Pandora: Betting On Radio's Failure

Why radio shouldn't be too cocky
 

Updated: The opening bell clanged earlier this week as executives Tim Westergren and Joe Kennedy and investors stood high atop the stock market floor for the IPO launch of Pandora.

It was an exciting day. As one who was an early player in the Internet radio space (RadioCentral Networks), I exited the Internet radio game about the time Pandora was starting, 11 years ago. It's fun to see an Internet radio startup launch an IPO.

Though Pandora's stock (NYSE ticker symbol: P) debuted strong at a 40 percent increase, the reporters at CNBC were pressing for answers: "How is Pandora going to make money?" CEO Joe Kennedy repeatedly responded that Pandora is building a long-term business and focusing on the listener experience. The reporters would not let up, asking the same question 20 different ways, trying to get an answer. Kennedy continued to talk about how Pandora has 3 percent of all radio listening and that its intent is to grow because radio listening is strong, making up 80 percent of all music listening. But the reporters kept asking Kennedy and other executives to show them the money. Not once did anyone say Pandora plans to make money. It was like a retro repeat of the dot-com boom days, when no one cared about making a profit.

And by the end of the week, it looked like those reporters' doubts were spreading to investors: Pandora closed Friday at $13.40, far below its $16 IPO price.

Pandora pre-IPO investors have put $91 million into the company, and no profit has been made, even with a claimed 90 million registered users. Unlike the traditional radio model, which has 40-50 percent margins and is not penalized in royalties for every listener it adds, Pandora has to pay bandwidth fees for every minute of streaming and artist royalties for every listener to every song it plays. Pandora must find a way to make money without growing its listening base, which means more paid subscribers, like Sirius XM, or more ads. Of course, the relative lack of ads is a big consumer attraction to Pandora.

So where is the secret sauce? Why have serious investors -- who are not likely to be rattled by the volatility of the public markets -- put big money into Pandora?

Those investors believe in the strength of the radio business, and they believe the core premise of pushing radio programming via transmitters is flawed for the future. They are betting on consumers and advertisers falling out of love with terrestrial radio. They are betting that radio will cling to the world it has always known and won't make the digital shift required to please advertisers and consumers, and that, like newspapers, radio won't be able to survive without cannibalizing itself. These investors are expecting that radio, like so many other non-digital businesses, will experience a sea change in its business model once connectivity -- and Pandora -- become ubiquitous in homes, mobile devices, and cars. They expect terrestrial radio to go the way of travel agencies and film for cameras.

So why did the bloom come off Pandora's rose so quickly after its exciting opening? Perhaps the reality of Pandora's unprofitability simply sank in a day late, and some analysts are saying they're relieved because the rapid turnaround may be a sign the IPO market is not in danger of becoming "overheated," while others say Pandora violated a very basic tenet: Don't go public if you're not making money.

But this is not a reason for terrestrial radio to get cocky. The people who have put tens of millions into Pandora are no fools.

I once attended a function with a group of Silicon Valley venture capitalists where an investor in Facebook was asked about revenues. He responded, "We'll worry about that later. Our primary goal is to build a strong and loyal base of users." Though I wanted to snicker, I also knew there was some sense in what he was saying. After all, most of the radio industry snickered when XM and Sirius emerged. I cautioned radio to not be overconfident or flip about satellite radio while we were saying people wouldn't pay for the service, nor would satellite make any money on advertising. Yet Mel Karmazin has made the company profitable and had top-line revenues of $2.8 billion in 2010, just ahead of Clear Channel. 
 
Though I recently made the point that Pandora is not radio, looking primarily at the differences terrestrial radio should be focused on since Pandora can do a better job at commercial-free music, I don't think our industry should write it off as a fad or a fluke. Pandora is about to ramp up, is opening local sales offices in your market (just like Google, Yahoo, Groupon, and LivingSocial have), and plans to capitalize on its popularity to bring advertisers on board. Though we can defend our position with statistics, we must not forget that all buying decisions have an element of emotion, especially at the local level.

A year ago my eyes were opened at a local community street fair when three bright green Groupon vans pulled up and about 20 college kids in Groupon shirts started handing out prizes. It was an eye-opener that an Internet company was penetrating locally and doing radio-like street promotions. We also must not forget that Pandora can make money on things other than audio commercials, like player ads and direct marketing to its user base. Why not compete with Groupon? What if Pandora starts doing radio-like promotions in local markets like Groupon is doing? Would a direct attack on a core radio strength bring back its appeal to investors? (And what will Groupon's planned IPO look like?) 
 
Though it's tempting to grunt about how radio is strong and will always be strong and how Pandora will be like so many other fad products that challenged radio, I'm also a realist. Pandora is funded by some of the smartest investors in Silicon Valley. These investors are used to hearing people laugh and ask how they plan to make money, yet they usually figure it out.
 
I may have been 10 years too early into the online radio business, but I still believe that radio must not ignore the challenge that online radio may someday become a real competitor. Jerry Lee may be right that he cannot monetize streaming radio today, and it may not be reasonable for terrestrial radio to expect to make money on streaming. But that's assuming nothing changes. Like all other industries impacted by the digital world, we may someday see a shift.
  
At the root of all of this is the fact that radio is strong and everyone wants to take a piece of our revenues. When everyone is targeting you, it's easy to get cocky and say, "They all want to be radio, but they'll never figure out how to steal it from us." Yet my belief is that when smart people are after you, there is a chance they will find your vulnerabilities and find a way to take away your golden goose.  
 
A little paranoia is healthy. Being proactive is smart business, just like it's smart not to ignore a new competitor entering the market. Radio's new competitors are hoping you'll ignore them and remain confident that radio can't be touched. That's all the more reason radio needs to stick to its knitting and make sure we as an industry continue to serve our listeners with what they want. It's why we must continue to be entertaining, engaging, and locally involved. Those key factors built our loyal audiences, and it will be those factors that keep them loyal. But we also must continue to innovate and play hard so we can compete in a digital world. Being cocky and not paying attention is how we could allow others to take away our dominance. Others, like Pandora, are counting on it.
 

Comments

[Rick Hayes. [email protected]]

If radio is to be nothing more than a medium which plays songs from a hard drive, interspersed with voice tracks and spots,radio better be worried about Pandora because Pandora does music better than radio. If you want to hear how radio kicks Pandora's butt, listen to what Jerry Dietz is doing every day on KCSI-FM, Red Oak, Iowa. Listen to Steve Swick's WLKI, Angola, Indiana (Steve is also digital with 2 separately programmed HD channels which he re-broadcasts on translators). Check out Larry Mariner's KDLK in Del Rio, Texas. These are just a few very local
broadcasters who know that local radio is unbeatable. You might get a kick out of the birthday greetings, obituaries, real estate closings, birth and wedding announcements, endless local news, network news, commodity reports, recipes, swap shops, graduation notices, weather forecasts, talk shows, and a little bit of
music to give the guy on the board a chance to smoke a butt and maybe go to the bathroom. Real radio. Local radio. There's nothing like it. Except in a very few markets. Those towns are very lucky.

[William Bowin]

While I'm the chief engineer for our company, I believe that my position is more important that just fixing a sales computer or installing a new headphone amplifier. I'm the technical rudder for this company and do my best to stay apprised of the latest trends, both technologically and socially.

That being said, while I greatly respect Jerry Lee's opinions, I have to politely disagree with his decision not to stream. When it comes to making money with streaming, as you mention in your commentary, "we'll worry about that later." Radio's traditional delivery method, including HD, is dated and will some day go the way of analog TV. With cable penetration in the neighborhood of 85%, over the air viewing is only a small portion of TV's audience. Radio needs to exploit every possible delivery method in order to maintain and grow our "loyal base of users". Streaming, podcasting, smart phone apps, they're all essential. When new delivery methods become available we'd better take advantage of them too. In this age of technology, radio stations are nothing more than content providers that just happen to have a license to emit RF. If we don't take advantage of every delivery method available to us, we'll end up in the sinking ship right next to the newspapers and other print media.

My youngest son, a college student who obviously grew up in a radio household, recently installed a new radio in his car. Shortly after he commented to me "Hey dad, this radio has Bluetooth and I got it to connect right up to my phone. Now I can listen to Pandora and my iTunes playlist through my car's speakers." If radio is to have any future, kids now days have got to grow up listening to it and failing to stream or provide smart phone apps is just a nail in the coffin. Fail to provide compelling local content and they won't even try.

[Burt Sherwood]

this ia a brillant article, well thought out and properly presented.
"
For years we have said "it is only a matter of time". Perhaps it is time to wake up and smell the "coffee" Great thoughts Eric!
Burt

[Gary Willson]

You seem to have a vision for how to blend both radio and online radio. Lets hope those guys don't figure that out and take you away from radio by putting you on their management team or board of directors. Seems they would increases their chances of success substantially by doing that.

[Rich Sadowsky]

Darn this iPad, I couldn't figure out how to edit my post. It needs the equivalent of arrow keys so you can scroll within a text box. There probably is such a feature but it isn't very discoverable. Back to the hockey game. Go Bruins!

[Rich Sadowsky]

It was truly an honor to be part of your brilliant vision of the digital future of radio when we build RadioCentral. It is interesting how much has changed in the decade since but even more interesting how much has stayed the same. Many of the same operational challenges we faced remain the same obstacles that Pandora faces. While streaming services may be more of a commodity now than they were for us, the same harsh reality that you must pay an incremental fee for each new listener still remain a basic truth. I believe it will take more than just a clever business model to turn a service like Pandora into a profitable company; it will also take a technological breakthrough that wrestles the cost structure to the ground. So while the reporters are peppering Tim and Joe about how they plan to MAKE money, I would like to know how they plan to manage operational expenses. I see many possible avenues for this as this new age of cloud-based hosting emerges. Imagine if the challenge of delivering the songs is shifted from Pandora's servers (or Pandora's CDN's servers) to a cloud service such as Apple, Google or Amazon that handle the delivery over the last mile (or the last inch as I like to think of in this age of mobile devices). If Pandora doesn't exploit this emerging opportunity someone else will. At the end of the day people want compelling listening experiences. Pandora has some good core technology for generating compelling playlists but I have yet to see any breakthrough innvovation that will help really disrupt the operating cost structure. Their costs must be quite high with a need to create a custom experience for each listener's channels. If I was looking to invest I'd want to peak under their kimono and understand the technology roadmap.

Switching gears back to the revenue generation side, I see so many revenue producing opportunities lurking just outside of view. Think partnerships with LiveNation, tighter integration with their listeners online social networking activities... I recently pitched a business development idea to Tim over email and got back a polite messge about how many such pitches he was getting but he needed to focus on the IPO. Now that the IPO is behind them I can only imagine what the biz dev pipeline looks like!

[Jay Clark]

Right on. J.

[Anonymous]

This 'graph in your article piqued my interest:

>>A year ago my eyes were opened at a local community street fair when three bright green Groupon vans pulled up and about 20 college kids in Groupon shirts started handing out prizes. It was an eye-opener that an Internet company was penetrating locally and doing radio-like street promotions. We also must not forget that Pandora can make money on things other than audio commercials, like player ads and direct marketing to its user base. Why not compete with Groupon? What if Pandora starts doing radio-like promotions in local markets like Groupon is doing?<<

This was most interesting because "radio-like promotions" have become extinct! The collateral damage of all the cuts in the last few years: eliminating the street teams pounding the pavement, doing van hits in hot ZIPs, canvassing street fairs. In my market, unless a client is paying for the "street team" (read: promo kid) to come out and set-up, those hours are non-existent. Rolling a van load of kids out to where the people are, to hit-up potential listeners and advertisers with specialty items? LMAO!

It seems as an industry we are completely moving away from the basics that ingrained radio into our culture. Our legacy of being on the street, connecting with people and building our radio stations one listener and one advertiser at a time has been foregone as we chase bigger margins by cutting costs with technology-based (read: virtual radio) solutions that actually are moving us further away from local, in-your-face station-building.

How paradoxical, but perhaps fitting, that our enemies (Internet radio, Groupon, etc) are pushing into our territory by using radio's tried-and-true tactics, while radio abandons the things that got us here and instead invests resources to become more like the enemy, adopting more of the areas where our enemies are weak (read: automated playlist, non-existent local presence, etc).

The formula for keeping our industry healthy and growing: get back to investing in local people, and return to executing our basic marketing tactics to promote all the things TODAY's radio has to offer. That's how we get to higher margins over the long term and fortify our loyal audience and advertiser bases.