Spotify is a music streaming platform that gives users access to a large catalog of music. It uses a freemium revenue model that offers a basic, limited, ad-supported service for free and an unlimited premium service for a subscription fee.
Spotify relies heavily on its music algorithms and its community of users and artists to keep its premium experience delightful. Its premium subscriber base has grown from 10% of total users in 2011 to 46% in 2018.
From the start Spotify saw itself as a legal alternative to pirated music and paid song purchases on iTunes. Spotify pays a significant portion of its revenue in the form of royalties to music labels. It has paid close to $10 billion in royalties since its launch in 2006.
The company accelerated the shift from music downloads to streaming and disrupted Apple iTunes in the process.
For the first time in company history, Spotify made a profit in 2019.
1. Attract a large base of users with a free service
Spotify’s free music stream- ing service gives users access to a catalog of millions of songs. The free service has basic functionality and users have to listen to messages from advertisers that partially subsidize the free service.
2. Convert free users to a premium value proposition
Spotify has been extremely successful at converting free users to paid users. Its premium service has additional features and it removes advertising. In 2018, 46% of Spotify’s users are premium users, who generate 90% of its total revenues.
3. Manage retention and churn
Like in any subscription model a user’s lifetime value (LTV)—how much Spotify can earn from a user over time— increases the longer the company can retain users. This is called managing customer churn. In the first half year of 2019, Spotify’s premium subscriber churn rate fell to a record low of 4.6%.
4. Balance cost of free and premium
Spotify pays record labels close to 52% of the revenue generated by each stream. Over 85% of music streamed from Spotify belongs to
four record labels: Sony, Universal, Warner, and Merlin. In 2018, Spotify pays €3.5 billion in royalties for premium users and €0.5 billion for free users, which equates to 74% of overall costs.
5. Finance it all with your revenue stream from premium
The particularity of the freemium model is that you need to be able to cover the costs of free and paying users. Spotify’s user base grows to over 248 million users in 2019 for which it needs to pay royalties. Of those users, 54% consume (limited) music for free.