Spotify is going through changes. Recently their CFO announced he would be leaving and an in-house candidate was chosen to succeed him. The Company is in a fierce fight with the likes of Amazon and Apple over music streaming. They are also looking at ways to maximize ad-revenue and further monetize the growth of podcasting. There is not a shortage of happenings at the Company.
Because of all the happenings at the Company and its business model, there is an opportunity for small business owners to grab a few takeaways from Spotify. I always think that it is fascinating to look at larger businesses and translate their strategies down to smaller companies. I am a believer that there are only so many business tactics and strategies out there. The biggest difference in them is just the scale in which they are applied.
This article will take a look at three of Spotify’s on-going strategies and break them down to the small business level.
Customer Acquisition Costs
At a very basic level, customer acquisition cost (CAC) is calculated by taking marketing expenses divided by the number of customers acquired over a period of time. If a business spent $100 in September to acquire 2 new customers, their cost to acquire a customer would be $50.
Spotify and similar business models have believed that in order to scale, they need to re-invest their earnings into acquiring new customers. Many observers will often remark about why a certain company is so highly valued when they haven’t turned a profit. It is often due to the business reinvesting all of their earnings (and sometimes more) into acquiring new customers (we’ll explain why this thinking can make sense later).
When calculating CAC for Spotify, the water is somewhat muddied because they have both a freemium platform and a subscription model. However, in 2018, its’ customer acquisition cost was basically $16.20.
Whether this is good or not, depends on several things such as what is the value of a customer and how much does it cost their competitors to acquire a customer. The answer to the first question can tell you if the company is profitable (or can be) and the latter tells you if their marketing is effective and efficient.
No matter the industry or the size, every business has a cost to acquire a customer. I’m sure you have heard the saying “it is 10 times more expensive to acquire a new customer then it is to retain a current one. This saying and philosophy are at least partly rooted in data provided by this calculation.
Lifetime Customer Value
Lifetime customer value (LTV) is a calculation telling a company how much revenue they can expect one customer to generate over the course of their relationship with the business. To calculate LTV, you need to calculate the average purchase value and then multiply it by the number of average purchases a customer makes over the life of their relationship. Yes, there is a math exercise, but let’s not get too much into that. The important thing is to understand what LTV represents.
Spotify in 2018 had a calculated LTV of $31.10. This means the average customer represents $31.10 of total value to Spotify.
Remember when we said above we would get back to if it made sense for a company to intentionally lose money to acquire customers. At a basic level, we are now ready to do that analysis. For Spotify, the LTV is $31.10 and the CAC is $16.20. Spotify makes roughly $14.90 per customer. That $14.90 is what makes up the rest of the Company’s expenses. The Company is betting that at some point, they can either decrease their customer acquisition costs or increase their LTV to create a more profitable company.
There are several ways to determine if this is a healthy business, but some would suggest that their ratio of LTV to CAC is somewhat low (a ratio fo 3 or higher is considered good).
A business (cough..cough…Uber) that does not have a high enough LTV to CAC will struggle to ever be profitable. This does not mean the business is doomed, rather it means that the business should consider changing its strategy to either increase their customer value or decrease the cost of acquisition.
At this point, you may be saying this all makes sense, but it doesn’t apply to my business. Yes, it does. Every business has costs to acquire new customers and has a customer lifetime value. The only difference is that you may not know yours, while Spotify’s can be readily computed based on their financial report filings. Yes, Spotify has systems in place to capture this information and your current business may not. That is where a discussion with an outsourced CFO can aid in determining the best path to start capturing this information.
Using Data to Create a Strategy
Soon after Spotify’s CFO left, they named Paul Vogel as their next Chief Financial Officer. In the Wall Street Journal, Mr. Vogel said he expected to stick to the Company’s previous goal of breaking even or producing a small profit while continuing to invest in growth. Translation…he will continue to reinvest profits heavily in acquiring new customers.
Mr. Vogel also had some interesting comments about how to decrease their expenses paid to artists. He said that they would look into a strategy of charging artists or labels for data and services. Part of how Spotify computes their LTV is to deduct fees paid to artists from their customer revenue. As a result, the more fees paid to artists, the less LTV for each customer.
The point of this is not to dig too much into either of these strategies. However, Mr. Vogel is clearly aware of the Company’s data and what is driving the business model. While he doesn’t necessarily use the terms LTV or CAC, the strategies he is committing too are clearly aimed at improving each metric.
A small business owner needs to do the same. In my experience, very few small business owners typically understand what drives value in their business. However, those that do are able to employ systems to collect the data they need and then drive strategy to maximize those key metrics.
Krieger Analytics works with businesses to help them with their profits and grow through accounting, finance, and bookkeeping. We are not the perfect match for all businesses so we have honest conversations upfront to see if we are a good match for you. Contact us now for a call to learn more about us and have a conversation about your business.