Spotify’s Churn Rate and Inactive Subscribers: Should the Music Industry Be Concerned?

For recorded music companies that historically relied on one-off sales from one release to the next, rather than on sustained, month-over-month customer loyalty, the concept of “user churn” might seem foreign and irrelevant. But as major streaming platforms like Spotify wield ever stronger influence over the music industry’s growth, churn and other metrics typically reserved for software-as-a-service (SaaS) companies will inevitably come to the forefront for artists and labels alike.

Churn is a vital metric for measuring a SaaS company’s health, in part because it is much more expensive to acquire new customers than to keep existing ones. Every subscription business suffers from churn, especially on mobile: a 2015 study found that the average Google Play mobile app lost 77 percent of its daily active users within just three days of installation, and a whopping 95 percent of daily active users within 90 days.

How much churn is too much? According to David Pakman — former CEO of eMusic and co-founder of Apple’s Music Group, now a partner at VC firm Venrock — the acceptable threshold for average net monthly churn rate is 5 percent or lower. Anything above 5 percent should pose a red flag, argues Pakman, because the larger a business grows, the more and more marketing dollars it needs to devote to replacing churned customers, which can frustrate shareholders seeking better returns. Netflix is a prime example of a subscription company whose success is directly related to low churn, at only around 1 percent per month; in contrast, Blue Apron and several other food delivery services have churn rates of as high as 12 percent per month.

How is Spotify performing against this benchmark? The good news is that its churn rate is steadily decreasing, even as its user growth continues to outpace those of Apple Music and other rivals. According to its SEC filing, Spotify’s churn rate among Premium subscribers was 5.1 percent in Q4 2017, a decrease from 6.0 percent in Q4 2016 and 7.5 percent in Q4 2015.

Media-tech analysis firm MIDiA Research recently arrived at similar conclusions, finding that churn across both Premium and ad-supported tiers on Spotify fell from 6.9 percent in Q1 2016 to 5.7 percent in Q4 2017. On an annual basis, churn fell from 20 percent in 2016 (i.e. a loss of 9.4 million subscribers) to 19 percent in 2017 (13.4 million subscribers).

Yet, those 13.4 million churned users still account for 37 percent of all subscribers Spotify gained in 2017. What’s more, the service’s inactive subscriber base — calculated by subtracting the reported figure for monthly active users from the sum of paid and ad-supported users — has grown from one million in Q1 2016 to four million in Q4 2017.

While this is a much smaller proportion of inactive users than what Spotify saw at the end of 2011 — when 70 percent of total registered accounts were reportedly inactive — the stat is still worth scrutinizing for anyone serious about the streaming-driven future of the music industry, especially considering that churn might increase slightly as Spotify expands further into emerging music markets.

“At this phase, Spotify is prioritizing growth and market share over margin, so it is spreading its acquisition net wide,” Mark Mulligan, managing director of MIDiA Research, tells Billboard. “This means it will end up with a significant quantity of lower-value subscribers that will be more likely to churn.”

The potential relationship between Spotify’s acquisition strategy and its churn rate lies in what the company’s SEC filing calls the “rest of the world” (RoW) — i.e. any markets not in Europe, North America or Latin America. The RoW is accounting for a steadily growing percentage of Spotify’s net global subscriber additions over time, clocking in at 10 percent of net new subs in 2017 versus 7 percent in 2016.

Without a wholly owned physical distribution channel to compete with Apple, Google and other big-tech conglomerates, pure-play streaming services tend to lean on pre-paid and/or discounted telco bundles for their expansion strategy, especially in RoW markets. For instance, Deezer announced a partnership with Indonesian telco Hutchinson 3 in Feb. 2018. This past Friday (Mar. 23), Indian pure-play streaming service Saavn announced a landmark merger with mobile network operator Reliance Jio’s own music service JioMusic, in a deal valued at over $1 billion. Spotify itself has a handful of telco partnerships under its belt, including with Vodafone in the U.K., Singtel in Singapore and Indosat Ooredoo in Indonesia.

One can draw a direct link between the rise of telco bundles and what Mulligan calls “super trials,” or heavily discounted trials offering three-month subscriptions for $1 or less, which lead to significant spikes in user growth. Between Q4 2015 and Q4 2017, quarters with active “super trials” gave Spotify an average of 7.5 million net new paid subscribers — nearly three times the 2.8 million subs added during the quarters without active super trials. The impact was more pronounced in RoW markets: quarters without super trials saw no net subscriber growth at all, but those quarters with active super trials saw an increase of one million net new subs.

But as Deezer has encountered over the years, the danger of relying too heavily on telcos for user acquisition is ending up with too many “zombie users” — registered accounts that are never logged into by their owners — once those bundles go inactive in the long term. Universal Music Group’s senior VP of digital strategy and business development Jonathan Dworkin recently warned that countries with low credit card penetration face as high as 60 to 70 percent payment failures on pre-paid telco plans at large.

Will this high churn be a thorn in Spotify’s growth narrative? Mulligan says not to worry for now: “Telcos are a much smaller part of Spotify’s business than Deezer, so they are less exposed,” he tells Billboard. As for concerns around whether super trials will increase Spotify’s global inactive user base — as super-trial users realize they need to pay higher fees to stay on board, and cancel their billing details as a result — Mulligan also “suspect[s] the impact is small, as the overall trend is long and linear rather than shaped by trial cycles.”

Nonetheless, in its SEC filing, Spotify does warn investors that monetizing RoW markets efficiently will be challenging, and that investments and costs for international marketing and field sales teams will continue to rise as a result. To ensure that its overall churn rate continues to trend downward, Spotify may have to strategize more deliberately with both telcos and music companies and rights holders when it comes to sustaining new user engagement from month to month — and convincing them that music is indeed worth paying for in the long term.

This story first appeared on Billboard.com.