Spotify

Spotify releases multiple software products each year, from website updates to database improvements to streaming software. The goal is to increase subscriber volume, accounting for 90% of revenue, and advertising, which accounts for 10%.

Spotify’s R&D spending was about $500 million in 2017, just under 10% of its revenue. But as a software company, its product development cycle time is much shorter than Apple’s. I’m going to assume that a typical cycle for Spotify is 6 months. That means we’re looking at an investment of $250 million.

How long does it take Spotify to make that investment back? Spotify’s average revenue from a subscriber is $6.50/month, or $78/year. It makes a gross margin of 21% (the reason it’s so low as a software company is because of the royalties it pays), so every new subscriber brings in $16/year. 

Spotify added 26 million new subscribers in 2017, a nearly 50% increase, generating additional profit of $416 million (21% margin x $78). Its base of free users is larger than its base of paid subscribers. Those users see ads that generate about $500 million in annual revenue. I’ll conservatively assume that ad revenue increased 20% in 2017, adding another $100 million (pretty much all profit).

Was all that new business generated by Spotify’s software updates in 2017? Again, it’s impossible to say. But given the fast-paced nature of that industry, and the abundance of competitors, one could argue that Spotify would start to lose, not gain, subscribers pretty quickly if it didn’t keep innovating. 

We also need to take into account lost sales avoided, in other words, the subscribers who would have left Spotify if it were not refreshing its software. Hard to know, but I’ll assume that perhaps 10% of their prior base of 55 million subscribers would have left. At 21% margin, that’s an additional $88 million. 

So Spotify’s $250 million investment pays back just over $600 million in one year, making its time to breakeven just slightly under 6 months. Again, not a bad return on investment.

Next up: Boeing.