Spotify Technology S.A. (SPOT) Earnings Call Transcript & Summary

Okay. So if everyone can find their seats, we're going to go on to our next fireside chat. Good afternoon, everyone. It's my pleasure to welcome Gustav Söderström, Co-CEO of Spotify to our Communacopia and Technology Conference, his first investor conference in that role. For those of you who haven't met them before, Gustav is an engineer by training and a founder by instinct. He built Kenet Works, which was acquired by Yahoo! in 2006 and 13th Lab, an augmented reality start-up acquired by Oculus. He joined Spotify in 2009, spent the next 15 years as Chief Product and Technology Officer. In that time, he called the mobile shift early, better machine learning more than a decade ago and help transform a music app into a place for nearly 800 million people listen and watch podcasts and books as well. He became co-President in 2023 and stepped into the co-CEO role alongside Alex Norström this January. Gustav, welcome to the stage of Communacopia.

Thank you. Appreciate it.

I always love welcoming people to their first Communacopia Technology Conference. Thanks so much for taking the time to do it. I really appreciate it.

Thank you for having me. It's exciting.

Let's start with the future and the technology shifts that are underway. You've been a key architect of Spotify's evolution through a number of technology shifts. Drawing on that experience, how are you thinking about Spotify positioning itself for where the industry landscape is going over the medium to long term?

So the way I think about technology shifts often called macro waves, that's what we talk about internally is that in times of no change, market shares tend to stay stable, in times of changes where you have opportunity, the Spotify was borne out of one of these opportunities. It was the shift to low latency, high-bandwidth broadband business while Spotify could start in Sweden because Sweden, fortunately, for us happened to have that before everyone else. It was one of these technology shifts that enables Spotify. And then Spotify grew. We had our desktop and mobile proposition. And then the smartphone happens, and it was a big change. It was scary, but the outcome was that Spotify figured out how to reposition itself for this age. And once we did, we started growing very quickly. Then, the connected home happened. We figured out with connect, and we started riding that macro wave or surfing the wave driving the tailwind. So this is how I think about AI and where we are right now. The job for me and Alex, the other co-CEO, is to be able to understand technology deeply, try to understand what it means for Spotify, for the business model, reposition the company to turn it into a tailwind and then write it. So I always tell everyone, I've been at Spotify for almost 18 years now. And I haven't had this much fun since the smartphone because now everything is changing. So now there's opportunity to do something, to get bigger, to raise their ambition and to increase market share.

Let's build on that last answer because you guys as a team hosted an Investor Day just a couple of months ago in May. You laid out a lot of key strategic priorities that are anchoring the business going forward. How would you frame those key priorities and how you're thinking about the execution road map ahead for the companies when measured against those priorities?

So Alex and I, obviously, we've seen this AI wave coming, but everyone says it's coming. The interesting question is, what does it mean? And what we saw happening -- we saw a few things happening a few years ago, and we had a few answers to what it would mean. One thing that it would mean would be that for the first time in history, computers would start to speak English. So there was about 1 million people globally who could speak to computers, they were called developers on GitHub. It's been evident for some time that anyone will be able to instruct the computer. And today, you can do that. So we realized that all 8 billion of us are going to be able to talk to computers. So the question is, what does that mean for consumer services? So we started rebuilding Spotify to be the first truly intelligent media service. We could see consumers sitting there with ChatGPT over here, basically AGI. And then over here with the media service that at least a few years ago, was done with a [ rock ], that's not going to last. Of course, you're going to want to be able to talk to your media service, the way you could talk to ChatGPT. Previously, when a consumer heard a song on Spotify, if you go back a few years, they might say, this is a great song. Now I want to see the music video, I have to go to YouTube to do that. That's not great for us. Today, you have all the music videos on Spotify. But you may also say like who is this? What is this band? Who is it? When are they touring? All of those questions, well, we sent them away. So now we rebuild Spotify. So you ask all of those questions to Spotify, right there, and it tells you who the band is, who the drummer was, who produced this song, when they're touring, where they're touring. It has both all of our proprietary information that we've licensed or bought even who you sample this song from, but they also have access to all the world information of what the people are doing right now. So we create a new vision for the consumer product, and we think we're early with that. And we think right now, we're quite far ahead in the capabilities that Spotify has and what you can ask it to do. So that was one change. The other thing that happened was that -- because more and more features would start using AI and inference, the Internet would start going from what has for the longest time, been a fixed cost amortization business into a marginal cost business. What I mean with that is since before software, since Silicon, Silicon Valley has been about fixed cost upfront investment amortization and then after Silicon software had the same dynamics. This is now changing. Now you're starting to have marginal cost per user in terms of inference. Fortunately, so we looked at business that this could be a challenge and a headwind for a company like Spotify. Let's turn it into a tailwind. Fortunately, for Spotify, we're one of the few companies that always had marginal cost. We've always had per stream fees in the free tier. If we had grown too quickly through our journey, we could have gone bankrupt. So we were never -- we were never fortunate enough to just let growth run wild and then monetize later, we had to grow and monetize. So we developed a lot of discipline in this, in this genre over the years. So Alex and I looked at this and we said, how can we turn this into an opportunity. But Investor Day in May, we presented this power law. And it's been true forever that usage of services is not a linear curve. It's a parallel. We have a long tail of users. They use the service a little and you have people to use it more and more. But then you have a head who do not use it twice as much. They use it literally 10x as much. Now if you think about having marginal cost, in a fixed cost environment, those 10x users, they don't matter that much. It was just the upfront offer cost. We have marginal costs. Now these 10x users will cost you 10x each month. So you have to have a business model that supports this or you're just going to have to cut them off and shift them up to service. So we had started another business a few years ago called audiobooks, and audiobooks has that same dynamic. We have some amount of cost per listening hours. So what we did was, we put a large amount about 15 hours of audiobooks listening into premium, an amazing offer. The average audiobook is only 7 hours. So for most consumers, this is all they have they can listen to in a month. This was very well-received. The audiobooks business is growing like crazy right now. But you have these power users who did not want 50 hours. They wanted 100 hours. So we created add-ons for them where you can buy additional hours. We were very hopeful that this would work well, but it worked much better than we thought. This add-on is already on $100 million ARR after only about a year. So very encouraged by this. We said this is the model for inference-based products as well. We put a bunch of inference into the free tier. We put more inference into the paid tier, but we control how much. We control our margin. This is -- the margin is a managed outcome. And then if you want more Spotify instead of saying, no, go away, go somewhere else, go to a competitor. We say, sure, you can pay for more. You can pay for as much more as you want. So this is how we think about our business now. We have a free tier that maximizes the opportunity, right? I think all subscription businesses eventually are going to have the free tier. We were just early to that. If you want to maximize the opportunity. We think the TAM for music is literally 8 billion people. If you want to maximize that, you need a free tier. Then we have one of the world's largest subscription tiers, which lets us use bundled economics to enter new areas of audiobooks, et cetera. But what we didn't have until the spring was the ability to also monetize the rest of this power law, the head, which we now do with add-ons, with audiobooks, with inference add-ons and several other add-ons that are coming along the way. So we feel that this is the right business model for a modern company in the age of AI. You need to be -- you need to let users buy as much as they want of your service.

Okay. So against that, how do you -- probably a question, I get a fair bit from investors as well is how do you see your own competitive positioning in the audio landscape, and when you think about some of the growth opportunities you laid out at Investor Day, how do you think you could possibly change the positioning you have competitively and build even larger amounts of scale around the business, mostly tied to engagement is what I thought the messaging was coming out of Investor Day.

Yes. So there are a few different dimensions that we can compete on. As I said, the business model itself is one competitive advantage. The premium business model that we've now added add-ons, too. So we can both play with growth. We can play with price rates for the premium tier, but we can also play with finding niche audiences that have much higher ARPU, like audiobook listeners, heavy AI users, other things that are coming up. So this is one dimension. The other dimension that we've been playing with is to add more verticals. We went into podcast because we saw that there was a lot of engagement there but no one was really innovating on product. We went in there and we became market leaders. Then we saw audiobooks, which we also thought was a great fit for Spotify. And if you look at the Scandinavian countries, where I come from, audiobooks is not a niche feature, it's a mass feature, which is why we put it into premium. So we are going to go into more and more verticals. And one of the things that we think is unique about Spotify versus many other consumer apps is, the most consumer apps, you take a video app. That's a use case. It's a situation. Spotify is not a use case. Spotify is you're studying, you're running, you're dinner with friends, your car commute. We're everywhere. So we have so many use cases to go into. One that I'm very passionate about, for example, is fitness. Almost everyone uses Spotify when they're running and when they're in the gym. So we think we have the brand promise to go into many more areas than other brands. So many people look at Spotify and say like, okay, maybe they have 3 verticals, music, podcasts and audiobooks, but how many more can there be? We think there are many. We think our brand is strong enough and has enough elasticity for a lot of areas. And we think we're already in those use cases. The last thing I would say is, Alex and I, we look at others, we try to learn from the best, but you would like to have your own strategy, right? You would like to be differentiated. So one of the bets that we made that we talked a lot about at Investor Day was that, it's clear that short-form videos is eating enormous amounts of engagement. It's very effective. It monetizes, advertising extremely well. We have an ad break like every 30 seconds. It's also very addictive, and it's also true that most of the consumers regret most of the time they spend on these services. This is not something I made up. What we did was we asked someone to survey our user base, 50% our user base, 50% non-Spotify user base. They asked across all the big service, all of them, Spotify, Apple, YouTube, TikTok, all of them. Two questions. How much of the time you spend do you regret? And how much of the time you spend do you value? Which is the same question as two ways just to control for the answer. And what turned out in this survey, which we talked about was that Spotify was the lowest regret content on the Internet, at least in this group. So people regret less than 10% of the time they spend on Spotify. And conversely, they value more than 90%. This is not true for most of the other services, some of them people regret up to 70% of the time they spend. This was an insight for us. I previously thought that I have kids on my own. When they sit there and scroll and scroll and scroll, my view was that they're probably trapped and they love it. It turns out, now they're trapped and they know it and they don't like it. They hate it. So we decided to turn this into a strategy. Because we were the lowest regret, we said we are going to beat the lowest regret or the most valuable time spent on the Internet. Why is that a good strategy for Spotify? It is because Spotify still sort of 90% subscription revenue. If you -- if we were 90% advertising revenue, going after max engagement, would probably have been the best strategy, and it probably is for some of those companies. But if you're 90% subscription, you should maximize for subscription retention. So the question is, at the end of the month, when they used to decide if they want to pay again, when they vote with their wallet, what do they ask themselves, do they ask themselves like where was my max engagement? Where did I they scroll the longest? Now they don't. They ask themselves, do I regret the time I spend? Or do I feel good about it? So that's what we're trying to maximize. And I think that's differentiated those subjectively because I haven't seen anyone else say it, but also structurally because if most of your monetization is from ads is going to be very expensive to follow. Does that make sense?

It does indeed, yes. Really interesting. Okay. Let's come back to the Analyst Day for a second because you see in the Investor Day, you threw out some targets around where you want to go over the next couple of years after 2030. Thinking about mid-teens growth, gross margin ranges and 20% or better operating margin. When you guys think about all that you want to accomplish over the next 4, 5 years, how do you think about striking the right balance between investing in growth, making sure you capture the growth opportunity that sits in front of you, but also delivering on that margin trajectory.

Yes. So I think what is nice about Spotify. I'm sure you've heard a little Lindy effect. What has happened before is very likely to happen more. So Spotify has almost 20 years of the Lindy effect. And what I like about this is sometimes when I talk to investors, I say the following, actually, I'm sort of paraphrasing Alex Norström here. We have something like between 3% or 4% of the world's population, paying us every month today for subscription. If you look at a market like Sweden, 50% of the population are paying for Spotify, does a percentage of -- and that includes babies and the elderly. You could imagine that the conversion percentages is very high. And it doesn't stop, it just keeps going up. We have never seen it stop. Conversion has never stalled out in any market, right? So then you say to yourself, maybe Spotify won't convert 70%, 80%, 90% of the world to premium, but is it unreasonable that we would convert 15% of the world. Then you have a 5x story already. So then the question is, what do you have to believe in a 5x story? The truth is just more of the same. Because Spotify started in Sweden, we were still paid users. It's gone from 0% to very, very high percentages. But this is true for every market. Conversion is a function of time. The longer you stay in the market, the longer conversion goes up. So Spotify has something like 40-ish percent conversion on average. But that average doesn't exist. It's a blend of super high conversion, what we've been for a long time, lower conversion where we're nascent. And so for the longest time, people said, okay, I buy that Sweden converts well, but Swedish are different. And then he worked in Scandinavia and they said, well, I buy the Scandinavian and even are different, but it will never work in Europe. Many work in Europe, and people said, but never in the U.K., right? It's a different market. Guess what? It worked in the U.K. And then we came to America and people said, well, not America, surely, it's the world's biggest music market. Same story, and then they said, okay, but never ever in Latin America, right? Cannot be. Guess what? Exact same story. We're converting like crazy in Latin America. And now they're saying like, well, what about India? It can't be true, right? Of course, it's going to be true. And it's going to be true for Africa as well. So really, what you have to believe is just more of the same, which I think is a very good base. Now Alex and I are not content with saying like we're just going to do the same thing for another 20 years. But it is important to know that you don't have to believe more than just the same for a few more years for Spotify to get and the music industry to get many X bigger. Now on top of that, we are going to do a lot more. As I said, we're going into more and more verticals. We are trying to become something very different for consumers, a truly intelligent media service. We are going from what we said at Investor Day is we're going from passive single-player services to interact with multiplayer services. What do we mean with that? Well, multiplayer means we have a feature called Jam, there's over 50 million users, where you play music together, listen in the same room, but also remotely. This means that if you're in college, it matters which music service you have. You have to be on Spotify or you can't be at the party. So we think multiplayer network effects are very important, especially at our scale, but we also think interactivity is very important. So Spotify started as a pretty passive consumption service. The thing you did, though, was your curated playlist. That was very valuable for Spotify, users help tell us like these songs go well together into playlists, that was the basis for machine learning. What they're doing now since the year back since we added mixing is they're not saying just what tracks go together in a playlist. They're also saying how they transition well, exactly in which millisecond. So if you listen to our automatic mixes a year ago, they were okay but not great. If you listen to them now, they're really good. Why is that? It's because millions of people have told us exactly how these songs go together. So they're curing the catalog for us. Now why are they doing that? It's not because they're working for us. It's because they love to interact with the music. So this is why we're so confident about the thing I'm sure going to ask about remixes and covers using AI to be able to play much more with the music. To take your favorite song and transform it, not just beat stretches and do a nice DJ transition but actually change the whole song. Do a remix. So we're betting a lot on interactivity. These are some of the questions on how we are planning to grow. I think the baseline is incredibly strong, but the ambition is much higher than baseline.

Okay. That's super interesting. And I do want to come back and go a little bit deeper in some of those topics. But let's end this part of the conversation. You talked about the way the consumer thinks about your product. You talked about layering in more engagement, more utility, and obviously, the conversion theme that we talked a lot about at Investor Day, how do you think about the pricing dynamic around the product longer term? If you're delivering more utility to the consumer, how do you think about pricing elasticity?