rushdee work sample pandora case study

7/26/2019 Rushdee Work Sample Pandora Case Study

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Rushdee Dewan

Economics of Information & Technology

10 March 2011

Case Study: Pandora

Pandora is a personalized online radio station. In 2010, the company made about $114

million in sales, and in February 2011, they filed with the SEC to raise up to $100 million

in an initial public offering1. The company started in 2000, and in its early years, co-

founder, Tim Westergren and his team worked without salaries and struggled to find

investors for a three-year period. Over the years, Pandora switched business models,

overtook competitors, dealt with increasing artist royalties, chased new platforms and

strategized to their way to success. This paper investigates the process through which a

project of coding music became a multi-million dollar company.

Pandora and the Music Genome Project

In 2004, Tim Westergren and his friends in San Francisco launched Pandora as a direct-

to-consumer Internet radio service. Pandora is a free and highly customizable online

radio fuelled by the Music Genome Project.

In January 2000, composer and musician Tim Westergren, a team of musicians

and technologists under the guidance of Stanford University professor Nolam Gasser,

created the Music Genome Project. They collaborated to create a highly comprehensive

analysis of music. Their idea was to build a music discovery engine by “capturing the

essence of music at the most fundamental level.” The group organized hundreds of

musical characteristics or “genes” into an elaborate Music Genome. These genes capture

the distinct qualities, such as melody, harmony, rhythm lyrics etc., of individual songs2.

Pandora employees who examine each song are usually musicologist or trained

musicians. These analysts spend at least 15-30 minutes codifying around 400 different

attributes into a song’s “musical DNA.” This “DNA” is used to match similarly codedsongs that ultimately enabled listeners to hear artists and songs based on the beginning

song choice and mood. For a three-year stretch founders worked without salaries and

" The Huffington Post, http://www.huffingtonpost.com/2011/02/12/pandora-to-file-ipo-

looks_n_822315.html, accessed 1st March 2011. # $%&'()%*+(,- ./001233444*1%&'()%*+(,3,51*6/0,78- %++9669' :%)+/ "60 #;""*



struggled to find investors. Meanwhile, the project evolved into a coded library of

thousands of songs3.

Business Model

To monetize the Music Genome Project, Westergren initially licensed his music

discovery engine to facilitate online and offline music stores. Also, the Music Genome

Project was used in AOL’s and Barnes and Noble’s music portals, in kiosks for Best Buy,

and Borders and Tower Records. The licensing model proved unsuccessful because the

revenues were insufficient to sustain a lucrative business.

In 2004, the new CEO of Pandora, Joe Kennedy, changed the existing business

model and transformed Pandora into a free, direct-to-consumer Internet radio service.

Pandora generates revenues in three ways. Firstly, they have advertisements on their

website and mobile application (Exhibit 1). This stream of revenue came from display

and text ads that accounted for 93% of the company’s revenue (they later added audio

ads). Next, they charge users who want ad-free service subscription fees. Finally, they

earn affiliate fees from iTunes and Amazon.com. Pandora is a leading referral site for

music sales for these two online music retailers4. At the end of 2009, Pandora reported its

first profitable quarter and $50 million in annual revenue5.

The company gives advertisers several value propositions. Advertisements have

great visibility as listeners frequently used the site’s interface to discover new music.Also, Pandora gathered information about its users from account registrations (gender,

age, location, etc.) and from their listening preferences. So, advertisements can be highly

targeted to different segments of the population. Pandora’s 80 million registered users

tune in on an average of 11.6 hours a month6. The size of their user base and their ability

to keep listeners on the site attract well-paying advertisers.

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>9LE94- O+0(?9) #- #;;P- K%)L%)' MN6E&966 H+/((7- "60 :%)+/- #;""*R The New York Times, http://www.nytimes.com/2010/03/08/technology/08pandora.html?_r=1, accessed

March 1st 2011.

S The New York Times, http://www.nytimes.com/2010/03/08/technology/08pandora.html?_r=1, accessed

March 1st 2011.



Pandora’s expenses primarily consist of advertising commissions, streaming

costs, performance royalties, and employee salaries. Between 60 percent to 70 percent of

Pandora’s revenue is paid to the nonprofit music industry group SoundExchange to

compensate for the songs it plays7. In aggregation, Pandora raised over $57 million in

venture funding to sustain itself 8.

In February 2011, Pandora filed with the SEC to raise up to $100 million in an

initial public offering. For the 12 months ending on October 31, 2010, Pandora had $114

million in sales. Pandora’s latest valuation is somewhere in the neighborhood of $300

million pre-money, and its impressive acquisition price is approximately a half-billion9.

Industry and Competition

Web Broadcasting (webcasting) is the distribution of digital audio through the Internet

via streaming media technology. This technology emerged in the early 90s and was a

successor of traditional “over-the-air” radio. The first Internet-only webcasters based

their revenue models heavily on advertising and started appearing around the mid- 90s.

Early webcasters attracted advertisers by offering display and text ads on the websites as

opposed to only audio ads on traditional radios. As the Internet became faster and

broadband became more widely available during the early 2000s, online radios

flourished. This new generation of webcasters offered better features, more channels and

a higher degree of customizability. Pandora started in the mid 2000s with the secondgeneration of Internet radios.

During that time, digital music retailers such as iTunes garnered much attention.

Westergren thought of the opportunity for Pandora and pointed out that “broadcasting has

always been an industry multiple times the size of record sales.”10 By 2007, major media

and Internet companies owned many of the prominent webcasters. At the time, Pandora’s

T Bloomberg, http://www.bloomberg.com/news/2010-10-12/pandora-chases-drive-time-radio-after-

capturing-mobile-market.html, accessed March 1st 2011. U Venturebeat, http://venturebeat.com/2009/07/10/report-pandora-caps-off-pretty-good-week-with-35m-in-

funding/, accessed 1st March 2011. P Vator, http://vator.tv/news/2010-07-07-why-pandora-may-end-up-acquired-by-google, accessed 2nd

March 2011.

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major competitors were AOL, Live365, MTV, RealNetworks, and Yahoo. Exhibit 2

shows the relative market shares in terms of unique visitors between Quarter 2, 2006 and

Quarter 1, 2007. During this period alone, Pandora increased its market share from 5% to

16%. Yahoo and AOL saw their market share percentages plummet, while Live365’s

market share percentages remained relatively stagnant. Other entrants in the web radio

industry included smaller webcasters, non-commercial webcasters, and traditional radio

“simulcasters.”

In the 2010’s, a number of web radios and music discovery services emerged.

Some potential threats for Pandora are Apple’s Lala, iLike, Grooveshark, Qloud and

CBS’s Last.fm. In the year 2010, Pandora exceeded its top competitors in terms of unique

visitors (Exhibit 3) and number of site visits (Exhibit 4). How did Pandora earn such a

dominant role in the web radio industry?

Product, Strategies and Entering New Platforms

Pandora’s primary assets are: a great music recommendation engine, a large listener base

and strong networks with music labels. Music discovery using the Music Genome Project

involves critical analysis of music. The playlist generating algorithm plays songs based

on comparisons in instrumentation, harmony etc., and aims to capture “the fundamental

essence of music.” By contrast, most other online radios discover music and generate

playlists based on sales data, search engine data and other commercial data. Pandoraemploys a reputation system for songs by using thumb- up and thumb- down buttons. The

system keeps track of user preferences and allows users to customize their listening

experience. The reputation system locks-in many listeners into the service and builds up

consumer switching costs as listeners spend time modifying their playlists and archiving

discovered music. Because Westergen and his team created such a unique product, they

obtained a patent for the Music Genome Project in February 2006.11 This patent acts as a

barrier to entry for new entrants in the industry that might try to imitate Pandora’s music-

consumer system.

"" Google Patents,

www.google.com/patents?id=LI54AAAAEBAJ&printsec=abstract&zoom=4&source=gbs_overview_r&ca

d=0#v=onepage&q&f=false, accessed 2nd March 2011.



When Pandora first launched in 2005, they used a “freemium” model: listeners

acquired 10 hours of free radio upon signup, after which they were asked to pay $36 per

year. According to CTO Tom Conrad, “In the first couple weeks we had 100,000 people

come through and the vast majority listened to every last minute of their free ten hours.”

However, the vast majority of these listeners did not end up paying for further service. In

November 2005, Pandora moved into their ad- based model and adopted to three tiers of

service: 40 hours/ month of free ad-supported music, $.99/ month for unlimited listening

after 40 hours, and $36/ year for Pandora One (the ad-free version of Pandora which

provides higher quality sound and fewer playing restrictions). As a result, growth

quadrupled overnight, and within three days, Apple called and asked to buy out ad

inventory through December. Pandora makes little off of affiliate fees from track

downloads and a small percentage of Pandora listeners subscribe to Pandora one. Thus,

the majority of their revenue comes from advertising.12

Pandora’s multiplatform strategy enabled listeners to easily use the service from

the nearest connected device. This strategy lets consumers enjoy Pandora on smart

phones, mobile devices like the iPad, in-home consumer electronics and cars in addition

to computers. Initially starting with the iPhone application, the Pandora application is

available on over 150 kinds of smart phones and more than 100 consumer electronic

devices.13 Pandora is now one of the most widely used mobile applications (illustrated in

Exhibit 5.14 Furthermore, Pandora developed a Facebook application, a side bar gadget

for Windows Vista, Windows 7 and Google Chrome. The application can also be

downloaded via iTunes. Pandora’s integration with these platforms enables it to take

advantage of other prominent networks.

In March 2011, Pandora initiated a Toyota campaign. Pandora launched Toyota

“Legends & Icons” campaigns on all platforms. This campaign will feature content from

unnamed, internationally popular musicians. Initially the campaign will place ads for the

Toyota Highlander on Pandora’s Top 40 station. Each month will bring a new pairing of

"# Gigaom,http://gigaom.com/2010/03/26/case-studies-in-freemium-pandora-dropbox-evernote-automattic-

and-mailchimp, accessed 2nd March 2011."< Branded Content, http://brandedcontent.adage.com/mobile10/network.php?id=4, accessed 2nd March

2011.

"Q Nielsen Research, http://blog.nielsen.com/nielsenwire/online_mobile/the-state-of-mobile-apps, accessed

2nd March 2011.



station and vehicle. Toyota’s Entune system, which connects mobile devices to the in-

dash system, will allow the Pandora application to play on the car’s touch screen

display.15 Entering the automobile platform will further integrate Pandora into listeners’

lives.

Pandora’s growth multiplied rapidly after the introduction of its mobile

application. Over half of Pandora’s new daily registrations come from mobile apps.

Furthermore, more than 50 percent of Pandora’s usage is on mobile devices. Also,

listeners on mobile devices are very engaged with the interface (much more than other

users and spend around 1.5 hours per day) on Pandora. Due to Pandora’s compatibility

with multiple platforms and ability to integrate into listeners’ lives, they are able to

monetize differently on each platform. Pandora’s ability to offer hyper-targeted

advertising attracts significant advertisers and makes the company even more profitable.

Hurdles and Risks

Despite Pandora’s success, the company faces hurdles and remains susceptible to risks.

Pandora’s largest expense is royalty payments to musicians. Around 60 to 70 percent of

the company’s revenue goes to the non-profit music organization SoundExchange to

compensate artists for played songs. To each listener, Pandora only serves around three

ads every hour.16 The Copyright Royalty Board announced in 2006 that performance

royalties (for webcasters) would gradually increase from $.0008 per performance in 2006to $.0019 in 2010.17 Considering the millions of performances that Pandora streams, the

increase in these micropayments will have a severe impact on Pandora’s profitability.

Although there were later negotiations, in 2008, Pandora was compelled to discontinue

service in the UK due to high royalty demands from music industry groups.18 Because of

limitations imposed by royalty holders, Pandora operates only in the United States.

Pandora’s future success is contingent upon expanding its user base.

15 Billboard Biz, http://www.billboard.biz/bbbiz/industry/digital-and-mobile/how-will-pandora-turn-a-

profit-new-toyota-1005059102.story, accessed 2nd March 2011.

"S Bloomberg,http://www.bloomberg.com/news/2010-10-12/pandora-chases-drive-time-radio-after-

capturing-mobile-market.html, accessed 4th March 2011.

"T $(=9&- >(?9)0 %&' >(69&@97'- A79B- C$%&'()%2 >(D%70E96 FE77 0/9 G9? >%'E( H0%)I-J K%)L%)' MN6E&966

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Pandora has limited listening options; while the simplicity of the product is

attractive, listeners can neither rewind nor repeat songs nor choose the exact song they

want to listen, facing a limited number of song skips. Compared to all other music-

streaming companies, Pandora’s library of songs is still quite small. The Music Genome

Project consists of 700,000 tracks, and the company has intentionally filtered out many

albums. Also, Pandora tends to repeat songs more than its competitors.19 Finally, cell

phone providers are starting to limit data plans. This might cause Pandora’s mobile usage

to drop significantly.

Conclusion

To continue to attract advertisers, the number of Pandora users must continue to increase.

Pandora needs to expand into international markets. Its’ applications should ideally

integrate with more platforms. But will webcasters negotiate lower performance royalties

with the Copyright Royalty Board? How can Pandora improve its features and continue

to add songs to the Music Genome Project? What other antics can Pandora use to entice

more listeners and subscribers? Pandora’s future relies heavily on the answers to these

questions, its competitors’ strategies and the decisions of the Copyright Royalty Board.

Pandora has unique products, successful entry into the online radio industry, a

working ad- based model and a multi-platform strategy to garner a loyal, large and

growing user base. In 2010 alone, the company made about $114 million in sales. InFebruary 2011, the company filed with the SEC to raise up to $100 million in an initial

public offering.20 Currently, Pandora continues to flourish, and its future is perceived

with rational optimism.

"P Vator, http://vator.tv/news/2010-07-07-why-pandora-may-end-up-acquired-by-google, accessed 4th

February 2011. #; The Huffington Post, http://www.huffingtonpost.com/2011/02/12/pandora-to-file-ipo-

looks_n_822315.html, accessed 1st March 2011.



Exhibit 1 Pandora’s Ad- Supported Website

Source: pandora.com

Exhibit 2 Market Share by Unique Visitors (%) Between Q2 2006 and Q1 2007



Exhibit 3 Number of Unique Visitors in 2010 for Pandora and its Top Competitors

Source: http://venturebeatprofiles.com/

Exhibit 4 Number of Sites Visited in 2010 for Pandora and its Top Competitors

Source: http://venturebeatprofiles.com/



Exhibit 5 Most Popular Cell Phone Apps on Different Operating Systems

Source: nielsen.com

rushdee work sample pandora case study

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