Pandora’s Epic PR Fail (And the Future of Internet Radio)

Pandora Radio has experienced some pretty incredible growth over the last several years. Today, the company lays claim to nearly 80% of internet radio traffic in the US, a category which has grown 33% since 2007.

With over 175 million monthly users, Pandora is the second most popular music-only streaming service on the web, right after SoundCloud. All of this has made founder Tim Westergren a very rich man. Not quite as rich as Daniel Ek of Spotify, but wealthy indeed.

Westergren has already cashed in much of his share of the company to big equity firms like Greylock Partners and Crosslink Capital and now retains less than 2.5% ownership. Last year alone, this reportedly earned him about $13.9 million. “It’s been a wonderful story,” he said at a Future of Music panel in 2012. “Our listenership just keeps exploding, and so does our revenue.”

It’s hard to begrudge Westegren his success. Anyone who’s used Pandora can tell you it’s an extremely well-realized service. It offers a seamless, user-friendly platform that adapts to the listener’s tastes. And at this time, it’s entirely free for most users, and has almost no ads.

One of the reasons Pandora and other internet radio companies have been able to sustain such growth is that in 2009, musicians’ groups gave the company a steep discount on its royalty rate to help the company grow during the awkward start-up stages. That year, Tim Westergren exclaimed “the royalty crisis is over!”

“…Pandora is finally on safe ground with a long-term agreement for survivable royalty rates,” he wrote on his company blog. “This ensures that Pandora will continue streaming music for many years to come!”

Within a few short years, he had changed his mind.

Enter IRFA

Tim Westergren’s proposed legislation, “IRFA” has become one of the most maligned acronyms since SOPA. It’s perhaps even better known for it’s Orwellian-sounding proper name “The Internet Radio Fairness Act.”

Opposing members in Congress quickly took to calling it “The UnFairness Act” and  “The Paycheck Reduction Act.” Meanwhile, musicians came up with more colorful re-brandings of the acronym, like “Income Reducing Freeloader Association” and “I Really F* Artists.”

By the end of 2012 the proposed bill, which promised to cut artists’ royalties by as much as 85%, seemed as dead as a Billy Ray Cyrus’ career (and just as manufactured.)

But in a surprise move, Pandora quietly began taking steps to revive the bill this spring, trying to drum up artist support through a series of vague and allegedly misleading letters. It backfired.

To Reduce Paycheck, Sign Here

In a letter signed by Tim Westergren, Pandora asked musicians to join their efforts to reduce royalty rates and sign a petition letter that read “We [are] fervent supporters of internet radio and want more than anything for it to grow; and grow as fast as possible.” (Emphasis original.)

The musicFIRST coalition, a prominent artists’ advocacy group, called itThe Worst Music Industry Scam Ever Seen,” and launched their own counter-petition titled “Tell Congress: Don’t Slash Music Creators’ Pay.

Meanwhile Blake Morgan, a musician who earned just over a dollar fifty for nearly 30,000 spins on Pandora, published his email exchanges with Westergren on the issue. It did not make Pandora look good. The company’s stock plummeted by $120 million the following day, or almost 5% of their entire valuation. (It has since recovered.)

“Just imagine,” Morgan told Bloomberg news at the end of May, “any other industry that says the only way we can stay in businesses is if we don’t have to pay for the only thing we’re selling.” He called the email “heartbreaking” because “in the beginning, we all loved Pandora.”

But what bothered him most was the double-speak he saw embedded in the company’s efforts: “I didn’t come out against Pandora,” he said. “I came out against lying.”

By The Numbers

For all its misleading rhetoric, there was some substance to Pandora’s claims. Internet radio stations may in fact pay a slightly higher rate per stream than terrestrial radio stations.

There are a few reasons for this. From one perspective, America’s early radio magnates were able to weasel their way out of paying artists performance royalties. (They only other countries in the world where this is the case are Iran, China, North Korea and Rwanda.)

From another perspective, terrestrial radio was offered a lower rate because it was seen as an effective promotional platform for musicians in a way that Pandora has not yet proven to be.

But instead of looking to bring parity to the system by recommending that traditional radio finally be held accountable for these fees (a move that might have brought incredible grassroots support from the music community) Pandora instead sought to join the ranks of Kim Jong Un and Clear Channel.

Today, Pandora claims that they pay 50% of their revenues to musicians, while satellite and terrestrial radio might pay as little as 10%. This is true as well. But the reason for this disparity is not tied to any difference in rate. In fact, Pandora is purposefully denying itself revenue so that it can focus on growth and dominate the market, much like Amazon and Spotify before it. That is their business model.

What accounts for the difference in payout is a difference in revenue, not costs. Conventional radio often plays upwards of 13 minutes of ads per hour. Pandora plays just 1 minute of ads. If Pandora increased revenue by playing 10 minutes of ads, this revenue gap would instantly disappear. Similarly, satellite radio charges sustainable subscriptions. Pandora is free for the first 40 hours, and costs just $0.99/month for users who exceed that high figure.

Forbes quotes BTIG analyst Richard Greenfield, a longtime advocate of Pandora who has called the company’s proposed legislation “crazy.” He agrees that the issue lies not with the current royalty structure, but instead with their failure to appropriately monetize their business:

“[T]he reason why companies such as Pandora pay such high royalty rates as a percentage of revenues is because they severely limit audio advertising to protect the user experience and keep people on the platform. If Pandora ran several minutes of audio ads per hour (the way terrestrial radio does) vs. just a few 15 second spots, the percentage of revenues paid out as royalties would be dramatically lower and would be more in line with satellite radio or cable TV. ”

“Just consider how crazy this Internet Radio Fairness Act really is: Pandora chooses to not generate as much advertising revenue per streamed hour as it could to enhance the user experience [in order to] capture share from terrestrial radio (based on lesser ad load), satellite radio and music downloading/playlist sites (iTunes)…

“So, Pandora is effectively asking the government to intervene and reduce its cost structure, helping it remain a viable business because it knows its business model only works while running limited advertising.  Why should the U.S. government allow musicians to be harmed simply to help Pandora and its investors generate enhanced returns?”

Like many musicians and third party analysts, Greenfield suggests that Pandora’s royalty rate, like all streaming rates on the web, should be increasing rather than decreasing. This action “would force them to either increase the ad load and survive at that ad load…or find other ways of generating revenue to sustain their service.” That’s just the nature of business — somebody’s got to pay for all this stuff.

Greenfield concludes: “Pandora may simply need a new business model if it hopes to exist long-term.”

That may happen someday. But for now, operating at protracted loss is a way for many tech companies to grow to a place where they become the only game in town. It’s a popular business model these days. And Pandora may choose to continue down this road for some time.

The Future of Internet Radio

For the time being, it’s probably wise to take the words that Westergren sought to put in musicians’ mouths as face value: “we want more than anything for it to grow; and grow as fast as possible.

Pandora is demanding that musicians, through action by Congress, subsidize that growth by cutting their own paychecks.

But what if that growth does occur? The most likely outcome is that musicians will have precious little bargaining power left to preserve fair payments down the road. For evidence of this, we need only look back to terrestrial radio, where musicians have never been able to secure performance royalties from the powerful broadcasting conglomerates, much to the bemusement of the rest of the civilized world.

Even with this aside, would it by wise to make these accommodations for a service that has not shown an ability to convert listeners into buyers in the same way that old-school radio once did?

Although it’s not a strictly on-demand service, Pandora does appear to become a replacement for album buying in many cases, rather than a supplement. Today, younger listeners aged 13-35 do nearly 1/4 of their listening through the service. And so far, it seems they supplement their online radio experience with album-buying and on demand streaming. Not the other way around.

For all the failings of terrestrial radio, it may very well be that “the new boss becomes worse than the old boss.”

Westergren says that musicians should forget the careers of the past, and instead strive to enter the shrinking middle class as their loftiest ambition. It’s a goal that may ring hollow when it comes from a man who- according to the SEC- was recently earning over $1 million each month in stock options, and is asking Congress to step into the middle of labor negotiations in order to lower his costs, without making a single gesture toward increasing revenue.

The Pandora “Radio UnFairness” debacle may go down as a demonstration of how not to win favor through public advocacy. Inciting grass-roots support requires not friendly rhetoric, but real listening, and policies that are borne out of the interests of average people in the field.

Had the company instead lobbied to raise rates on US terrestrial radio in order to match those of the rest of the world, Westergren’s campaign may have gotten somewhere. Instead, his company seems to have lost the trust of the music community. That faith that may prove difficult to restore.

This entry was posted in All Stories, Featured Stories, Industry Trends, June 2013, Most Popular, Rants and Raves. Bookmark the permalink. Both comments and trackbacks are currently closed.
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