Why Pandora Radio Cannot Turn a Profit

The job that Pandora is doing for its customers is that the company is providing a music streaming service. Its user base consists of customers who stream music for free (the main base—their streams are interrupted intermittently by advertisements) and those who pay for streaming (via subscription—the minority base). The users can enjoy unlimited hours of diversified music for free, only having to endure ads every so few songs.
By basically allowing users access to a huge pool of free content that can be streamed without charge, Pandora is essentially giving music away for free: it pays for the content (the company is charged a royalty fee for every song that is streamed) and since its user base is enormous and growing by the hundreds of thousands every day, the company is paying a lot in royalty fees—more, in fact, than it is making from its advertising revenue.
The effect is that Pandora acts like an Internet radio station. A radio listener is not obliged to pay for what is heard—the station makes money from selling advertising or from collecting donations or grants. Pandora relies upon advertising but is now considering charging its user base a fee for listening—either in the form of a subscription or in the form of a freemium (a user who listens to more than 40 hours of music per week would have to pay a dollar).
The company exposes listeners to a lot of new music that the base might otherwise never hear or be exposed to—so by charging users a small weekly or monthly fee, the company may not risk losing its user base, since there is still a discernible exchange of value that can be identified.
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Other Internet stations provide these services as well—I Heart Radio, iTunes, Amazon, SiriusXM, and others offer streaming services. What separates Pandora from the others is that up till now, users have basically been able to get their music for free. Pandora has been able to secure such a large user base so quickly and without marketing (mainly through word of mouth) because it has offered content at virtually no price to music lovers.
What happens if Pandora decides to start charging all users across the board? How does the company differentiate itself from other music streaming services? Pandora could quite possibly retain its market share by keeping its rates low—at least lower than its competitors. That would allow Pandora to generate more income and possibly turn a profitable quarter. Most streaming services are able to gradually increase rates and pass fees associated with the music industry’s royalties onto the consumer. This is understandable and Pandora, in order to maintain its service, will have to do something like this in the future. It will be able to continue to disrupt the sector by continuing to do what it does—which is to offer an eclectic mix of music to its listeners in a way that no other music streaming service is doing.
Pandora’s attractiveness for customers is that it sets itself apart from others by allowing the users to generate their own stations basically: the user sets up the framework for what it wants to listen to and then Pandora takes care of the rest—this is the essence of what makes the company unique.
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The key elements of Pandora’s business model are currently: 1) it offers free music for unlimited streaming to users; 2) it allows users to customize their station by selecting a frame for the type of music they wish to hear and basing alternate music choices at that initial selection. The user is free to change the frame at any point and begin a new station.
The business has never depended upon marketing because of the viral nature of the word-of-mouth marketing that users have done for free for the company. So this is one positive exchange between Pandora and its users. However, in order to be profitable Pandora has to receive revenue from somewhere—and that is why it has turned to advertisers. By collecting data from its users, Pandora is able to show to advertisers that they can market their goods and services to specific age groups, genders, and communities by looking at the data collected by the company.
Still, this approach has not enabled Pandora to be profitable: it is still paying more in royalties than it is collecting in advertising (mainly because many users leave the streaming service on all day and, since they pay nothing for it—Pandora does not pass the costs on to the consumer—they are not inclined to limit their streaming). Additionally, the advertising sector is beginning to crack as online advertisers look more deeply into whether online advertising is really leading to more sales for them.
That is why Pandora must change its business model to implement a revenue stream by way of subscription for all or freemium usage for some. Either way, the free music era must come to an end because it is simply not profitable. Pandora cannot afford to give music away for free. And if it chooses to continue to do so, it must also figure out a way to leverage its user base for income from an alternate channel.