Attention Arbitrage & Spotify’s $340mm Acquisition

In the last article I wrote, I talked about how the Amazon Celebrity Store and Spotify’s acquisition of Gimlet Media and Anchor, two of the podcast industry’s largest production houses and platforms were more closely related in strategy than they might seem, and that the strategy behind both of these moves could be summed up in two words:

Attention Arbitrage.

In the previous email, I talked about the strategy behind the Amazon Celebrity Store (essentially monetizing the attention that celebrities already have by slapping their face on the cover of a “store” and selling products that already exist on the Amazon marketplace).

In this post, we’re going to talk about the strategy behind Spotify’s $340mm acquisition.

But first – a 10,000 foot overview of the podcasting industry and the Spotify business model:

The Podcasting Industry

As “mainstream” as podcasts might feel to you and I (if you’re reading this email, you are almost certainly an early adopter of media), the podcast industry as a whole is still in it’s infancy, and as a result is fragmented and disjointed.

Compared to radio, podcasting is still barely a blip on the media map. In 2018, podcasting advertising revenues made up just 1.4 percent of total radio revenues, coming in at around $650mm (radio advertising revenue, on the flip side, was $45.2 BILLION).

(And yes, for those of you where are doing math, that means Spotify payed approximately 50% of the ENTIRE PODCASTING INDUSTRY revenue in 2018 to acquire Gimlet and Anchor).

While total podcasting ad revenue doubled in 2018 from the previous year – it still has a long way to go to become much more than a rounding error when compared to radio ads (which are also projected to grow).

Why is this?

See 5 paragraphs above – podcasting is still in its infancy and is highly fragmented and disjointed.

Unlike traditional radio ad buys, there are few podcast networks (most podcasts are run by independent individuals or companies), and there are NO platforms available to purchase advertising inventory at scale across podcasts.

Most podcast advertising deals are struck on a 1-to-1, channel-by-channel basis.

As a result, while podcast ads CAN be incredibly profitable (I’ve seen 350% ROIs over a 6 month period, and the constant advertising by Squarespace, Mailchimp, mattress companies, subscription box companies, etc also suggests they are profitable), it is INCREDIBLY laborious and time-intensive to reach any sort of scale, especially if you have a product that appeals to a specific demographic of customer.

The podcast ad buying process looks something like this:

  1. Reach out to a dozen podcasts in the industry you want to target
  2. Hear back from 8 – 10 of them
  3. Receive individual quotes and deliverables from each podcast after a few back and forth emails
  4. Negotiate and come to terms
  5. 2 – 5 additional rounds of back and forth revisions on the ad and how it will be presented (customized for each podcast, because that performs best)
  6. Sign contract, send individual payments to each podcast
  7. Congratulations…you’ve invested MAYBE $100k for 3 – 6 months of ad inventory, unless the podcasts you happened to reach out to were in the top 5% of podcasts worldwide.

And while that $100k may be profitable, it’s just not realistic to scale that ad spend to 7 or 8 figures. The amount of niche podcasts you would have to create independent relationships with would be overwhelming.

Compared to the ad-buying process for radio, where the agency or brand calls up a network, let’s them know the demographic of consumer they want to target, gets them the ad copy, and the radio network distributes that ad to affiliate networks across the nation (resulting in a $100k – 8 figure ad budget with as little as a few back-and-forth emails), and you can see why SO MUCH ad spend is being pushed into radio. It’s flat out easier.

Enter the greatest opportunity (and challenge) for the podcasting industry – creating a way to deliver ad inventory at scale.

Midroll’s acquisition of Stitcher (a podcasting platform) in 2016 is an attempt to capitalize on this gap by taking a platform on which podcasts are already hosted and listened to, and utilizing that platform to dynamically insert ads into any podcast on the platform.

It’s a win for advertisers (who can create ads at scale and role out their ads based on target demographic, vs manually researching podcasts themselves).

It’s a win for podcasters who participate in a rev-share in the advertising without having to manually negotiate ad deals themselves.

And obviously, it’s a win for Midroll/Stitcher who takes a cut off the top.

The problem is, Stitcher only accounts for 5% of podcast listens. And the key asset here is audience ATTENTION, not podcast production.

iTunes is actually in the best position to capitalize on this opportunity with their Podcasts app (which accounts for 50 – 60% of podcast listens), but they don’t appear interested in the opportunity, and frankly it goes against their business model (which is, to over simplify, creating a walled garden of superior user experience to charge a premium on what would otherwise be a commodity – their hardware).

Enter Spotify.

You might be starting to see the opportunity, but let’s quickly break down the Spotify business model to frame up this opportunity and decision.

The Spotify Business Model

Spotify primarily generates revenue from 2 ways:

  1. Direct-to-Consumer subscription of $10/month for the ability to listen to music without ads, and
  2. Generating revenue based on ads from free listeners

So – it’s a typical platform business model, where the play is to build out a platform with as many fixed costs (and as few variable costs) as possible, to then monetize a small amount of revenue per user per month across a massive scale.

This is what Facebook does. It’s what Google does, and it’s what Amazon does.

The downside to Spotify’s model, however, is that their variable costs ALSO scale 1-1 as their user base scales, because they have to pay a royalty to the record labels for every song that is streamed.

Which means in its current form as a pure-play music streaming service (and unlike FB, Google, and Amazon), Spotify can’t realize the full benefit of a fixed-cost platform with massive scale, because it ALSO has variable costs that scale in step with its customer base.

What Spotify DOES have, however, is the attention of the end user at scale.

Because the profitability of the product it currently sells (music streaming) doesn’t scale along with their users…they just need to find a product that does.

And along comes the Gimlet Media and Anchor acquisitions.

Here’s how I see it playing out:

The Gimlet Media Acquisition

Gimlet Media is one of the largest podcasting production houses in the world, with 25 shows under their roof. These podcasts are professionally produced, and reach a large number of listeners.

This acquisition gives Spotify in-house production capabilities (think Netflix Originals), which allow Spotify to capture 100% of the upside from ad revenue.

The Anchor Media Acquisition

Anchor is an app that allows people to quickly and easily record, produce, and publish podcasts with a few taps of a button on your phone.

Anchor is to podcasting as YouTube is to video, or Facebook is to journalism – it lowers the barrier to entry to produce content to essentially zero (to be clear, I’m not suggesting Anchor will be the next Facebook or YouTube, but it has a similar effect on content creation).

Most creators who start podcasts remain incredibly niche – certainly too small to expect to be approached by large corporations with meaningful ad budgets.

But what happens if you, as a creator, have the opportunity to 1) Create and publish a podcast with as little as a few taps of your phone and 2) can then immediately publish that podcast on a platform with a built-in user base of 207 million active users and 3) Also have the opportunity to participate in advertising rev share that you don’t need to negotiate or deal with?

You’re going to jump on that deal.

Now any individual niche podcast makes up a minuscule amount of listenership…but the long tail in aggregate is where 80-90% of podcast listenership goes.

That’s a massive win for Spofiy in it’s current form, and it plugs podcast content directly into Spotify’s existing business model – giving paying listeners the ability to listen to podcasts ad free, and creating a platform for advertisers to publish ads at scale across hundreds and thousands of podcasts.

Spotify’s Opportunity

Those are the facts as they currently exist – but what happens if Spotify takes a page out of Amazon’s book and implements the podcast version of KDP Select?

(KDP select is essentially an agreement that an author will offer their ebook exclusively via Kindle, and in exchange they’ll receive promotional advantages via the scale of Amazon and built in KDP Select readership, and they receive compensation for their book based on the number of pages that were read.)

If you’re a niche podcast creator (i.e. in the 99% of podcasts that make no money from ads), and Spotify approaches you with a deal that says “Hey, publish your podcast exclusively on Spotify, and in exchange earn a rev share based on total listener time, and oh by the way we have a built-in network of 207mm listeners and your podcast will have promotional advantages by being a part of our Spotify Exclusive Podcast Network….and also if you don’t do this you’re no longer going to earn revenue from the Spotify Platform.”

Again…you’re going to jump on the opportunity, because realistically there’s not a better way for you to monetize.

And if and when the bulk of the long tail podcasts go Spotify exclusive, so too will all the listeners.

It becomes a positive feedback loop and network lock-in effect at scale.

And if all of the end user’s attention is already on Spotify, that will bring the rest of the larger podcasts over to Spotify as well, which will allow Spotify to monetize THOSE podcasts (whether they are exclusive to Spotify or not).

Which means, if this plays out and a lot of things go right, this acquisition could set Spotify up to become the Netflix of podcasting over the next decade.

So there you have it.

Attention Arbitrage.

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