The More Pandora Sells, the More It Loses

originally appeared in The Wall Street Journal:

Pandora Media Inc.'s 18% stock drop Wednesday is a sobering reminder that fractions add up, a tenth of a cent might not sound like a lot of money, except when advertising sales don't keep pace.

Pandora projected slower revenue growth and red ink in the current quarter, triggering a 19% plunge in the shares of the Internet radio company.

Pandora's music royalty costs, typically paid in tenths of a cent, are skyrocketing. At the same time, the more people who listen to Pandora via mobile devices, such as on smartphones, tablets or through car dashboards, the less advertisers pay to reach those listeners, compared to the ones listening on desktop or laptop computers.

In other words, the more successful Pandora becomes, the more it loses. And those through-the-looking-glass economics of Internet radio set off the drop in Pandora shares.

Pandora's audience statistics would be the envy of many media companies: In the most recent quarter, it had 59.2 million active users who listened to nearly 3.6 billion hours of music. And they appear highly loyal: its giant 47% uptick in active users was outpaced by a 67% increase in the amount of music served, meaning more people are using the service to listen to more music than ever.

Yet because Pandora must pay record companies and music publishers for every one of those "listens," its "content acquisition" costs—the price it pays the owners of all that music—rose nearly 75%. At $65.7 million, those costs ate up nearly 55% of Pandora's revenue for the three months ended Oct. 31.

Pandora's ad revenue totaled $106.3 million in the quarter, up 61%. It also brought in $13.7 million in subscription fees from users who pay $3 a month to listen without ads.

They are in many ways a victim of their own success according to Triton Research LLC, which analyzes startup companies for investors. (The firm is unrelated to Triton Digital, which audits Pandora's usage.)

While the company's audience and related costs have ballooned, 77% of its listening hours now take place on mobile devices, which generate less ad-sales revenue for the company than laptop and desktop listening.

The company sold $21.56 worth of ads per 1,000 hours of mobile listening in the past year—a slight uptick but less than half what it made from the same amount of desktop listening. The company made $55.18 in ad sales per thousand hours of desktop listening in the same period.

According to Pandora's CFO, if a TV network had to pay the production house more for every viewer of 'Breaking Bad'—and they didn't have a real ad-sales force in place—they would hate it if they had a big audience.

After their fall Wednesday, Pandora shares now trade at $7.80, close to their 52-week lows. The stock debuted in June, 2011 at $16 per share.

The company is making efforts to turn the situation around. Pandora's advertising sales force is 75% larger than a year earlier.

Pandora's CEO said they've demonstrated in Q3 that in mobile we can grow revenue faster than listener hours. We think we can continue that trend and that is what defines our success.

But the big issue facing the company is the cost of the music it plays, which is dictated by a blanket agreement between online radio companies and record labels, represented by an arm of their lobbying group called SoundExchange.

Under that agreement, which lasts through 2015, the rate goes up gradually each year. The rate paid per song will rise to 0.14 cent in 2015 from 0.11 cent this year. The rate schedule was negotiated in 2009, when Pandora was not the behemoth it is today.

Pandora has aggressively lobbied Congress for a law that would significantly cut those royalties. The Internet Radio Fairness Act, as the proposed legislation is known, may be the company's only chance at robust profits, says Triton's chief research officer.

He feels that from a strategy perspective it's the best single thing they could do for their business, without that, if they run their business perfectly, they are a low-margin business.

Pandora argues it has been paying disproportionate fees to artists, and that the legislation would put it on an equal footing with rivals. It also says whatever artists lose in the short term will be made up for in the future, because more attractive royalty rates would create a boom in Internet radio.

The Internet Radio Fairness Act would establish the same criteria for setting Internet radio royalty rates that is now applied to satellite radio company Sirius XM Radio Inc., SIRI +1.08% which pays significantly less than Pandora and other webcasters.

Not surprisingly, many artists, who stand to have their royalties cut sharply, object to the legislation, especially as Internet radio promises to catch on.

Jonatha Brooke, a singer with several albums released both on major labels and independently, estimates that one million plays of her work on Pandora nets her a bit less than $500. If the legislation passes, she believes proceeds from the same number of plays could be less than $100.

She says that these streams are becoming more and more important. The idea of Pandora crying the blues and wanting an 85% cut in what they have to pay me is just galling.

Ms. Brooke's name appeared with hundreds of other artists in an ad in Billboard magazine last month, criticizing Pandora's efforts on behalf of the bill.

Pandora's CEO will pay about $250 million in royalties to SoundExchange this year. He declined to speculate on how that amount may change in the future should the Internet Radio Fairness Act pass.

Pandora's founder says he has been trying to make personal contact with musicians about the issue. His hope and belief is that after this wave of rhetoric and mercenary type of PR, there will be a discussion based on the facts.

Pandora and Facebook: So Happy Together

WIRED

The leading online radio service and world’s biggest social network have forged a bond that will solidify both companies’ dominance, while offering music fans a way to share music with each other that appears to lack any significant downside. Pandora pays copyright holders, and integrating your Pandora and Facebook accounts won’t pollute your Facebook stream with endless notifications about what you’re listening to.

The upside for Pandora users is significant, due to the ways in which it broadcasts their taste, helps them discover and enjoy new music through their friends. There are countless ways to do these exact same things elsewhere on the web, and you’ve already been able to share Pandora stations with friends. But Pandora + Facebook = such easy math that even the busy or excessively lazy can integrate it into their lives.

This joint announcement is twofold. One part involves “Like” buttons that Facebook and others will embed on its own site and partner sites around the web using the Open Graph API Facebook announced yesterday. Whenever you click one of these buttons, that information gets added to your Facebook Graph, which Pandora can then tap in order to present you with stations based on what you’ve liked on Facebook and around the web.

It’s too early to call at this point, because the buttons haven’t shown up yet, but if this aspect of Facebook’s initiative takes off it will make the company the de facto storage point for our musical preferences, while boosting Pandora’s utility. Best of all, Pandora won’t blast all your Facebook friends with messages about what you’re listening to, should you integrate your accounts. (If you want Facebook to notify people about what you’re listening to on Pandora, you can still click the share button on the currently playing song, and choose the Facebook option.)

With that out of the way, let’s move on to the aspect of this announcement that you can start using right now. Here’s how to get your Pandora account to make friends with your Facebook account — you only have to do it once, and there doesn’t appear to be a downside unless you don’t want people knowing that you spend most of your Pandora time listening to Menudo. Integrating your accounts widens your listening options within Pandora considerably, and immediately.

To activate Pandora’s optional Facebook integration, go to Pandora then click the Friends’ Music link at the lower right.

If you’ve already used Pandora’s own social networking features to add friends, they will show up here. Click Add Friends to proceed to the part where you integrate Pandora with Facebook.

Then, click the Connect With Facebook button. Nothing appeared to happen, but when we reloaded Pandora, our Facebook friends appeared alongside their Facebook profile pictures, their most recently played station, and the songs they’ve liked most recently. I can now make my own stations from any of that music:

That’s it — you’re connected. We should note that all of these features can exist without using Facebook at all, because you can enter another Pandora user’s e-mail to friend them, although Facebook makes it far, far easier. With your accounts integrated, you can make stations from any song a friend has liked and can copy their artist stations over to your own profile, where they will be shaped by your own musical preferences (for instance, songs in friends’ stations that you’ve banned won’t play).

Making the Pandora listening experience even more social, whenever you encounter a song that one of your friends likes, a tag will appear to let you know. One side effect of this new feature will likely be to encourage Pandora users to add more tracks to their favorites, because now, other people have such an easy way to see them. And the more they sculpt their stations and preferences, the more reason they have to stick with Pandora for their online (and, increasingly, device-based) radio listening. And now that Pandora includes video ads (we saw our first one today), it’s even more prepared to monetize repeat visitors.

Pandora tried this strategy earlier with its own social network, but who wants to create a whole set of friends manually on Pandora? Facebook is the social networking king of the hill right now, so it makes more sense for Pandora to grab peoples’ friends from there.

Ultimately, Facebook’s bold attempt to become the central repository for peoples’ musical taste, among other socially identifying elements, could help the company avoid the fates of its ancestors, Friendster and MySpace.

Judging from the smoothness and power of this Pandora part of the equation, it just might work.