No Profit No Problem

Internet companies dominate business conversation, amongst many other types of conversations. You may have even heard the word “growth” a few times, if it isn’t already the word synonymous with companies like Uber, Snap, Spotify and Amazon. In all other types of conversation, these companies are key prompters. “Should we just Uber our way to the dinner function?”, “Why didn’t you Snap me the other day, I thought we had a streak going”, “Let me search that song up on Spotify” and “It’s way too expensive here, I bet I’ll find it cheaper on Amazon”. What do these phrases have in common? They signify the depth of penetration that Internet companies have over the commercial and social aspects of daily consumer lives. In short, their usage is omnipresent.

Judging by their popularity, it may be astonishing to know a truth, these companies barely generate profit. In Amazon’s case, recently this has turned around, but in the case of Snap, Spotify and Uber, heavy debt is a predominant feature on financial balance sheets. This yields no simple explanation, and cases are unique to each company’s business model, but an underlying characteristic of the modern Internet company may shed some light on such a contrasting phenomenon.

Spotify is currently the outright industry leader in America for music streaming services, with its 159 million listeners outpacing competitors such as Apple Music and Google Play Music. Shazam, a music recognition application, has even partnered with Spotify to directly link recognised songs to the mother application, Spotify. Such is its span, that telecommunications companies such as Virgin Mobile in Australia include built-in functions such as limitless Spotify streaming on all its mobile phone plans. Leveraging on its multitude of key partnerships, together with a sizeable user base, how can Spotify still not be making a profit and yet, maintain a following base so valuable that it has announced plans to go public?

The answer is in revenue, and growth. Despite posting a loss of $1.5 billion in 2017, there is a $4.9 billion revenue justification, with further reasoning being that roughly $1 billion in losses was due to one-off costs. The loss is due to mounting pressure from music companies – publishers, songwriters, labels – to increase their payouts from the provision of their music. They argue that the current payment model, tied to a portion of Spotify’s revenue, is not enough, despite the $9.76 billion the company said it paid out in late 2017. Some, have even taken to court with complaint on how Spotify provisions its music, with a $1.6 billion example from Wizen Music Publishing currently pending. But the company, along with Snap and Uber, have one justification for why it is still so popular despite its debt – potential for growth.

Typical of a Silicon Valley start-up mindset, if companies can maintain revenue growth while cutting losses, lack of profit is not an issue. As long as there is significant revenue. And hence, potential for growth. Spotify has many avenues for revenue boosting and further cutbacks on its loss. According to Nielsen, the average American spent 32 hours per week listening to music in 2017, paving ripe opportunity for advertisement revenue. Methods of customer retention present itself in ‘sticky’ product offerings such as podcasts. If you are subscribed religiously to a particular daily show, you are unlikely to change the platform providing it. Hence customers are more likely to be convinced that paying a subscription fee would be worth it.

Similarly, in Snap, investors are putting their faith in the company’s future potential, rather than instant gratification from receiving profit making news in the short term. Debuting its IPO in March 2017, the opening price was $24, already a lofty height above the original $17 offering price. Compared to industry stalwarts such as Google, this valuation is tremendous considering Snap’s lack of foundation and smaller reach. How can a company seven years old with service offerings including frivolously edited photo messaging be valued at $28.3 billion? Concretely, by the end of 2016, users totalled 158 million daily active, a growth of 48% since the beginning of the year. With a growth rate matching or exceeding 2016’s, its lofty valuation would seem more reasonable.

But crucially, investors are placing faith in Snap’s vision of the future, where communication method between younger generations will involving the replacement of written language with digital media. Some more bullish reports even value the company at $30 billion. Whether this will prove a false prophecy remains to be seen, but in we witness a company which has truly turned the tables on its loss-making trend and affirmed the high-growth, at the cost of significant losses, business model.

In the fourth quarter of 2017, Amazon made a huge profit of $1.86 billion in net income, shattering its loss-making reputation. For a sense of history, it had debuted on the Nasdaq in 1997, from which the subsequent two decades it made negligible profit, with red predominantly colouring its balance sheets. Jeff Bezos was a consistent proponent of immediately investing revenue back into channels of growth rather than making quarterly earnings targets. As a result, maintaining perennial operating cash flow has enabled Amazon to develop in innovation at an unprecedented pace, with products such as Amazon Prime hugely more omnipotent as a service than the humble online bookstore the company was originally introduced as. High growth and accelerating market adoption, at the sacrifice profit reassurances, it seems, has enabled Amazon to reach its nearly $460 market capitalisation. And it has only just made its first significant profit.

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