by Tiffani Bova
Sweden-based start-up Spotify launched for public access in October 2008 and had momentum like no other digital music service to date. As of January 2018, the music, podcast, and video streaming service had more than 140 million active monthly users and 70 million subscribers (up 20 million from the year before), triple that of Apple’s music service.
You never get a second chance to make a good first impression.
—WILL ROGERS, actor
In its most recently published financials, the company enjoyed more than $3 billion in revenue. Not bad for a company with a business model few people thought would work, after the challenges Napster faced when it hit the scene in the early 2000s. The key? Spotify figured out not only how to grow its paying customer base but how to control its churn at the same time. According to its SEC filing, Spotify’s churn rate among premium subscribers was 5.1 percent in Q4 2017, a decrease from 6 percent in Q4 2016, and 7.5 percent in Q4 2015. The good news is that its churn rate is steadily decreasing, even as its user base continues to grow. Spotify is in one of the most competitive (consumer subscription) markets right now, going up against two of the largest brands in the world—Apple Music and Amazon. There was even a third competitor, Microsoft, with its Groove service. However, at the end of 2017, Microsoft closed its music store and streaming service and moved customers over to Spotify.
So, what has made Spotify so successful? It’s business concept was simple. The idea was that once you drove users onto the platform via a “freemium model”—like what Salesforce did in its early years—paid for by advertising revenue, and they saw the value of the service firsthand, they would be more willing to upgrade to a subscription-based, advertising-free service. Users would be able to search a seemingly endless supply of songs by artist, genre, album, even label, as well as share playlists on social media. And they could listen to the music for free in exchange for also listening to occasional advertisements, which today accounts for the quantity of content—Spotify offers access to more than thirty million songs.
This freemium model was nothing new to the music industry. After all, for nearly a century radio stations had employed this strategy of offering listeners free music that was subsidized by advertisements. Thus, for most users, using Spotify was anything but a radically new experience—it was comfortably like the radio experience they all knew . . . with the added appeal of letting them choose the music they wanted to hear.
“Freemium,” a portmanteau of “free” and “premium,” refers to products or services that a company gives away free of charge, then charges customers for additional features or continued use.
In other words, by being ubiquitous, free, and familiar, Spotify made adoption almost barrier-free. Millions of customers responded. That was just the bait to hook potential customers to the service. Spotify cultivated loyalty by delivering a highly differentiated Customer Experience, through its curated playlists and personalized music recommendations. This encouraged users to spend more time on the service and eventually switch from the freemium offering to paying $9.99 a month to listen to music advertisement-free. Its ability to use Customer Base Penetration to convert free users into paid customers has been impressive—which is why Spotify’s revenues jumped 80 percent between 2014 and 2015.
PLUG THE LEAKY BUCKET
Getting customers to pay is one thing. Keeping them paying is another. Spotify applied another industry’s (cellular carriers) standard practice by using term contracts to “lock in” customers. That strategy not only helps stabilize revenue, but Spotify used it as another value-based addition to its service, a lateral Product Expansion, if you will. If you committed to a two-year contract, for example, you were protected from any price increases. Good for Spotify. Good for its customers.
Additionally, part of the attraction of Spotify’s pricing model is that it has offered a range of price points for differentiated products, allowing its customers to decide what is best for them and their budget. That Product Expansion effort has resulted in reaching a wider range of customers, extracting value from those most willing to pay for a “premium” service, and even giving its customers an option to “downgrade” to a less expensive service. While this may sound like Spotify was doing the unthinkable—cannibalizing its own customer base—it was a great way to avoid customer churn altogether. A lower rate is better than having them go back to the free service.
Here is an example of using the Churn path not as a “defensive” strategy but as an offensive strategy. The alternative to this approach would have been to design a marketing “win-back” campaign, then wait until a customer leaves (churns), have customer service call or e-mail the customer—and then offer a discounted monthly subscription. The message that approach sends is: you can get a better rate, but only if you try to leave—which doesn’t present a great customer experience. Instead, Spotify was proactively, preemptively getting ahead of the effect of customers wanting to pay less—and leaving.
Spotify has also invested heavily in customer service to ensure, if customers have issues, that they are resolved quickly, especially if they are shared on social media. Scaling this kind of model can be difficult, but Spotify has cut no corners in this area.
“Scaling Spotify’s support function to match the customer base has been one of the biggest challenges of the last four and a half years of my life! When I started at Spotify [years] ago we had around eighty advisors, and the social team in its initial formation was like ten. Today the total number of advisors is well over one thousand and the social team is over two hundred,” says Chug Abramowitz, vice president of customer support and social media and marketing at Spotify.
Like both PayPal and LEGO, if you want to pursue a particular growth path, you must ensure that you have the right organizational structure in place to support the effort; otherwise you might have the right strategy but it fails under the weight of internal dysfunction. This example wasn’t about the products Spotify was developing, it wasn’t about its customer service, it wasn’t about its customer segment—it was about its organizational structure and the metrics used to manage each team. If functions are managed by different leaders, and metrics pull each group in a different direction, the result is a less-than-memorable experience for customers.
OFFER VALUE TO GET VALUE
Price is what you pay, value is what you get.
—BENJAMIN GRAHAM, author of The Intelligent Investor
Spotify has not only done a brilliant job of attracting new freemium and paid customers, but it has also reduced the churn of its entry-level customers by offering a free product so appealing that those customers stick around almost indefinitely . . . until they become so acculturated to the service that they are more willing to pay the fee to take the experience to the next level. Why? Because its conversion rate is about 27 percent from free to paying customers. So the more new customers it gets, the more paying customers it will enjoy. In other words, Spotify not only has figured out how to cast a very wide net to pull in prospective customers, but then also has a long test period to prequalify its most loyal users to determine how best to monetize the relationship over time.
One of the biggest challenges the company faces with these first-stage customers is to offer sufficient added value (such as exclusive artist content) to the subscription service to make the jump to subscription seem worth the price.
So far, Spotify has accomplished that by taking advantage of both technology (it offers a higher bit density, and thus higher-quality sound for subscribers) and content (removal of advertising) offering product and up-selling its massive customer base with other products and services. In November 2017, Spotify extended its merchandising Partnerships with its artists to allow them to sell products such as makeup via its arrangement with Merchbar. Although it will not earn direct revenue from this, the idea, instead, is to sweeten the deal for artists and give them more opportunities to make money via the platform and connect with their
fans in multiple ways on Spotify. It will also get its subscribers coming back to do more on the platform (Customer and Product Diversification) than just listen to music, remaining sticky on both sides of its marketplace—ultimately another way to reduce churn.
These efforts, in combination, help Spotify differentiate itself from the likes of Apple Music, which is entering into exclusive deals with artists. Yet even as Spotify surpasses 170 million monthly active users, which includes 75 million paid subscribers, 99 million ad-supported monthly active users, and $5 billion in revenue, controlling churn will be critical to Spotify’s long-term viability and profitability. Controlling Churn for Spotify means optimizing Customer Experience, offering greater product and service variety (Product Expansion) and fewer restrictions than its competitors, especially with its stated 10–20 percent YoY “fast growth mode.”
SPOTIFY
KEY TAKEAWAYS
While it’s impossible to eliminate churn entirely, it is possible to reduce it. There are three key actions Spotify did that help them manage and reduce the likelihood of churn:
A good first impression is key. Whether you’re on a date, at a job interview, or browsing Spotify for the next song to listen to, first impressions count a lot. When onboarding new customers, you should make it seamless, giving them a quick overview of your product and getting them started (using it) right away. This is critical. If you can get new customers to start using your product immediately after purchase, they are more likely to better understand all you have to offer, making your product much more desirable and hopefully indispensable. And if you can do that, you’ll naturally reduce churn—proactively, I might add.
Offer great value for the price. Value doesn’t have to mean free or discounted offerings. Knowing your customers and their buying and usage habits can help you personalize the way you communicate to them and make them feel valued. Fifty-three percent of consumers want a totally personalized experience, in addition to instant savings and rewards based on past purchases. Customers now provide so much data to marketers and brands through online subscription services that they want something significant in return.
Set, meet, and exceed customer expectations. One of the main reasons customers churn is because the product or service doesn’t deliver on their expectations. As you have read in the previous chapters, customer expectations are increasing for both the brands they choose to do business with and the products they buy. Another great way to reduce churn is always to strive to meet or exceed these high expectations. Do that thing that makes your customers feel special or go the extra mile. Sometimes it doesn’t require much, but it makes a huge difference when it comes to churn.
STORY
2
NETFLIX
TWENTY YEARS OLD (AND COUNTING)
There’s no business like show business.
—IRVING BERLIN in Annie Get Your Gun
ACCORDING TO CNBC, NETFLIX WAS one of the market’s best-performing stocks of 2017. It brought in 8.3 million new streaming subscribers—including almost 2 million in the United States for the fourth quarter of 2017. Netflix expects the momentum to continue. For the first quarter of 2018, the company is forecasting 6.35 million new streaming customers (versus 5 million in the year-ago quarter), comprising 1.45 million domestically and 4.9 million internationally. Netflix has also announced that it will ratchet up marketing spending more than 50 percent in 2018, increasing it from $1.3 billion to $2 billion.
It has by far the greatest reach of all of the various streaming services in the United States, with Amazon reaching only half as many households as Netflix. It has grown steadily both its domestic and international subscribers over the past ten years and, in the process, has pioneered an entirely new way of delivering entertainment: streaming OTT.
At the beginning of 2017, 19 percent of all broadband households and 29 percent of households subscribing to an over-the-top (OTT) video service had canceled one or more services within the past year.
Having a customer base the size of Netflix’s has its advantages, but it can also plateau the growth of a subscription business if you don’t keep churn under control. Losing 5 percent of your customer base when you have 1,000 customers means that the first 50 new customers you acquire only gets you back to even. When you have 104 million subscribers, as Netflix does, losing 5 percent of your customer base to churn means that it will take you 5 million new customers to just break even. What complicates matters even further for Netflix is that as Apple, Amazon, and Disney enter the streaming entertainment business, customers have more options to choose from, which increases both the cost of customer acquisition and the volume of “brand switching.”
Parks Associates research shows that more than 50 percent of U.S. OTT subscription households subscribe to multiple video services. Of these, 81 percent use Netflix plus some other services or combination of services, typically Amazon or Hulu. To put that 81 percent number into perspective, there are over one hundred OTT video services available in the U.S. market as of March 2016. So, having that kind of dominance is a huge advantage Netflix doesn’t want to squander. While that level of market share is an advantage, it also means that Netflix and its customer base becomes a prime target for the totality of the competition, looking to outmaneuver Netflix on quality, products, and price.
The nature of subscription video-on-demand services like Netflix, Hulu, HBO Now, and others makes it easy to cancel. Even if you’ve had Netflix for years and decide to leave for a few months (Churn), you can pick them back up easily at any time with the click of a mouse. Parks Associates also found that, apart from Netflix and Amazon Prime, OTT services are experiencing churn rates exceeding 50 percent of their subscriber base (both free and paying customers), whereas Netflix, Amazon, and Hulu have actually continued to reduce their churn rates. This industry is a bit unusual because it has customers who simultaneously have multiple for-fee and free services in the same category, with 63 percent of households subscribing to five or more services. So, while some of the churn is natural for those trying out the service and choosing not to upgrade to the fee-based service, the rest may in fact be due to paying customers switching providers.
How can a company build stronger brand loyalty and fend off competition when customers are perfectly happy using multiple providers, all for the same type of service, and they have a low barrier or no barrier to switching? Answer: provide an original and unique product, keep customers from going elsewhere or leaving altogether (churning). How? For Netflix, it’s content.
HOUSTON, WE HAVE A SOLUTION: ORIGINAL CONTENT
Netflix plans to spend $8 billion to make its library 50 percent original by 2018.
When it comes to acquiring subscribers and keeping them, it appears that Netflix has found the right combination of product, quality, and price. Even as its business transitioned from DVDs via mail to online streaming, it has been able to stay in front of changing market context. Most of the company’s recent growth has come from new subscribers as they pursued Market Acceleration across the 190 or so countries that it entered in 2016 alone and Customer and Product Diversification as it further develops original content. Netflix saw a 49 percent year-over-year increase in global subscribers, including 850,000 in the United States, taking its global total to 104 million during the third quarter of 2017. Both of those results are a testament of Netflix’s comprehensive efforts aimed at acquiring new customers and keeping engagement high, price for value in line, and churn low.
What makes Netflix a “must-have” for so many households is its investment in original programming with a long-term goal of ensuring that nearly 50 percent of the content streamed on its platform will be original. From House of Cards, Orange Is the New Black, and its recent blockbuster grab—persuading Shonda Rhimes to leave Disney/ABC for an overall deal at Netflix—it now says it will spend $7 billion to $8 billion on (all) content in 2018.
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sp; Netflix was the top-earning app of 2017 that wasn’t a mobile game, according to Sensor Tower’s new year-end report on the most successful apps and publishers across Apple’s App Store and Google Play.
By comparison, Amazon is expected to spend $4.5 billion and HBO spent $2 billion in 2016. Netflix believes “its future largely lies in exclusive original content.” Switching becomes tough if you love a show on Netflix, or Drake on Apple Music. There is no question that Netflix will need its head start, because Disney recently announced plans to start its own streaming service, acquired a majority stake in BAMTech, another streaming and marketing service, and decided to end its partnership (for a subset of its content) with Netflix in 2019.
CONTROLLING CHURN
Customers choosing to leave your service because they just don’t want the kind of product you are selling anymore is one thing. Customers switching to another provider for the same or similar service is a completely different challenge. And customers leaving you because you discontinue the service they were using, which is totally self-inflicted churn, is another. Netflix is facing all three of these challenges. Netflix Q1 2018 results showed noticable improvements in reducing churn rates between Q1 2017 and Q3 2017 by 3.2 percent. However, as a direct result of a 10 percent price hike, overall churn rates increased by 1.9 percent . . . to 9.7 percent.
So far, the results from the effort to expand its product to include even more original content seems to be paying off. However, it doesn’t come without some level of risk for future churn. Netflix has acquired customers since it began on a robust library and catalog of “other people’s content”—that was its value proposition, which means that it must be careful not to alienate the subset of customers who don’t want to watch original content. Just as when it expanded beyond DVDs in the mail to streaming, not all customers wanted to make the shift.