Why Spotify Is Investing $500 Million On Podcasts

Apple (NASDAQ:AAPL) used to be the only company that mattered in the world of podcasting. That's changing quickly. Although Spotify (NYSE:SPOT) joined the podcast party late -- it didn't support podcasts until 2015 -- it is dead set on dominating the medium. Spotify has pledged to invest up to $500 million in 2019 to acquire podcast companies and has already snapped up three businesses. Will Spotify's aggressive entrance into podcasts pay off?

The podcast market is ripe for Spotify's entrance

Why does Spotify want to get into podcasts at all? Because podcasts have experienced booming growth in popularity and play to the company's core strength in distributing audio content. Frankly, if Spotify didn't get into podcasts it would risk losing share of the audio listening market to other platforms.

According to Edison Research, the number of Americans listening to podcasts has grown significantly over the past few years. In 2018, 26% of Americans over the age of 12 listened to a podcast at least once a month, this is a big increase over the 17% statistic reported for 2015. Data suggests that the average listener is consuming more content, too. The bottom line is that the podcast medium is showing very strong growth in demand.

Importantly for advertisers and platforms, the demographics of podcast listeners skew younger and wealthier than other forms of media. 30% of listeners are between the ages of 12 and 24, and according to Nielsen, nearly half of listeners make more than $75,000 in annual income, sparking a gold rush in advertising revenue for the industry.

The podcast market has developed a large audience that is eagerly supported by advertisers. It makes a ton of sense for Spotify to capitalize on the growth opportunity. The platform already has a large audience listening to podcasts, and, to the extent it does a good job catering more content and providing strong curation, it can solidify itself as a podcast destination.

Acquisition spree

Rather than build its own content studio or simply host third-party content, Spotify has chosen to buy podcast companies, earmarking up to $500 million to be used for podcast acquisitions in 2019. So far, it has already used $400 million of that budget to acquire Gimlet and Anchor in February and Parcast in April.

Gimlet and Parcast are both podcast content studios which have several popular series. Gimlet, in particular, is known for best-in-class content and has won several industry awards. Spotify is getting top-quality studios that will serve as creative engines for pumping out original and exclusive content. This is somewhat analogous to when Disney goes out and buys a studio like Marvel. Gimlet and Parcast can create content, but Spotify will be able to distribute it to a larger audience and improve content monetization.

Unlike Gimlet and Parcast, Anchor is a podcasting platform that provides tools to help record, publish, and monetize low-budget podcast productions. 40% of new podcasts use Anchor, making it the go-to platform for creators. Think of Anchor as the "youtube" of podcasting, where do-it-yourselfers go to have their voices heard. With Anchor, Spotify sees an opportunity to open its platform to self-published content and cover a different segment of the market.

These three acquisitions -- and possibly more down the line -- give Spotify a robust content studio that can provide it with a stable of exclusive content. This is in addition to the more than 250,000 podcasts already found on its platform, most of which are not exclusive to Spotify. These moves send a clear message: Spotify is serious about podcasts and will provide a differentiated listening experience.

Podcasts are poised to attract subscribers and improve churn

Podcasts will do more than just give Spotify a bigger market share in an emerging medium. The hope is that by securing a leadership position, it will see a bump in its premium subscription numbers and will be able to keep its subscribers longer.

In Spotify's Q4 2018 earnings release, it noted:

Growing podcast listening on Spotify is an important strategy for driving top of funnel growth, increased user engagement, lower churn, faster revenue growth, and higher margins. We intend to lean into this strategy in 2019, both to acquire exclusive content and to increase investment in the production of content in-house.

At the surface level, these goals seem lofty, but they are not unrealistic. For one, music streaming is an intensely competitive industry. Spotify basically offers the same content as other big players such as Apple with limited opportunity for differentiation. To the extent it is able to offer exclusive podcasts that people actually want to listen to, the platform would be giving potential subscribers an additional reason to choose Spotify over Apple or Pandora.

CEO Daniel Ek said that users who listen to podcasts are almost twice as engaged as non-podcast listeners and spend more time on the platform as a result. An engaged subscriber is a subscriber who is less likely to cancel their plan. The promise of attracting more subscribers and keeping existing subscribers longer directly translates into the company making more money and indirectly helps it improve its profit margins due to economies of scale.

Obviously, there is a cost to gaining the benefits of developing its podcast capabilities and the cost comes in the form of hundreds of millions invested in acquisitions, and then investing additional money in creating content from newly acquired studios. The company has cautioned that these investments will be an upfront hit to margins because the podcast investments will take time to pay off. However, Spotify is confident that it is making a valuable long term investment in its platform.

Podcast investments will pay off

Spotify's foray into podcasts is a good idea. Podcasts have already proven to be a popular and fast-growing category of audio and are complementary to Spotify's core business of music streaming. Despite how popular podcasts are, none of the other large tech players have made a concerted effort to differentiate their podcast platforms with substantial exclusive content or additional innovation. Apple's podcast app has the largest listenership and selection of content today, but it has done virtually nothing to innovate new features or curation in years.

Podcasts could represent a way for Spotify to find a new pocket of subscriber growth and improve subscriber churn in the process. To a tech giant like Spotify, $500 million doesn't represent a colossal amount of money, but investing in podcasts could accrue significant financial benefits down the road.

This article originally appeared in the Motley Fool.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Luis Sanchez has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Apple, and Walt Disney. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.