Entertainment storage and conveyance have changed dramatically over the last few decades thanks to relatively rapid advancements in technology. People regularly kept pre-recorded music on records and cassette tapes in the 1970s until the introduction of the compact disc (CD) in the early 1980s. Movies and visual content that were recorded and stored on film or VHS migrated to new platforms with the release of DVD technology in the late 1990s.
Today, many media consumers no longer use their own hardware to store their media content. Instead, providers store it in centralized data centers where we can stream it to our devices on demand.
The best part about this model is the cost: Consumers can stream unlimited music, movies, and television shows for a monthly subscription fee lower than what they used to pay for one CD album or one movie on a DVD!
While streaming companies have already created enormous value for investors, it’s clear this business model is the way forward, so further gains are likely over the long term. But it’s important to buy shares in best-in-class providers with rock-solid user bases and proven financial results because that’s the recipe for longevity. Here’s why Netflix (NASDAQ: NFLX) and Spotify Technology (NYSE: SPOT) fit the bill.
Netflix was once a true disruptor. It began with the idea to mail TV shows and movies on DVDs to consumers to save them a trip to the video store, and it went a step further when it introduced its streaming service in 2007. By 2010, those innovations had driven Blockbuster’s brick-and-mortar video rental business into the ground and pushed that company into bankruptcy.
Netflix is now the world’s largest streaming service with 238.3 million subscribers, but that means it’s no longer the up-and-coming, disruptive story it once was. In fact, the company’s quarterly revenue growth slowed to single-digit percentages because the streaming model reached saturation in most Western markets. Plus, Netflix pared its aggressive investments in growth to focus on generating a profit instead, which pleased many investors.
The company introduced a new subscription tier at a lower price point, which is supplemented by advertising. It’s designed to attract new members who might be willing to pay $6.99 per month rather than $15.49 for the Netflix Standard plan, or $19.99 for the Premium plan.
On Wednesday, the company’s chief financial officer, Spencer Neumann, gave a speech at the Bank of America Media, Communications, and Entertainment Conference, and he gave the audience some information about the company’s plan to grow the new ad tier.
In a surprise to investors, he said Netflix’s top priority was to scale up the reach of the new service tier to entice advertisers to spend money on the platform. Monetization and profitability would, therefore, be taking a back seat, which is likely to hurt the company’s operating profit margin. Investors have sent Netflix stock down 9% since that revelation, but that might be a buying opportunity.
Why? It sounds like Netflix turned its attention back to subscriber growth. According to the company, the ad tier is extremely lucrative because accounting for the $6.99 subscription fee and the advertising income combined, it generates as much revenue per user as the $15.49-per-month Standard tier.
Combined with a recent crackdown on password sharing, Netflix’s ad tier is already yielding results. The company added 5.9 million new subscribers in the second quarter (ended June 30), which was far above the 1.7 million Wall Street expected. It also represented growth of 8% year over year, which was the fastest pace since the end of 2021.
In short, Netflix might be on the cusp of a new growth phase, and since streaming is still increasing as a percentage of U.S. consumers’ total screen time, this is a great time to be selling advertising spots.
Netflix and its rivals are able to compete by offering different TV shows and movies from one another, but the music streaming industry doesn’t have that advantage. Each provider delivers an almost identical music catalog, and while Spotify is the largest platform, it’s difficult for the company to differentiate itself from its competitors like Apple Music and Amazon Music.
As a result, Spotify is investing heavily in improving the user experience instead, with some help from advanced tools like artificial intelligence (AI). The company uses AI to learn what music each subscriber likes so it can curate playlists and keep a listener engaged for longer periods of time.
But it has also rolled out a new feature called AI DJ, which is powered in part by OpenAI‘s technology. It selects songs based on a user’s preferences, and it features an AI-generated voice with comments during each set — much like a real-life DJ. It’s unique because individual users will have a different experience based on their taste in music.
In March, Spotify announced another new feature called Clips. It allows musicians to create short-form videos to engage their fans on a deeper level, whether they want to announce a new project or show off their creative process. It piggybacks off the success of short-form video on social media platforms like ByteDance’s TikTok, and Meta Platforms‘ Facebook and Instagram, and it further differentiates Spotify from its competitors.
Spotify has two cohorts of users: those who pay a monthly subscription fee, and those who use the platform for free with ads. In the recent second quarter (ended June 30), the company expected to acquire 15 million new users but instead attracted more than twice that: 36 million. The majority (26 million) were in the free ad tier, which monetizes at a much lower rate, but the 10 million paid subscriber additions were the most in company history for a second quarter.
The company attributed some of its strong user growth to Generation Z listeners, and as the platform continues to invest in features like short-form video, it will likely capture more of that audience, which is great for the long term.
Spotify’s net loss ballooned to $305 million in the second quarter, from $125 million in the year-ago period. That was a concern for investors, but some of the jump was attributable to a 34% year-over-year increase in research and development costs, which highlights the company’s focus on innovation to fuel growth.
As a result, Spotify is the most exciting story in the music streaming industry, and it will likely continue to maintain a leadership position.
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Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Bank of America is an advertising partner of The Ascent, a Motley Fool company. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Anthony Di Pizio has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon.com, Apple, Bank of America, Meta Platforms, Netflix, and Spotify Technology. The Motley Fool has a disclosure policy.
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