The Disconnect Between Love and Profits: A Pandora Story

This weekend I came across a Business Insider article that described why buying Pandora stock doesn’t make financial sense. The key takeaways? More listeners are using Pandora on mobile, which in turn hurts ad rates, Pandora won’t be making much money on ads anyway, and the costs of paying music royalties are getting higher and are eating away half of Pandora’s revenue. The outlook is bleak and as music label royalty rates increase through 2015, and possibly beyond, one can only imagine the difficulties lying ahead for Pandora to turn a profit.

As Hypebot pointed out in a recent post, analyst Rich Greenfield of BTIG had some sobering remarks regarding the impending Pandora IPO:

“As consumers we love Pandora. It is free, incredibly easy-to-use, works across a growing array of platforms in/out-of-home, and has a de minimis amount of advertising compared to terrestrial radio…Investing in Pandora is a whole different story. While Pandora is creating a large active user base, its reach/frequency continues to pale in comparison to terrestrial radio, as does its profitability….We recommend investors do not participate in the Pandora IPO.”

Ouch! With every article I come across, people question the future of Pandora and its ability for financial success. They almost went under in 2007 and we don’t know what’s in store in the coming years. While there is still the possibility that Pandora finds its way into more devices and even into every new car, there are no guarantees that Pandora will be able to penetrate the market to the extent it needs in order to become a profiting juggernaut.

This disconnect between the love people have for the product and its ability to monetize is a problem faced by many digital companies in recent years. Facebook struck gold with their ad platform and other strictly online sites have been able to succeed off a freemium model (meaning free for most users with the premium, paid accounts carrying the financial burden for the rest). Unfortunately for Pandora, not enough users are willing to pay $36 per year for a premium account to make the freemium model work on a large scale.

For many digital companies, if you build a compelling enough product then you can expect a small but meaningful percentage of your users to pay to use it. By allowing people to try it your product for free and only upgrade if they want premium features, you can build a large enough userbase while still getting enough loyal subscribers on the premium side. With Pandora, on the other hand, the users tend to be listeners who are passively listening rather than engaging in multiple ways (as you would find on other more social sites). Most listeners expect music to be free and don’t gain much utility from the product otherwise, so it’s harder to get them to pay when they can look elsewhere for music (Grooveshark, Spotify, etc.).

The lesson from all of this: no matter how many people love and use your product, you don’t have a guaranteed road to financial success unless you can find a model that works for both the company and its users. With Pandora fighting an uphill battle against increasing royalties and content costs, the future remains shaky. Until then, many will probably hold off on purchasing Pandora’s stock when IPO time rolls around. Of course in a hot market like we’re in right now, many won’t be able to resist.