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Ferruccio BalestreriCTO and Co-Founder at June

11 May 23

Reverse engineering Spotify's SaaS metrics

In this article we'll be reverse engineering Spotify Premium's SaaS metrics. Estimating revenue growth numbers, churn, expansion and retention.

One of the main differences between how B2B SaaS businesses grow versus consumer businesses is through expansion versus new customer acquisition.

In order to have more solid proof of this we need to read through the lines of a B2C company’s financial reporting and derive the metrics that a B2B company like Slack would report on.

We'll focus on estimating the following numbers for Spotify's Premium business between 31 December 2021 and 31 December 2022:

  • Revenue
  • Net Dollar Retention
  • Expansion of revenue
  • Subscriber churn
  • Number of returning subscribers
  • Number of new acquired subscribers

Starting from public filings

If you want to know more about the financials of a public company - you want to look up their SEC filings.

The first step is usually to open Edgar and look up the public company you’re interested in.

In Spotify’s case the name of the entity is Spotify Technology S.A. (SPOT on NYSE).

In order to get an understanding of how a company is doing the most interesting documents for a US based entity are the quarterly (Form 10-Q) and annual (Form 10-K) reports.

Spotify in this case is a foreign private issuer so they release equivalent documents called Form 6-K quarterly and annually a Form 20-F.

A look into SPOT Form 6-K and 20-F

After scanning through the annual reports we can find some key numbers that will be useful for our calculations:

  • 180 million Premium Subscribers on December 31, 2021
  • 205 million Premium Subscribers on December 31, 2022 (14% growth)
  • Premium Subscribers ARPU (average revenue per user) was $4.40 on December 31, 2021
  • Premium Subscribers ARPU was $4.55 on December 31, 2022 (3% growth primarily driven by favorable movements in foreign exchange rates, increasing Premium ARPU by €0.21, offsets a decrease in Premium ARPU as a result of changes in product and market mix.)
  • Premium revenue was $8,460m in 2021
  • Premium revenue was $10,251m in 2022 (up 21%)

With these numbers and information at hand we can now estimate their expansion.

From the ARPU section we now know that the NDR (net dollar retention) is negative and the only reason why they're able to show higher ARPU numbers is exchange rates, not expansion of existing accounts. What's really happening is that Spotify is charging each customer less year over year.

The reason being that there is increased adoption of student and family plans, which have lower ARPU but help attract and retain subscribers. Even if these subscriptions have a lower ARPU, if their effect is lower churn, it can result in a higher LTV (Life-Time Value).

Estimating churn and new customers

Surprisingly I couldn't find any mention of the exact amount of churn in their recent reportings. I think without understanding how much churn there is it is really hard to understand the nature of Spotify's business.

I then dug a bit deeper into their past filings. In their quarterly filing in Q3 2020, they reported that their average monthly churn rate fell below 4% for the first time. I also found another article where the CFO of Spotify revealed at the end of 2021 the churn rate to be 3.9% on average for 2021. It's also reported to be between 1-2% in the most mature markets - like the US.

So calculating the annual churn rate is trivial:

Annualized Churn Rate = 1 - (1 - Monthly Churn Rate) ^ 12

Calculating the expression:

Annualized Churn Rate = 1 - (0.961) ^ 12
Annualized Churn Rate = 1 - 0.691
Annualized Churn Rate = 0.309

The annualised churn rate is approximately 30.9%. This means that, on an annual basis, about 30.9% of Spotify's subscribers are expected to cancel their subscriptions, based on the monthly churn rate provided.

But how does Spotify sustain their growth with such high churn number? I went back to their company filings and found a note in Q1 2020 that said "roughly 70% of churned users are back with Spotify within 45 days of leaving". This number includes subscribers coming back to either Premium plan or Free plan.

I then checked the ratio of Premium plan subscribers and total users. The rate is quite consistent over the last three years. In 2022 about 41% of total users subscribed to a Premium plan. In 2021 and 2020 the ratio was around 43%. So I'll use the average number 42% in my calculation.

Returning Premium Subscribers = Churn users * Return rate * Ratio of Premium subscription

I put in the numbers and I can calculate the returning subscribers for both 2022 and 2021.

  • In 2022, out of 205 million Premium Subscribers, 18.6 million churned users returned to a Premium plan
  • In 2021, out of 180 million Premium Subscribers, 16.4 million churned users returned to a Premium plan

Once I have the number of churned users and returning users, it's easy to calculate new acquired users by comparing the number with last year.

New Acquired Subscribers = Subscribers in Year N - Subscribers in Year (N-1) - Returning Subscribers + Churned Subscribers

We now have a clear understanding of Spotify's performance in terms of user acquisition, retention, and reactivation.

Connecting the dots

  • Spotify has a negative NDR and their ARPU is declining every year. They have little or no room for expansion.
  • It's actually a strategic choice for Spotify to sacrifice expansion in order to lower their churn rate. They encourage users to move to Premium products like Family plan and Duo plan, which are cheaper but have a higher Life-Time Value.
  • These efforts showed a decrease in churn (compared with three to four years ago), and an increasing retention rate.
  • On the other hand, to keep growing, Spotify must continue with their acquisition in new users. With more than 30% users slipping away every year, Spotify managed to have ~9% returning users. However, they need to acquire another 30% users to increase their revenue by 20% year over year.

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