Spotify takes 12 months to break even after a free users becomes a paying subscriber

Spotify

Spotify CFO Barry McCarthy

• Spotify relies on its ad-supported free service to acquire paying users, but that customer acquisition strategy can be expensive, Spotify CFO Barry McCarthy told investors Thursday.
• It takes Spotify 12 months of a user subscribing to Spotify's premium service for the company to recuperate the cost of having them as a free user, on average.
• McCarthy, former CFO of Netflix, thinks Spotify will become profitable as it scales, and expects gross margins of 30% to 35% over the long-run.

Spotify loses money on every new user that takes advantage of its free service tier, but that shouldn't concern investors in the long-run, Spotify chief financial officer Barry McCarthy told investors on Thursday.

"The ad supported service is also a subsidy program that offsets the cost of new user acquisition," McCarthy told investors.

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The Spotify service comes in two tiers: First, a free version, supported by ads. And then, there's the $9.99 ad-free Spotify Premium service, where the company makes most of its subscription revenue.

But while the free tier eventually leads many customers into eventually becoming a Spotify Premium customer, it's still a costly investment: After a customer moves from the free tier to Spotify Premium, it takes 12 months on average for Spotify to recoup the costs of all the music they listened to without paying.

The company attributes those losses to the music licensing fees and royalties that it has to pay on every song that streams on its service. That's added up to $10 billion in music fees since Spotify debuted in 2008. In 2017, it meant that Spotify lost $1.5 billion on $5 billion in revenue.

Spotify sees its free service as a marketing and acquisition expense, McCarthy said, and believes that it will pay off financially for Spotify once the company has the scale necessary to grow its margins.

McCarthy, who served as CFO at Netflix from 1999 to 2010, said he saw how scale impacted the video streaming service's ability to make money. He expects Spotify to have a similar experience.

"Scale can be a great enabler," he said.

Long term, McCarthy said that Spotify is prioritizing that growth over profitability, but expects to have gross margins of 30 to 35%.

Here are two charts McCarthy shared with investors:

Spotify

Spotify