Pandora disrupts the commercial radio signal

Despite a relatively low-key entrance into the Australian market, Pandora is already making some serious noise.

The online service, widely popular in its home market of the United States, officially launched in December of last year, helmed by former Fairfax Digital executive Jane Huxley. To date Pandora has taken a soft approach, picking up users through word of mouth and offering users a deep digital music product at no charge.

Pandora is different to the likes of Spotify, rdio and Deezer in that it isn’t an on-demand product where a user can access any song they want at any time, rather it mimics radio in that it serves up music to you based on your preferences and listening habits. As an experience it is a very different one to the streaming, on-demand services.

After a lot of bluster in 2012, the area of music online hasn’t been as heavily hyped in 2013. Last year, products like Deezer, Spotify and rdio entered the Australian market generally with free, ad-supported models and paid, non-advertising carrying, products.

Reported takeup across the board for the paid, premium products has been poor, with most users looking to engage with the free products. Ad supported subscription services, according to ARIA figures, contributed $9 million to the recorded music industry in royalties for 2012, with premium paid services contributing just $2.1 million. Combined these make up around 4 per cent of total revenues for the recorded music industry.

The challenge for the on-demand services is to create a viable business model amongst some challenging situation factors. The biggest? Royalty rates paid to record labels for the on-demand services account for a large proportion of total revenue. Unlike radio, on-demand services need to negotiate on a case by case basis with labels and labels are free to block their content from these services if they do not believe a deal is equitable. Radio doesn’t have this problem – it is protected by government revenue which mandates it pays a very small percentage of gross revenue to the requisite collections body in Australia. According to industry body PPCA, the present rate of the commercial broadcast licence fee is about 0.4 per cent of gross revenue of the commercial radio industry.

On-demand royalties mean the businesses engaged in this area have scaling problems – the bigger they get the more they pay out. Combine this with a reliance on users accessing the free product and the economics are extremely challenging. Despite businesses like Spotify raising funds in late 2012 on a valuation of $3 billion, no one seems to be clear on what the model to profitability looks like for these services.

Pandora is not without its own profitability concerns either. For the 12 months ending January 31 2013, it lost $37 million from its revenues of $427 million. For the same period the year prior it lost $10 million from revenues of $274 million.

Right there is the issue. Revenue increases by over 70 per cent year on year, but losses triple for the same period. The killer is the content acquisition costs Pandora incurs in the US. Over a 12 month period in US fiscal 2012 these equated to $148.7 million. For the same period for fiscal 2013 these were $258.7 million, a 74 per cent increase.

However, it appears in Australia Pandora may not be subject to such high licencing costs. Huxley has stated that Pandora in Australia is not a streaming service. “We are not a streaming service. We operate under a radio licence but it’s highly personalised. There is a big factor of discovery in Pandora you don’t get on a terrestrial radio station.”

Joan Warner, chief executive of Commercial Radio Australia was far from amused at Huxley’s claims. The two engaged in a very public back and forth on trade website Radio Today. Warner’s tone indicated that CRA is somewhat concerned about this new entrant.

And they have good reason. Whilst Spotify, rdio and the like are good services, they are not a replacement for good radio. If anything, they are complimentary and present a larger threat to music sales rather than radio listenership. Pandora is a direct threat to radio as it takes the experience of radio and enhances it using digital technology. It is also looking to get its product into automobiles, recently signing a deal with General Motors, which has seen Pandora locally integrated into the Holden Cruze. Make no mistake, Pandora has its eyes set on the $680 million plus radio advertising pool.

The bigger potential issue is the implication by Huxley that as Pandora isn’t a ‘streaming service’, it perhaps shoudn’t be liable for the same licencing fees as the streaming services instead paying the same percentage of gross revenue that broadcast radio does. For commercial radio this is perhaps its strongest competitive advantage against digital disruption. The odds are stacked against the digital services as the amounts they are required to pay to rights holders are too high to develop a sustainable model without significant amounts of venture funding.

Commercial radio doesn’t need to worry – it is protected by legislation that keeps its royalty payments to set levels and ensures even in sluggish advertising markets the commercial broadcasters maintain healthy profits. It could be argued the present situation is stifling innovation in the way Australian’s consume music.

Pandora is definitely one to watch locally, both in terms of how it grows users and presence, and also how its broadcast competitors react.