🗞 These 5 Companies Are Increasing Profit Margins Fast

Happy Sunday!

Here’s what’s on the docket for this week’s newsletter:

• 🎙️ The Spotify turnaround no one saw coming

• 📊 5 Companies That Are Increasing Profits Fast.

Let’s dive in!

Company Spotlight

The Spotify Turnaround No One Saw Coming

In January of 2023, things were looking dour for the world’s largest audio streaming company Spotify.

Profit margins were negative, the stock was down 40% from its 2018 IPO, activist investors were circling, and layoffs were on the horizon.

Ever since Spotify’s IPO there’s been one consistent narrative about the company. That narrative goes something like this:

“Yes it’s a great product, yes music streaming is a growing category, and yes Spotify should continue to grow users, but in the end all of the profits will accrue to the rights holders (primarily the big 3 music labels)”. 

And for a long time that narrative made sense.

From 2019 to 2023, Spotify’s gross margins were stuck at ~25%, and the company was consistently unprofitable despite surpassing more than 500 million monthly active users.

But fast forward 2 years, and it turns out Spotify didn’t have a cost of revenue issue, Spotify had an operating expense issue.

At the end of 2022, after years of loose spending and a growth at any cost mentality, Spotify’s CEO Daniel Ek quickly changed his approach. In fact, during the Q4 2022 conference call, Ek stated “we are shifting to focus on tightening our spend and becoming more efficient.”

This focus on efficiency persisted throughout 2023 and 2024 leading to two separate rounds of layoffs, including a 17% reduction in the overall workforce.

While it remains to be seen whether or not these layoffs will have any long-term effects on Spotify’s product velocity, the financial impact was quite clear. From Q3 2022 to Q3 2024, Spotify’s free cash flow has exploded and operating margins have jumped from -8% to 11%.

Featured Story

5 Companies That Are Increasing Profits… Fast

Operating leverage is a beautiful thing.

When a business has high fixed costs but the additional cost to serving new customers is low (cough, cough Software companies), they can expand their profit margins quickly as they reach scale.

Here are 5 timely examples:

1.) Uber 

In its race to scale, the leading ride sharing marketplace spent billions in an effort to build the best tech and attract the most drivers and riders. While that culminated in extensive losses, Uber is now popular enough that it doesn’t have to spend nearly as much to attract new customers. This has resulted in a rapid expansion of profit margins for the company.

Operating Margin:

• 2017: -49%

• 2024: 6%

2.) Netflix

Streaming leader Netflix has shown remarkable operating leverage over the last decade as its content production costs began shrinking as a percentage of overall revenue. While many streaming companies are struggling to generate any earnings, Netflix is showing the power of scale in their industry.

Operating Margin:

• 2015: 5%

• 2024: 26%

3.) Salesforce

Though it took more than 20 years to appear, one of the largest software companies in the world is finally flexing its profitability muscle. Masked by two decades of expense growth, Salesforce’s latent profitability has finally showed up over the last two years as a swarm of activist investors encouraged tighter cost controls.

Operating Margin:

• 2015: 1%

• 2024: 20%

4.) Shopify

E-commerce enabler Shopify has rapidly expanded its margins over the last several years as it slowed down its aggressive headcount growth and instituted broader cost controls. Like others on this list, Shopify has high fixed cost requirements for building its world-class e-commerce platform but the cost to attract new merchants is relatively low which has helped the company increase margins.

Operating Margin:

• 2019: -9%

• 2024: 13%

5.) Google Cloud

Alphabet’s cloud computing division has seen remarkable operating leverage over the last several years as the hyperscaler continues to capture global cloud demand. This success at Google Cloud has even helped Alphabet overall expand its profit margins.

Google Cloud EBIT Margin:

• 2018: -74%

• 2024: 17%

Meme of the week

This is the time of year when many hedge fund managers start sending out their annual letters.

While these letters are often full of high quality investment ideas, it’s hard not to notice the same macro complaints that show up time and time again. This year, the valuation gap between “growth” and “value” cohorts has been a big point of emphasis.