Why Netflix knows how to make money, and Spotify doesn’t
Cost structure is the foundation on which any viable business is built. Effective cost management can help spur profitability and growth, while ineffective cost management can bury a great business with burgeoning debt, threatening its very survival; Netflix and Spotify know it well.
Both companies have proven to have the potential to scale, both have a large market size, both can replicate their system very easily, and the lifetime value of their customers is long. But when it comes to their cost structures, ( business mechanics ) they are not that similar.
Spotify’s cost structure is a bit tricky, and that’s why they are having trouble generating profit. They pay music creators a fee every time one of their songs is played. This means that the more users Spotify has, the more music is played and therefore the higher fees they’ll pay (variable costs). This reduces their margin making it extremely difficult to scale without external investment.
Spotify is aware of its cost structure problem, that’s why they have been working on implementing new business mechanics. They started to go into the podcast ecosystem by buying podcast companies and exclusive podcast shows. They do a good job recommending new music to their users, so they are using this feature to recommend podcasts to increase the number of podcast listeners. With this new mechanic, they expect to decrease their variable costs, increase their margin, and therefore their profit.
On the other hand, the case of Netflix is quite different. They pay content creators for movies and tv-shows. But unlike paying a fee for each visualization, they rent the content for a fixed fee, no matter how many people watch it. This means that Netflix benefits from having more viewers, as the cost of renting content per viewer decreases and their profit increases. So the challenge, in this case, is that if a movie or tv-show is very popular the creator has high bargaining power and may exert pressure by raising their prices or reducing availability.
But Netflix hasn’t been sitting on its hands, Netflix has been investing in original content for a long time, and by having information and data about their customers, they can make movies and tv-shows that fill in the blanks that people are demanding. That’s why they’ve been investing so much money in creating their own content because they know that these are assets that they’re going to be able to monetize and that will create more entry barriers.
Both, Netflix and Spotify, are changing the mechanics of their businesses. Their approaches are different, but the end goal is the same — to make progress. As they have a clear view of their cost structure and business mechanics, these changes have more chances to be effective.
There is no business equal to another, but regardless of what you do, the basics never change: know your costs and manage them effectively.
With ClearFinance you can have a clear view of your cost structure and the allocation of your resources; make sure your business strategy is viable before implementing it.
