Online Music Industry Needs to Stop Catering to Freeloaders

The growing popularity of internet radio stations has led several technology giants to enter the space. In June, Apple announced the release of iRadio, its online radio offering, to directly compete with internet radio stations like Pandora. Google also entered the space with the release of a paid service, Google Access, that lets users listen to on-demand music. Microsoft too is updating its XBox’s music offering to add a subscription service that will let users create stations based on artists and music genres and stream live to mobile devices as well as XBox consoles.

Pandora’s Financials
Meanwhile, Pandora’s (NYSE:P) Q1 revenues grew 58% over the year, and GAAP total revenue was $128.5 million. Advertising revenues grew 49% to $105.1 million and subscription revenues grew 114% to $23.4 million. The company ended the quarter with a loss of $0.10 per share.

Operating metrics continued to improve. During the quarter, listener hours grew 35% to 4.18 billion. Pandora’s active user base grew 35% over the year to 70.1 million and their share of U.S. radio listening grew to 7.33% in April compared with 5.86% a year ago.

For the current quarter, Pandora expects revenues of $155 million-$160 million with a loss of $0.02 per share to earnings of $0.01 per share. It expects to end the year with revenues of $615 million-$635 million. EPS is projected to be between a loss of $0.02 per share and income of $0.08 per share for the year.

Pandora’s Market Expansion
Pandora recently announced that more than 2.5 million automobile drivers will now able to listen to Pandora radio as the company extended its partnerships with 23 automotive brands and eight aftermarket manufacturers. It estimates that nearly a third of the new cars sold in the U.S. this year will come with Pandora pre-installed. The radio station is available in more than 100 vehicle manufacturers and makes, including Acura, BMW, Buick, Cadillac, Chevrolet, Ford, GMC, Honda, Hyundai, Lexus, Lincoln, Mazda, Mercedes-Benz, MINI, Nissan, Scion, Suzuki, and Toyota. As part of this expansion, Pandora plans to extend this arrangement with other manufacturers, including Dodge, Infiniti, Jeep, Kia, and Ram.

Pandora’s Fight for Lower Royalties
Royalty payouts remain a big concern for Pandora. Last year, it is estimated, that the company paid nearly $0.12 per stream. That cost is expected to rise to $0.14 within the next two years. Pandora needs to work hard to reduce costs if it ever hopes to make its business profitable. Earlier this year, Pandora capped the number of hours that a free mobile device user can listen to music on their service to 40 a month. Pandora hopes to convert free subscribers to paid subscribers through this capping and earn extra revenues to cover their growing costs.

At present, royalties paid by radio stations vary depending on whether they are traditional satellite based or Internet based. Internet radio stations pay some of the highest royalties in the industry, a practice that Pandora believes is unfair. Satellite radio stations need to pay about 7.5%, cable radio stations 15%, and Internet radio stations like Pandora pay 60% of their revenues as royalties. Things become even more worrying for Pandora because the rules allow for players like Clear Channel, which has both terrestrial radio stations and the Internet radio station, and iHeartRadio, to pay lower royalty fees. Pandora has thus been fighting for the Internet Radio Fairness Act, which will be able to end this discrimination.

Besides lobbying for ad changes, Pandora also recently bought a traditional terrestrial radio station to lower its royalty costs. Earlier last month, it bought KXMZ-FM of Rapid City, South Dakota, which will enable them to reduce some of their royalty charges. Terms of the deal were not disclosed. The music industry is not impressed by the move as it thinks Pandora is artificially reducing royalty payouts through these moves. Pandora has already received a lot of flak from artists such as Pink Floyd for its poor payouts.

Competition Heats Up
The increasing competition is not making things easier for Pandora. There are Internet players like Sweden-based Spotify who are becoming major players in the industry as well. Spotify also has a Pandora-like offering where users select the kind of music that they want to and Spotify identifies other music that may interest these listeners. Listeners can choose to access Spotify for free or take an ad-free subscription model for on-demand listening. Their radio service caters to more than 24 million monthly active users and has 6 million paying subscribers. Spotify has a bigger collection of songs and boasts of a catalog of 20 million licensed songs, compared with Pandora’s comparatively meager collection of one million songs. Despite the former’s massive library, Pandora beats Spotify hands down on its subscriber base. But like Pandora, Spotify suffers from high royalty costs, which have hurt its ability to turn profitable. Despite revenue estimates of $889 million this year, Spotify is expected to continue to suffer losses.

In April 2013, the market was abuzz with news that Google was looking to acquire Spotify for an estimated $4.2 billion, but Google decided to launch its own music service, Google Play Music All Access, instead. Priced at $9.99 per month, Google Access will grant users unlimited to access to on-demand music on the go. Google has also signed licensing deals with all three major record labels in the U.S. for its music service.

Apple is also not to be left far behind. Like Pandora, Apple’s iRadio will be offered as a free ad-supported version as well as an ad-free subscription based version. But what makes iRadio different is the agreement with the music industry. Besides the per stream payout to record labels, Apple is also sharing 19% of its ad revenues with the labels. Pandora can definitely not afford such payouts as ad revenues are helping it stay afloat. Revenue sharing deals such as those announced by Apple will hurt Pandora’s already worsening relations with the music industry. Apple can afford such deals because of its massively profitable portfolio of businesses.

Pandora’s stock is trading at $19.94 with a market capitalization of $3.49 billion. It touched a 52-week high of $20.29 earlier this month.

I hope that users will get off the freeloader mind set, and start paying for services like Pandora and Spotify, as well as Google Play Music and Apple’s iRadio. It costs money to produce, market, and distribute quality music. I don’t see why consuming that music should be perpetually free.