Podcasts Paying Off For Spotify

Spotify added more subscribers than expected in the third quarter, and management says its investments in podcasts is one of the big reasons why, reports USAToday.

"For music listeners who do engage in podcasts, we are seeing increased engagement and increased conversion from Ad-Supported to Premium. Some of the increases are extraordinary, almost too good to be true," management wrote in its letter to shareholders.

And engagement is growing. Spotify says podcast hours increased 39% quarter over quarter, and 14% of all monthly active users listen to podcasts on the streaming service.

Podcasts are essential to Spotify's future growth and profitability. Outgoing CFO (and former Netflix Barry McCarthy even went so far as to say, "Streaming was to Netflix as podcasting is to Spotify," during the company's third-quarter earnings call.

So far, Spotify can't quite prove podcasts are driving increased engagement and conversion to paid subscribers. "We're working to clean up the data to prove causality, not just correlation," management wrote. "Still, our intuition is the data is more right than wrong, and that we're onto something special."

Management's cautious optimism should be welcomed by investors. It's already pouring between $400 million and $500 million into podcasting this year, which represents over 5% of its full-year 2019 revenue outlook and creates a considerable drag on its gross margin. Ensuring the strategy is actually working as expected – or even better than expected – is critical.

While podcasts seem to be having a very positive impact on Spotify's top line and user metrics, the investments in technology and content are a near-term drag on its cost of revenue. Indeed, the company's gross margin has remained stable this year despite a mix shift in listeners to higher-margin paid subscribers.

If Spotify's podcast investments can produce stronger subscriber growth today, the company will see improved profit margins long-term as more of its streaming hours move from licensed content to fixed-cost podcasts. Management expects its long-term gross margin opportunity is about 35%. That's 10 percentage points above the company's full-year 2019 forecast. So it's likely going to be a long time before management is ready to ease off the gas with podcasts.