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.
- 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
- Business Wire: “Digital Music Subscriptions Services Market Report: 2015: http://www.businesswire.com/news/home/20151009005697/en/Research-Markets-Digital-Music-Subscription-Services-Market
- Pandora’s 2014 10-K Annual Report. Available on SEC Edgar.