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Does Spotify have the right business model?

Spotify has posted the group figures for 2010. According to Financial Times, October 10th, their business model could be questioned.

It's not good if total cost are higher than revenues. It's even worse when 'cost of sales' are higher than revenues. Something is fundamentally wrong if the 'cost of sales' increases proportionally more than revenues! The good news is that the latter does NOT seem to be the case with Spotify. Revenues increased 5.6x and 'cost of sale' increased 3.4x. Implying there will be a volume point where the 'cost of sale' will be less than revenues. The bad news is that in order to reach the volume increase this come with a heavy price for Spotify. 'Other cost', mostly marketing, administration and tech development, has increased 7.5x!

We estimate the volume point where revenues pass 'cost of sales' have been passed during 2011. If not urgent action probably will be needed.

There are two obvious easy fixes to Spotify's business model, increase the price/user and renegotiate the terms with the music industry. The first one are probably not viable due to the competitive landscape and the second one will be difficult. During 2011 Spotify obviously has tried to address this with new pricing plans and limitations to the 'free' plans. The result remains to be seen. Spotify's fix and tune of their business model will be a delicate affair and an interesting act to follow!

By the end of the day Spotify might still be a good investment for the current owners. Most probably provided a trade sale to the right buyer. A sure bet is that such a buyer have rights to most of the music in Spotify's usage portfolio. Perhaps this was what Spotify was geared up to from the beginning...

Update: Originally we posted this article 2011. However, we still think the findings are relevant. If anything these five years has proved that Spotify is very dependent of music rights holders and ultimately artists (like Prince) bargaining power. There is a growing concern about the revenue sharing model among artists as well as listeners. More competition from new entrants, like Apple, have not brightened the outlook for Spotify either. To date the growth has been fueled by 'private equity'. Should this air pump stop, e.g. due to Central Banks interest hikes, Spotify's business model will soon be tested. And probably their ability to rapid change and adaption. Still streaming is the way to go and will continue to grow as a distribution channel. Hopefully FY2015 will show positive cash flow from operations. However we are not convinced Spotify have found the 'secret sauce' yet. In the meantime we enjoy the (paid) listening.