Pandora's Box

I never thought I'd say this, but Pandora needs to start monetizing their stream with more on air ads. They need to make this business model succeed. I have been a listener for well over three years and have come to appreciate and even rely on the free music service. In a world of ever growing musical choice it is nice to know that I can just simply turn on Pandora and let it do all the work for me. I keep asking the question, how can this last? How can Pandora continue to fund its business paying hefty royalty fees and only getting modest income from ad revenue?

As I looked a little deeper into what Pandora is doing I found that they are implementing a very smart and potentially effective strategy. At the beginning of last year they started experimenting with in stream ads and began inserting short 15 seconds ads every 20 songs in their free streaming service. Paid subscribers of their premium service at $36 annually do not receive these ads, but the free listeners of over 50 million strong do. This was the initial opening of Pandora's box. They can drive both free ad driven services and subscription based ad free services.

In order to get this to work they also needed to get the RIAA on board because without a solid agreement in place Pandora's business model remained on very shaky ground. In July of last year they finally struck a deal with the RIAA so that the royalty payments could not be greater than 25% of their annual revenue. Prior to this deal, Pandora had paid up to 70% of it revenue in royalty payments which made the prospects of this business seem dismal. Now Pandora could go out and confidently sell ads and claim legitimacy in the internet radio world. With this deal in place, Pandora pulled in about $40 mil last year in advertising revenue and in the words of their CEO Tim Westergren were on their way way to becoming profitable now.

Pandora is now moving to become a strong competitor to traditional terrestrial radio. While their royalty rates are higher, they have a much larger national audience, and they can provide more targeted customized ads to its listenership, making the ads they serve more valuable to its advertisers. Just this month Pandora rolled out its SMB Initiative to target small and medium sized local businesses for on air ads. This move will put Pandora in a head to head position with local radio stations.

I have a strong feeling that if this is executed well, this will pay off big time for Pandora and in the end I will be able to continue to get my free personalized music service, even if I do wind up paying for the subscription service. Either way, we both win.