Listener Question: What's Spotify's Game Plan?

As it stands today, Spotify doesn't have the most sustainable business model in the world. Maybe it even has one of the much-less-sustainable-than-normal ones. But that doesn't mean the company is doomed to follow the path of slim margins and hyper-intense competition to a grim, broke conclusion.

In this segment of the Industry Focus: Tech podcast, host Dylan Lewis and Motley Fool contributor Evan Niu take a dive into some of the most interesting and unique paths that Spotify could take to differentiate itself, from becoming the YouTube of music to making the most of podcasts and more.

A full transcript follows the video.

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This video was recorded on March 9, 2017.

Dylan Lewis: Austin asks -- and this is listener Austin, not our producer Austin -- he wrote in and said, "What's the long game for Spotify? It can't be their current model." Austin goes on to throw out a couple ideas. "It could be leveraging data and machine learning, expanding on their personalized playlists, maybe even hyper-focused ads, possibly some sort of packaging with podcasts as an option." Evan, I know you have some thoughts on what this business could morph into and the optionality they have there.

Evan Niu: Right. I'm not a huge fan of the cost structure as it is because those royalty costs are so astronomically high. Eighty percent of revenue, how do you pay for things? It's really hard to envision them being a profitable company. But, an early Spotify investor had mentioned in a recent interview that there's this idea that Spotify can basically create this marketplace that connects artists directly with listeners, which has this potential to cut out the record labels all together, because the record labels are basically just middlemen. Not to say that record labels are going to die or anything like that, because they certainly have their place in this industry, particularly at the high end of the value chain with prominent artists. But, if you think about little guys, little up and coming artists, if you can remove the middleman and just appeal directly to your users, you have a pretty good opportunity there. A, Spotify can cut out this huge cost. B, directly connecting artists and users has a lot of potential.

And, they are actually very specifically looking at some things that Austin just mentioned, because they are using machine learning, because all of their curation algorithms that are meant for content discovery are all built on AI and machine learning. At the same time, they're helping artists be able to target other users not with ads, but trying to find users that might like their music. And they also deliver analytics to artists. They've even started to provide creative tools. They just started this new lab last year to create a bunch of tools artists can use to make their music.

If you look at this from that perspective, I'm seeing Spotify in the future as having this potential of being a new, modern, digital distribution platform of streaming. Think like YouTube, but just for music. YouTube is another platform that got big by connecting people directly and providing all these different types of tools to help content creators build their business. You get analytics, you get all sorts of stuff.

So, I think that's really exciting. And they make some references to this in their filling, but nothing really concrete yet. Certainly nothing that's financially meaningful quite yet. But, if we take a step back and zoom out five or 10 years in the future, that would have me excited.

Lewis: Yeah. And actually, I think Austin makes a very interesting point with the podcasts, with the last bullet there. You think about ad fulfillment for podcasts. A lot of organizations use some third party to handle that, or they have an internal sales staff that handles all that. I would think that Spotify would have pretty robust user data that would allow for hyper-targeted ads on podcasts on the platform. The difficulty there is, they are not the sole distributor of podcasts, in that a lot of people get them through some third-party app or through the Apple Podcast app or something like that. But I think there might be something there, too, where they work on the ad side within audio advertising.

Niu: Yeah. So, even though I'm not super thrilled about the financials right now, I do see a lot of potential for Spotify in the future as a really vibrant distribution platform for artists. It's the biggest one in the world. If you're an artist and you want to reach the biggest audience, that's where you go.

Dylan Lewis owns shares of Apple. Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.