Photo: BI Intelligence
Online radio Pandora reported quarterly earnings, and the stock jumped because revenue increased faster than anticipated, 58% y/y. However, total costs and expenses were up a striking 80%. Losses widened from $6.8 million to $20.2 million (Pandora showed a smaller earnings per share loss, but that’s because it had increased its number of shares outstanding). Pandora’s product is widely beloved (see chart at right) but its business model looks really problematic, and that is for two reasons:
- The digital music business is still terrible. Before Pandora pays anyone on staff, half of its revenue goes right back out the door to record labels. But that’s not the only problem.
- Pandora is in a business—radio advertising—which is particularly hard and expensive to scale. Why? Because by and large, radio advertising is predominantly local advertising. And selling local advertising requires building a large, on the ground sales force to sell ads from local advertisers.
We don’t want to howl with everyone else who says Pandora will “never” be profitable, but it certainly has a very tall hill to climb. Those two cost disadvantages compound so that for every incremental dollar of revenue, Pandora has to spend very close to, if not more than, a dollar. Some of that is investment that will potentially pay off (at some point those salesmen will start bringing in bigger buys) but some of it is just operating cost. This cost structure disadvantage is terrible: paying record labels and an army of sales people is something that’s enormously expensive even before Pandora can pay for things like servers, offices and other staff. No wonder the company’s not profitable, and doesn’t think it will be in the foreseeable future.
And the reason why this is particularly unfortunate for Pandora is summed up in one word: Spotify. For Pandora, which is an entrepreneurial success story that one is inclined to root for, the problem is simply that Spotify has both a better product and a better business model. Unless something changes radically (and we don’t much see what), Pandora looks seriously threatened over the long term.
Spotify won’t “kill” Pandora tomorrow, or the day after, or possibly ever. Right now, the universe of music listeners with internet devices (basically, everyone in America) is so large, and Pandora and Spotify still so small (several million users each) that they are like ships in the night passing each other.
But it’s hard not to notice the advantages Spotify has:
- Spotify lets you access all the world’s music at your fingertips. Want to listen to a song? Type its name it, click, and boom, you’re listening to it. Largely for licensing reasons, Pandora can’t do that: it can only build customised radio stations around songs you pick or genres or artists. And some people like that better than Spotify’s buffet—they want to listen to music they like without having to think about what they want to listen, like they do with radio. But now Spotify also has radio so that Pandora advantage is gone. Spotify has become a platform with many apps sitting on top of it. More broadly, in this writer’s subjective opinion, Spotify’s desktop-based software is a joy to use: beautiful and responsive. Meanwhile Pandora’s web-based interface feels somewhat clunkier. For consumer products, these things matter.
- Spotify’s freemium business model is much more juicy than Pandora’s advertising-based business model. Pandora has a subscription option, and Spotify has advertising, but at its core Pandora is an advertising-driven product. Meanwhile Spotify’s goal is to get you to pay a monthly subscription. And Spotify has been stunningly successful at getting people to convert to paid usage. This recurring, direct revenue is obviously a much better revenue model than radio-style advertising which isn’t particularly targeted or interesting in some innovative way. Spotify still has the cost problem of paying licence fees to record labels, but it doesn’t have to tack on the added cost of a huge local ad sales force and almost certainly gets (much) more revenue per user.
If markets are about survival of the fittest, then Spotify looks like a step above the darwinian ladder compared to Pandora.
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