Pandora: Pay Us to Not Annoy You

Pandora falls behind competition on unique operating model.

The Digital Shakeup of the Music Business

The rise of the digital age and the prevalence of smartphones and tablets have caused upheaval in the music industry. Global record sales plummeted -62.5% from their peak of $40Bn in 1999 to $15Bn in in 2014.  Also in 2014, digital downloads and subscription services overtook compact disks as the dominant operating model for delivering music to fans (1).  Within digital music sales, there are two distinct business models: the subscription business model (i.e. Pandora and Spotify) and the download business model (i.e. iTunes classic).  By 2020, it is expected that subscription services will come to dominate the digital music market (2). As record labels scramble to stem the decline in music sales and search for sustainable digital-focused distribution partners, many companies have entered, making digital music sales highly fragmented and competitive.

Introducing Pandora: A Music Streaming Pioneer

Pandora (NYSE: P) was one of the earliest companies to enter the digital music streaming market. Pandora pioneered the concept of internet radio and led the way for companies over the last 15 years to develop alternative steaming music operating platforms.  The Company’s overall vision is to be the “effortless source of personalized music and entertainment and discovery for billions (3).” In 2005, the Company introduced its ad-supported radio service that today totals 250 million registered users.

Pandora’s Operating Model: Streaming Algorithmic Playlists

Pandora’s operating model is to deliver highly curated music playlists to its online users. The key difference between Pandora and other music streaming services is that, with Pandora, you cannot pick each individual artist or song, you can select the start of a playlist. In this way, Pandora is a more interactive form of radio than traditional car radio, but less customized than other streaming and music download services. Pandora acquires its music through licenses purchased from copyright owners, and delivers this content to its users through its website and mobile apps that are internally developed.  An additional key piece of technology besides the website and apps is Pandora’s collection of algorithms to determine playlist content and to recommend new playlists to users.

Pandora’s Business Model: Advertise to Listeners, Charge Listeners for No Ads

Pandora has two sources of revenue: advertising and its user subscription platform.  The Company charges marketers for the opportunity to post audio, display, and video advertising embedded within its listening service and on the website and mobile applications.  Additionally, Pandora offers the opportunity for its customers to pay $4.99 per month to access the Pandora music service ad-free, and in higher quality audio formats.  As of the end of 2014, advertising represented 80% of revenue and Pandora One 20% (3).  In terms of cost of providing the music, Pandora pays the owners of content in proportion to the frequency the music is played on Pandora’s platform.

Pandora’s Business Model / Operating Model Mismatch

Pandora has a unique operating model compared to other streaming music services and a large gap between its business model and operating model.  Pandora’s operating objective is to deliver high quality playlists to as many customers as possible, whereas its business model focuses on the presence or lack of advertising.  Therefore, Pandora is not necessarily compensated for availability or quality of music content on its platform.  Users are only incentivized to pay if the annoyance of advertising is enough to motivate them to pay for an ad-free experience.  Marketers are motivated to buy ads according to the size of the customer base available on the platform.  This stands in stark contrast to Pandora’s streaming competitors, most notably Spotify and Apple Music, who charge users a subscription fee and offer exclusive access to certain music content.  Although Spotify does have ads on its free-of-charge service, Spotify also charges its users to have access to its mobile platform, which is arguably more directly linked to its operating model.  This helps explain Pandora’s poor stock performance.  Pandora is currently trading 22% below its initial offering price and 67% below its all-time high price set in early 2014.  As a result of its divergent operating strategy from its competitors, Pandora has failed to make a profit as a public company.  The cost of acquiring customers and content in this business is highly competitive, and driving user growth is paramount to achieving economies of scale.   Pandora’s competitors arguable have stronger operating model to drive user growth due to a focus on charging for the actual music available, and also for supplying an operating model that delivers music on-demand.

 

Sources:

  1. The Verge: “Digital Music Revenue Overtakes CD Sales for the First Time Globally” http://www.theverge.com/2015/4/15/8419567/digital-physical-music-sales-overtake-globally
  2. Business Wire: “Digital Music Subscriptions Services Market Report: 2015: http://www.businesswire.com/news/home/20151009005697/en/Research-Markets-Digital-Music-Subscription-Services-Market
  3. Pandora’s 2014 10-K Annual Report. Available on SEC Edgar.

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2 thoughts on “Pandora: Pay Us to Not Annoy You

  1. The biggest question around Pandora is whether radio is enough? Pandora’s ability to create a personalized station through an algorithm provides better listening than a radio station that is beholden to whatever the masses like. The internet allowed this level of personalization. However, as technology continues to automate human functions, the best companies are finding a way to retain the human touch. Apple Music is a great example of this. It has the algorithm based internet radio, pairs that with playlists curated by popular DJ’s, and add’s the ability to make a curated playlist from its library yourself. Apple also has the added benefit of being built on an ecosystem that so many people are already connected to through their computers and their cellphones.

    Pandora will never be able to compete. As an internet radio station, its digital content licenses are built so that it can operate as a radio station. This means they cannot do things like play songs on-demand or skip through too many songs. Pandora, existed to fulfill a need for music delivered through the internet, they just made the wrong bet. The world didn’t want the radio on their computers, they just wanted music. The change of venue from the car to the phone or computer has changed what consumers expect from a music service.

    My guess it the Pandora will lose listeners which will drop ad revenue. They may attempt to build more attractive features to retain the paying customers. However, I think these attempts will fail as their content licenses are very limiting. I don’t think Pandora will go away. But, it will move from an active listening destination to a place for background music.

    1. Many thanks for your comment to my essay!

      Its a great point you raise that Pandora’s competitors, in addition to their differentiated services, also do provide a form of internet radio similar to Pandora’s offering.

      I also appreciate your identification of the underlying value of providing music to listeners: the human touch. This is an important operational factor for all curation-based services to deliver in order to capture value, and I believe it is very hard to create, especially when considering a technology-based approach rather than having humans complete the job.

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