by : Business, Featured Articles, Oct. '12

Apple Plans for Internet Radio

Apple Plans for Internet Radio

When Pandora Internet radio entered the market with a strong initial public offering in 2011, a reporter from Bloomberg TV asked the Chairman and CEO, Joseph Kennedy, about how his company compared to Apple. He said that, out of all the people who listen to music, eighty percent listen in a radio format in which someone else plays DJ. “We’ve focused on that eighty percent,” said Kennedy, “Apple and others do a great job with the twenty percent where you’re playing your own DJ.”1 Now it seems that Apple is preparing to move into the broadcasting space to expand their twenty percent. The Wall Street Journal and the New York Times issued the first reports in early Sep- tember that Apple was in talks to create its own version of Internet radio.

The news sunk Pandora’s stock and spawned rumors about a potential buyout. Moreover, several questions derived from the announcement. Could Pandora compete against Apple? Would Google, Amazon or Clear Channel purchase Pandora in order to stay in the race? Would Apple buy it? Even if Apple chooses to build rather than buy, Pandora still seems like a viable target for Apple’s competitors. Given its rapid growth rate, the Internet radio company is arguably a cheap buy at the moment, at 1.7 billion U.S. dollars.2 With a better revenue model, or perhaps if it can get a break on royalty fees, Pandora is showing potential to be a smart investment.

Pandora’s Finances

Pandora is experiencing large losses and large gains simultaneously. Its losses continue to grow due to music licensing costs as well as unaggressive monetizing strategies. Nevertheless, the company’s revenues and listener numbers have recently shown tremendous growth.

From 2011 to the latest quarter, Pandora’s revenues rose from $67 million to $101.3 million. The revenues can be broken down into three main sources: advertising, mobile and subscription. Advertising is up from $58 million to $89 million, and accounts for the majority of the overall revenue. Mobile revenue is the second largest contributor and is increasing quickly, rising 86% year-on-year in 2012. Subscription revenue is the least significant source. Pandora is projecting total revenues around $430 million for this full year and has reported steady growth in active users since 2008 as well as an 80% increase in total listener hours since 2011.3 Despite these promising figures, the company has yet to turn a profit. As of now, over sixty percent of Pandora’s total revenue ends up going to music licensing fees.

Licensing Strategies

Pandora’s failure to find a profitable business model is cause for concern regarding Apple’s future plans. Initial rumors in the press suggested that Apple was in talks with record labels and content holders to negotiate direct licensing deals. Now, Billboard Magazine reports that Apple plans to use the more traditional framework of a compulsory license and work backwards from there. It will request waivers from record labels so that its service can be exempt from certain regulations. Record labels have granted waivers in the past to work out custom agreements. For example, Big Machine recently crafted a deal directly with Clear Channel, which enabled both sides to be innovative in their terms.

On September 28th, The New York Post claimed that Apple would have liked to release its streaming service on the new iPhone 5.4 Those plans were allegedly halted by Apple’s inability to reach a licensing agreement with Sony/ATV, which now owns the largest catalog of music publishing rights. Sony/ATV is moving away from allowing performing rights organizations like ASCAP or BMI to handle their negotiations, opting instead to cut deals directly with music services. “This wasn’t us not wanting the service,” said Martin N. Bandier, the chairman of Sony/ATV, “We want the service. It’s like oxygen. We just want to be paid fairly, no different than the N.F.L. refs.”5

In exchange for waivers, Apple is offering the record labels two major incentives. The first is for the consumer to be able to easily purchase a song they hear on the radio service. Apple will need to be creative with how they incorporate this option since the feature already exists on Pandora and does not stimulate significant sales. This concept may be part of an effort by Apple to quell fears that a hypothetical “iRadio” could cannibalize iTunes downloads.

The second incentive is more interesting and something that is not available through Pandora. Record labels want to be able to place high-priority songs in front of consumers based on their listening history. This concept resembles the terrestrial radio format and could compromise the integrity of the listening experience. The perk is enticing for record labels, but Apple’s overall service could suffer if it sounds too contrived.

Compulsory Licenses

Apple can choose between two types of compulsory licenses. The pure-play license collects whatever is greater: 0.0011 cents per play, per listener (the rate escalates yearly) or twenty-five percent of all revenue. If Apple is able to capitalize on its huge reach and generate sizeable revenue with its online radio service, twenty five percent sounds like a lot to give up.

Sirius XM Satellite radio uses a different kind of compulsory license called the commercial webcaster license. This costs Sirius 0.0021 cents per play, per listener as well as five hundred dollars per station, which is capped at $50,000. This seems like a better option for Apple. They could however still decide to aim for a model based on revenue percentage, but try to argue a lower percentage.

Based on the commercial webcaster license model and Sirius’ current standing this year, satellite radio will pay around eight percent of its entire revenue in royalties. That number is still much lower than what Pandora pays on the pure-play model. Their per-play, per listener fee ends up exceeding twenty-five percent of their revenue and costs them sixty- four percent of the company’s total revenue.6

The Internet Radio Fairness Act

These fixed licensing prices are currently under debate. The “Internet Radio Fairness Act” was recently introduced to the U.S. House and Senate in late September. The purpose of the new legislation is to lower the royalties paid by Internet radio stations so that they are equal with the rates paid by satellite radio. Pandora is publicly asking its listen- ers to endorse the Act via self-made messages that run between songs on its service. If the company can succeed in tailoring a better deal for itself and improving its situation, it could change the entire landscape. The Act also represents enormous opportunities for Apple before it introduces its own Internet radio service. If it stands behind the Act, Apple can argue on behalf of all online radio and may not need to craft quite as unique of a deal.

Customer Approval

It is not certain that Apple will suc- ceed in this new venture. iTunes’ “Genius” feature was not very impressive and the “Ping” social networking extension never gained much traction. It is also important to note that Google’s Internet streaming service never took off. Apple might be moving into this space now because it believes it can do better than Pandora. But, if Apple corrupts the integrity of each playlist by prioritizing tracks that record labels want to promote, the theo- retical iRadio could be less fun to listen to.

Yet, Apple has reinvented the mu- sic market before with iTunes and it has the power to reinvent radio. With its cash flow, reach and resources, it could revolutionize the commerce of music again. Whatever it pays in licensing fees and generates in music downloads could amount to a welcome cash injection into the music industry. If Apple succeeds in somehow improving the online radio experience, it would seem unlikely for it to fail. Apple’s four hundred million users far exceed Pandora’s fifty million and Spotify’s sixteen million users.

Why Apple has decided to move into this space now could have a lot to do with what Joseph Kennedy told Bloomberg in 2011 about how people consume music. At that time, he also said that “234 million people listen to broadcast AM and FM radio per week.” Pandora has recognized an op- portunity in refining the radio experience and has been successful in offering a strong alter- native online, in cars and on mobile devices. Apple would make Pandora a competitor in- directly, in the sense that Apple is more likely going after AM and FM and positioning itself in broadcasting’s bigger picture. Pandora and services like Spotify could end up being casualties of a radio land-grab between com- panies like Clear Channel, Sirius XM, and, maybe soon, Apple.

 

 

 

 

 

By Emilie Bogrand

Endnotes

1. “Pandora’s Kennedy Interview on IPO, Strategy,” Bloomberg TV, June 15, 2011. http://www.bloomberg. com/video/blackrock-s-fredericks-on-investment-strategy- HQNNer11SJadFDtLVX3DFQ.html

2. Smith, Ethan and Jessica E. Vascellaro. “Apple Seeks to Create Pandora Rival,” The Wall Street Journal, Sep 7, 2012. http://online.wsj.com/article/SB1000087239639044 3589304577636110080423398.html

3. “Pandora’s Revenues and Listener Numbers Rise in 2Q12,” Music and Copyright, Sep 5, 2012, issue 465.

4. Atkinson, Claire. “Royalty ruckus scuttled iPhone 5 mu- sic streaming,” The New York Post, Sep 28, 2012. http:// www.nypost.com/p/news/business/sony_bites_apple_ kKe2i0rFHlCbeFRq5cJeiO

5. Sisario, Ben. “Apple’s Plans for Internet Radio Run Up Against Big Music Publisher,” The New York Times, Sep 28, 2012. http://mediadecoder.blogs.nytimes. com/2012/09/28/apples-plans-for-internet-radio-come-up- against-big-music-publisher/

6. Christman, Ed. “Apple’s iRadio Blossoms Into Internet Radio Market,” Billboard Magazine, Sep 14, 2012. http:// www.billboard.biz/bbbiz/industry/digital-and-mobile/ from-this-week-s-billboard-apple-s-iradio-1007949482. story

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