Digital content provider Pandora opens the box as it claims status as a radio station

When disruptive business models emerge, there’s always resistance to change by incumbent inhabitants of whatever landscape is being changed. Sometimes these will be legitimate, sometimes they will be luddite.

Streaming radio service Pandora is all too familiar with such resistance, the latest coming from a series of high profile music labels - Sony Music Entertainment, Warner Music Group, ABKCO Music & Records, Capitol Records, and UMG Recordings- which are accusing the digital content firm of failing to pay royalties for the use of recordings made before 1972.

They want Pandora to end what they claim is “massive and continuing unauthorized commercial exploitation” of songs by the likes of the Beatles, the Rolling Stones, Marvin Gaye, and Fleetwood Mac.

US copyright law only covers recordings made after 1972, but some state laws, including New York’s where the lawsuit has been filed, offer protection prior to that. There’s a lot at stake here. Pandora acknowledged in February that if the courts go against it, there would be “significant” penalty and if it is ordered to obtain licenses, the costs involved could harm the business.

Pandora CEO Brian McAndrews is of course publicly confident of Pandora’s legal position:

“To be clear, we paid publish royalties on these spins. But like other similarly situated companies including terrestrial radio, we do not pay sound recording royalties. Pre-1972 sound recordings represent approximately 5% of total spins on Pandora.

“Additionally this work is already at Pandora store delivers significant value to artist beyond just royalties, including access to more than 75 million monthly active users and exposure to a large precedent catalogs that go largely unheard Terrestrial Radio, in many cases helping extend the longevity of an artist’s career.”

Whether the Beatles really need Pandora to ensure their longevity may be a moot point, but the case is certainly one to watch as Pandora seeks to strengthen its hold.

Strong growth

Since launching in 2005, Pandora has become the dominant player in music streaming in the US, with 31% of the market, comfortably ahead of Apple’s recently launched iTunes Radio which claims 8%, according to to Edison Research’s 2014 Infinite Dial survey

More importantly for Pandora, its share of total US radio listening now stands at 9.1%, up from 8.1% year on year. That’s a crucial number as Pandora’s intent is to be measured less against online streaming services and more against traditional radio services.

Despite this, the firm remains in the red with its most recent financials for Q1 14, turning in a non-GAAP loss of $25.5. million, although that’s down from $30.2 million for Q1 13. Non-GAAP revenue reached $180.1 million, an increase of 54% over $170 million in the first quarter of 2013.

There’s also been a decline in subscriber numbers between Q4 13 and Q1 14, but McAndrews attributes this to the lift given to numbers in the holiday period at the end of the year:

“There is always a burst of activity around the holidays, not just listening to holiday music but also people get a lot of new devices in that timeframe.

“There is a reason why it’s such a big commerce period, lots and lots of new phones and tablets and TVs and all kinds of things where people are experimenting.

“I think the fact that we’re at 76.2 million in Q4 and at 75.3 million at this point in Q1, we consider that as a strong tailwind entering into the back half of this year from a user perspective.

“A slight decline, but certainly not one that we are worried about at all. In fact if anything we feel like we’re building momentum from a user perspective and certainly from an engagement perspective.”

In terms of that all important engagement, McAndrews points to an 8% year on year increase in active users from 69.5 million to 75.3 million, while listener hours grew at 12%, increasing from 4.26 billion in Q1 2013 to 4.8 billion in Q1 2014.

Some other talking points of note:

• In March, Pandora clocked up its first ever week with over 25 million active listeners every weekday.
• There were more than 26 million daily unique listeners every Friday in March for the first time, up from a 23 million high in 2013.
• Listeners used Pandora in March for record lengths of time consuming an average of 21.9 hours per active user for the last 30 days of March.
• Pandora is now available in 10 out of 10 of the best selling passenger vehicles, with more than 5 million unique users active through native automotive integrations.

The firm is also adding new functionality to its offering and often the simplest things seem to be delivering good results, such as an alarm clock feature. McAndrews explains:

“To highlight just one example of incremental impact these programs can deliver, people using our alarm clock functionality on Android are listening to Pandora 30% more days per week and 3% more hours each day than they listened prior.”

In another development, Pandora’s signed its first ‘bricks and mortar’ partnership, with Peet’s Coffee & Tea, to provide a partner branded radio station in a brick and mortar environment. McAndrews explains:

“Peet’s will now have its own customized radio stations on Pandora, that will be played in all of its nearly 300 stores across the US and will be available to all Pandora listeners. The partnership with Pandora allows Peet’s not only to refresh the music experience in stores but also to offer customers more music options, aligning with our own mission to help consumers find and enjoy music they love anytime, anywhere.”

Show us the money

All of that’s good and well, but where’s the money? With all that engagement going on, the advertising revenue potential for the likes of Pandora should be enormous.

In fact, total advertising revenue increased 45% in the first quarter of 2014 to $140.6 million, compared to $96.7 million in the same quarter last year. And encouragingly, it’s mobile that’s really driving the growth with mobile ad revenue accounting for $103.1 million, an increase of 59% over $65 million in the same quarter last year.

In terms of ad loads and sell-through rates, in 2013 the firm topped out at four ads per hour. For 2014, that number is up to six ads per hour.

There’s a self-inflicted challenge ahead as the firm alters its pricing. The monthly price of its (ad free) Pandora One service is going up by $1 to $4.99 per month for new subscribers. If you’re already signed up, the price hike doesn’t come into play - or at least not for now. In addition, the existing annual subscription option will be removed.

McAndrews expects any drop in subscription revenue as a result to be balanced out by increased advertising revenue. He adds that the firm needs to reflect its own costs:

“Over the past five years, content cost for this service has increased 53%. In order to optimize our business in a market with increasing content cost, we are implementing changes to our Pandora One pricing, resulting in a modest price increase to $4.99 per month for new subscribers and a discontinuation of our annual subscription option.”

Pandora uses a metric called RPM to measure monetization, with RPM standing for advertising revenue per 1000 ad supported listener hours. Total non-GAAP RPMs reached $37.55 in the first quarter, up 37% compared to the year ago period RPM of $27.4 while mobile advertising RPMs reached $29.46 in the first quarter of 2014 increasing 44% from $20.43 in the same quarter last year.

But returning to its ambition to be measured against traditional radio providers, part of the motivation for that is obviously to get at the advertising budgets allocated to local radio. To do that, Pandora is increasingly using measurement data from third-party firms like Strata, MediaOcean, and Triton Digital rather than its own metrics.

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So, for example, it partners with Triton Digital to measure its audience nationally and locally with the aim of providing advertisers and ad agencies with reliable listening numbers upon which to base buying decisions.

This ambition was helped recently when Triton’s Webcast Metrics local product - which provides radio metrics and average quarter hours in local market - received full accreditation from the powerful Media Ratings Council (MRC).

This is a big step, reckons McAndrews:

“The seal of approval underscores the fact that Triton’s measurement methodology meets the highest standards accepted by agencies, clients and publishers across our various industries. More importantly, it validates that the local audience data we provide to our clients is reliable and effective.

“Traditional broadcast radio planners can now more easily recommend Pandora in their local allocations of budgets to the radio buying group and include Pandora in their standard operations and workflow processes.

“The inclusion of Pandora measurements via Triton Webcast Metrics locally in Telmar is yet another positive indication that the demand for online radio in general and Pandora specifically is growing among the broadcast buying community.”

In the local advertising market, targeting is all important for traditional radio media buying, he adds:

“It’s the basics of demographics. It’s age, gender, and then you use patient types in order to determine kind of some level of demographics, whether you’re buying country music or rock music. And you get a natural sort of geo-location by essentially where – what counties these stations have a tower and what’s within 50 miles of that tower.

“It’s very high level sort of targeting. And that’s what those platforms are built around. Pandora, because of our first party data we collected at registration, we actually have all that information in extremely accurate fashion. So it fits very well into the radio buying profile once converted into AQH and Q, and the metrics that radio buyers buy.”

Apple threat

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There’s another reason for wanting to get this ‘we are radio’ meme firmly established in the minds of advertisers and that’s the lurking threat from Apple which could ramp up come June’s Worldwide Developer Conference.

According to the inevitable pre-Apple event scuttlebutt, the firm plans to integrate song recognition technology into the next update to iTunes and iTunes Radio, providing a competitive differentiator that Pandora does not offer. Partnering with music identification service Shazam, the app would be able to capture a song via the iPhone or iPad’s microphone using its voice-activated search feature, Siri, and match it in Apple’s iTunes database.

There is also ongoing speculation about an official iTunes app for Android which would increase the Apple footprint enormously if it can swallow such a move.

Verdict

The US radio ad industry generated over $17.6 billion in revenue last year, so it’s entirely understandable that Pandora wants a bigger slice of that action.

The firm’s making all the right noises and partnering with the right people. It also won an important psychological battle when a federal judge ruled that it was in fact a radio station.

But the competition is getting tougher and costs are only going to keep on rising. Pandora bumped up its own advertising budget by 63% to $61.9 million last quarter and it has to keep marketing heavily in order to beef up the subscriber numbers.

It also pays out more than half of its revenue in royalties and that position could clearly get worse if the record industry establishment get its way.

With this latest law suit now filed, there is a definite sense that the events of the coming months will see an important tipping point reached. This will be one to watch with interest.