The digital music business is famous for incinerating money. But Spotify has always insisted that it was going to be different: Trust us, the company told investors — once we get big enough, things will change.
Spotify is still burning an enormous amount of cash, but the bigger it gets, the better it looks
Spotify generates billions in revenue and gives most of that money to the music labels. But it is gaining leverage and getting better margins.
Now Spotify is big and it’s going public — and it’s still burning an enormous amount cash. The company posted an operating loss of $461 million on revenue of nearly $5 billion last year, according to filings posted today with the SEC.
But Spotify has also made some progress toward fulfilling its promise. As its business has gotten bigger, it has been able to gain leverage with the big music labels, and that has allowed it to start reducing the royalties it pays the labels.
You can see how that plays out when you look at Spotify’s gross margins over the years. At the end of 2014, Spotify was generating a gross margin of 16 percent. Last year, that number had crept up to 21 percent.
Those numbers should keep getting better. Last year, in preparation for its public offering, Spotify negotiated new licenses with the big music labels that make up 85 percent of the company’s streams.
Those deals gave Spotify better rates in exchange for making some new music harder to get without a paid subscription. (They also required Spotify to cut big checks to the labels in advance.)
One other positive note that Spotify wants you to focus on: The company’s so-called free cash flow has improved to about $133 million for last year. To be clear, cash flow is traditionally a measure of how much cash a company has to play with after costs like capital expenditures.
But Spotify is still going to generate lots of skepticism about its model until it can convince investors that it has truly solved the problem with digital music companies: Unlike Netflix, which pays once for a piece of content then can stream it as many times as it wants, music services have to pay music labels and other music owners each time a song gets played.
That is: The more users and the more usage Spotify has, the more content costs it has. Spotify can keep growing, but eventually it has to figure out how turn that growth into profit.
This article originally appeared on Recode.net.
