revenue through fewer users than ad-supported services, are the most closely watched metric in the music streaming industry. Spotify claims to have 157 million monthly active users in 61 countries, with 71 million of those in its premium paid subscription tier, which the company states is nearly double the scale of its closest competitor, Apple Music. However, it should be noted that the 71 million includes an undisclosed number of users who are still in a free trial period.

Apple Music doesn't report trial users in its subscription number, so the gap between the No. 1 and No. 2 services is narrower than it appears. Apple's services chief, Eddy Cue, earlier this month said that Apple Music has 38 million subscribers, plus another eight million users in free-trial mode. Spotify gives users the option of not paying for the service indefinitely, listening to ads in lieu of a monthly fee. Apple has no such permanent free option. Spotify also sees its premium subscriber growth slowing down slightly. The company said it expects to end 2018 with 92 million to 96 million premium subscribers, which would mark growth between 30% and 35%, below the 46% year-over-year growth it reported between 2016 and 2017.

Though 90% of Spotify's revenue comes from subscriptions, the company says the ad- supported offering acts as a funnel for paying subscribers. It says the more free users engage, the more likely they are to eventually subscribe. Spotify said as of December 2017, 50% of monthly active users became premium subscribers within 36 months. And the proportion of users paying for subscriptions has increased to 44% in 2017 from 31% in 2015.

Individually, those paying subscribers have been generating a shrinking amount of revenue-an average €5.24 a month ($6.29 a month) in the final quarter of 2017, down from €7.06 ($8.47) in 2015. That is because the company has introduced discounted plans for families and students, which it says help attract and retain subscribers. Such plans have helped Spotify hold on to more customers, with the share of subscribers who discontinue their subscription down to 5.1% in the last quarter of 2017, versus 6% a year earlier and 7.5% the year before.

Still, while getting bigger and gaining more leverage might seem better for Spotify, its costs do follow its growth closely; the service must pay record companies and music publishers every time a song is streamed. Those royalty payments make turning a profit a tough proposition. (This model differs from streaming giant Netflix Inc., which owns or pays for content once and then capitalizes the more it is streamed.)

Under its latest agreements with record companies, Spotify will see lower royalty rates as it attains a certain number of subscribers. Because neither the subscriber targets nor the royalty rates have been publicly disclosed, it is difficult to know exactly when the company may attain profitability.

During Spotify's investor presentation, Mr. McCarthy, who formerly held the same position at Netflix, indicated Spotify is betting on keeping its top-dog position, with the idea that the longer users remain subscribers, the more profitable they become.

On Monday, Spotify helped make its case by forecasting growing gross margins and climbing revenue. It sees margins ranging from 23% to 25%, up from 21% in 2017 and 14% in 2015.

Task

A. Based on the information provided about quarterly churn rates (see the highlighted text in yellow), determine the annual retention rates of customers ("r") for the years 2015, 2016 and 2017.

B. Based on the average monthly revenue per subscriber in 2015 and 2017, and the margin figures for the same years (see the highlighted text in turquoise blue), determine the yearly margin in $ per subscriber ("m").

C. Based on (A) and (B) what is the maximum acquisition cost per subscriber that Spotify can afford in (a) 2015, and (b) 2017 without making a loss on a per- customer basis?

D. Is family discounting a good idea for Spotify? Based on the figures provided in the case perform an analysis to support your answer.

E. One of the advertising channels Spotify used to acquire customers in 2017 was Facebook. The average acquisition cost per subscriber through FB was $80. Get the instant assignment help.

a. How much should the average monthly revenue per subscriber increase by to justify this acquisition cost (that is, the firm does not make a loss on the subscriber acquired through FB)? Assume the retention rate remains the same as what you determined in (A).

b. How much should the annual retention rate increase by to justify this acquisition cost assuming the average monthly revenue per subscriber remains the same?

F. Mid-way through 2017, Spotify found an extra $1million in marketing budget that it could allocate to acquire customers. The two options where it could invest this money were Twitter and Google Display Network (GDN). The average acquisition cost of subscribers from Twitter was $95 per subscriber with quarterly churn rate of 5 percent, while the acquisition cost per subscriber from GDN was $60 with quarterly churn rate of 11%. Which channel should Spotify choose to invest this extra money? Assume that there is no saturation effect in either channel.

Part II: Influencing Customers

In 2017, Spotify did some analysis on their customer base on social media and other channels and found that some of the customers were avid promoters of Spotify to their friends on these social media platforms. Using tools such as NodeXL, Spotify was able to identify these key opinion leaders (call them "influencers") and following their social network on these platforms, they were able to determine that on average, each such customer was able to influence 0.35 customers to join Spotify (that is, social contagion parameter is 0.35 - meaning 100 such influencers were able to persuade 35 new customers to join the platform). Assuming the same annual retention rates for 2017 for all customers, those who are current customers as well as those who join as new customers and a constant margin at 2017 figures, what is the maximum that you can pay to acquire such influencers without making a loss on them?