by : August 2013, Business, Featured Articles

Pandora’s Provocation

Pandora’s Provocation

Pandora Media is locked in a no-holds-barred fight for profitability. The commotion is affecting a large contingent of stakeholders—songwriters, music publishers, performance rights organizations, terrestrial and satellite broadcasters, pundits that square off in music and tech business websites like Digital Music News and TechDirt, and the United States Congress.

Planted on one side are Pandora, the largest Internet radio company, and, advocates of webcasting. This party claims that the royalty rates paid to artists and intermediaries, such as music publishers, are too high, and, if not lowered, could drive the company into the ground—casting a dark shadow over the future of internet radio.1 They are also upset about the disparity between their rates and those paid by terrestrial and satellite radio companies for the right to broadcast music.

On the other side stand the copyright holders who rely on the exploitation of their intellectual property to generate revenue. This includes artists, songwriters, publishers, and record labels. In addition to copyright holders, there are performance rights organizations, such as ASCAP, BMI, and SoundExchange, whose job it is negotiate and collect royalties on behalf of the rights holders from companies like Pandora.  These stakeholders don’t want to see a reduction in royalty rates, as the result would be less revenue for them. They claim Pandora’s losses are due to a flawed business model and that they should not suffer for it.

Pandora makes its money by selling advertisements that are heard by its listeners. Additionally, 4% of its users pay $0.99 per month for access to unlimited monthly listening.2 Despite the fact that revenues have doubled each year since 2011, peaking at $427.1 million in FY 2013, the company continues to lose money. Their income statement for 2013 shows net losses of $38.2m, up from $16.22m in 2012 and 1.7m in 2011.3 Pandora’s cost of doing business is spread across four key areas: content acquisition, product development, sales and marketing, and general/administrative expenses. According to Pandora’s audited 2013 financial statements, 60.6% of their revenue ($258.7m) was paid out to copyright holders—the owners of the recordings and compositions that the company webcasts.4

Tim Westergren, Pandora’s founder and chief strategy officer, is concerned about the direction his company’s royalty rates are headed. He wrote the following in February: “Pandora’s per-track royalty rates have increased more than 25% over the last 3 years, including 9% in 2013 alone and are scheduled to increase an additional 16% over the next two years.” Regardless of the rate increase, Pandora’s content acquisition costs grow lock-in-step with its listenership. The more people listen, the more it has to pay.

The company is employing two strategies to address this problem. First, Pandora is trying to raise the value of each stream by selling more advertising spots per unit of music streamed. It recently teamed up with two media-buying platforms, Strata and MediaOcean, to allow advertisers to compare its audience data next to that of terrestrial radio stations.5 Pandora already has 29 sales offices in major radio markets and is planning to expand.6

The second is an attempt to reduce statutory royalty rates for internet radio webcasters by way of a lobbying campaign aimed at congress and public opinion, which has resulted in the introduction of the Internet Radio Fairness Act (IRFA).  One of IRFA’s sponsors, Sen. Ron Wyden, claims the bill “requires that the Copyright Board… use the same standards to set royalties for internet radio that they use for satellite and cable radio.”7 However, the standards that the board uses are murky, which substantially complicates the task.8 Mr. Westergren is asking listeners and musicians to support the IRFA, citing the disparity between the rates Pandora pays and those paid by terrestrial and satellite broadcasters. He and Sen. Wyden may have a point.

According to a statement released by another IRFA sponsor, Sen. Jason Chaffetz, satellite and cable radio stations pay between 7 and 16% of their gross revenue in royalties.9 Terrestrial broadcasters pay far less—Clear Channel’s content acquisition costs equal 1.7% of their gross revenue, because, unlike internet and satellite transmitters, terrestrial broadcasters have historically been exempt from paying the owner of the sound recording. Unfortunately for Pandora, their direct competitor, iHeartRadio, a Clear Channel-owned internet webcaster, also pays the 1.7% rate. This prompted Pandora to recently purchase a broadcast radio station in South Dakota—an attempt to secure lower rates by reclassifying itself as a terrestrial company. BMI quickly responded with a lawsuit.10

ACPU, ARPU, and Sirius XM

Many commentators and stakeholders have shared pointed exchanges about the difficulty of comparing internet radio to satellite and terrestrial formats, as well as the vagaries in using streams and impressions for determining fair royalty payments.11 Perhaps better metrics for weighing the validity of Pandora’s complaints about high content acquisition costs are Average Cost Per User (ACPU) and Average Revenue Per User (ARPU).

ACPU is calculated by dividing a company’s annual Cost of Goods Sold by the number of users it has. Pandora reached 200 million users in Q1 of 2013, however the company’s annual report states that only 65 million of those users are active. Given that its content acquisition cost for FY 2013 was $258.1m, dividing by 65m active users gives Pandora an ACPU of $3.97.  Meanwhile, Sirius XM spent $830m on content, has 22.8m users, and an ACPU of $36.40!12  Pandora has 42.2 million more users than Sirius, yet pays artists $32.43 less per user.  This demonstrates that Pandora’s rates are not as unfair as the company claims. It also suggests that Pandora may be doing a poor job of monetizing its users.  Let’s take a look at revenue generated on a per-user basis to determine if this is true.

ARPU is calculated using a slight variation of the above formula—replacing COGS with revenue. Pandora’s ARPU is $6.57. Sirius XM’s is $149.21, given their annual revenue of $3.4 billion. This confirms that there is an issue with Pandora’s business model, and, that the company’s losses have very little to do with the amount it pays for content.  Sirius grosses $142.64 more per user than Pandora. What are they doing differently?

Sirius charges customers a flexible monthly fee depending on whether a user desires access in their car, wants to listen online only, is a business, or prefers a greater variety of channels and content types (i.e. comedy and sports). Pandora believes that only 20% of listeners pay for music, and that the greater opportunity lies in the 80% who do not.13 Pandora’s mission is to capture the non-paying listeners and then monetize them by increasing the amount of advertising they must hear in between songs. However, the soon to be launched iTunes Radio will be competing with them for this market, and are offering artists better deals. Thus, artists must ask themselves if they are willing to subsidize Pandora’s chosen strategy. Apparently, many are not.

Opposites Unite

Artists, publishers, record labels, and the PROs are furious with Pandora and the Internet Radio Fairness Act (IRFA). After experiencing devastating losses from the devaluation of recorded music over the last decade, these stakeholders are not happy about taking any more pay cuts. In December 2012, Rihanna, Billy Joel, Katy Perry, and over 100 other artists signed an open letter in opposition to the IRFA.14 This helped prevent Congress from coming to a vote on the bill. However, the IRFA is far from dead.

In May, many Pandora artists received a letter from Mr. Westergren, encouraging them to sign a letter of support for rate parity across all platforms.15 Mr. Westergren, who positions himself and his company as a champion of artists, claims that Pandora helps many thousands of independent musicians reach listeners who would never otherwise hear their music, i.e. the platform is a promotional tool. The IRFA, he believes, will help ensure a prosperous future for internet radio and preserve the newly-leveled playing field Pandora has helped create.

This has resulted in another industry-wide backlash. Roger Waters and other members of Pink Floyd blasted Pandora in an op-ed, published by USA Today, for attempting to trick artists into supporting the act. “Widespread artist opposition stopped them last year, so this year Pandora is trying to enlist artists support for their next attempt at passing this unfair legislation,” Pink Floyd wrote.  The article continues, “a musician could read this ‘letter of support’ a dozen times and hold it up to a funhouse mirror for good measure without realizing she was signing a call to cut her own royalties to pad Pandora’s bottom line.”  Meanwhile, Some songwriters feel that the existing rates are already too low.

Musician and artist rights advocate, David Lowery, kicked up a storm by posting an article on his blog, The Trichordist, stating that his band Cracker received a $42 check covering publishing royalties for 1.16 million Pandora plays of their “Low”.16 This amount did not include his sound recording royalty, which was significantly more, however, it does illustrate the paltry payouts songwriters receive. In response, a company spokesperson told the Huffington Post, “Mr. Lowery misrepresents and grossly understates Pandora’s payments to songwriters.” Pandora in fact paid about $93 for their performances of Low. The difference between the amount Pandora paid and Cracker received likely went to BMI and the song’s publisher.

The Recording Industry Association of America, MusicFIRST, and the PROs assume the position that Pandora is a maturing publicly traded company and is not entitled to special treatment that would help their apparently flawed business model. They fear artists stand to lose 85% of their current revenue from internet webcasters should the IRFA become law. Presumably, the 85% statistic comes from the disparity between the 55% of gross revenue Pandora paid copyright holders in FY 2012 and the 8% paid by satellite broadcaster Sirius XM. Pandora claims the statistic is not indicative of their goal.

Nevertheless the RIAA and MusicFIRST are backing another piece of legislation—The Interim Fairness in Radio Starting Today Act.17 The bill, introduced by Congressman Jerrold Nadler, would require terrestrial broadcasters to pay performance royalties to sound recording (SR) copyright holders, effectively closing the rate disparity across formats in the opposite direction. The Future of Music Coalition reported that Maria Pallente, Register of Copyrights, “called the lack of a public performance right for over-the air (AM/FM) broadcasts “indefensible,’” at a testimony before a House subcommittee on Copyright Act updates.

A High Stakes Test

Of course, Pandora would prefer to see internet webcasting rates go down, rather than watch other formats pay more (though Mr. Westergren has stated that he believes terrestrial broadcasts should have to pay a performance royalty to SR copyright holders). The National Association of Broadcasters and Clear Channel also support the IRFA—they would have to pay more under the competing bill.18

Presumably, Pandora’s management is aware of the disparity between their company and Sirius XM’s ACPU and ARPU, and the unflattering light it casts on their current position. It suggests Mr. Westergren and Pandora are indeed manipulating public opinion, not to benefit artists at all, but rather to establish a lower royalty rate before it attempts to substantially increase its revenue. The company has been investing heavily in growth and user acquisition, which should soon become visible in the company’s financial statements. The strategy of reducing variable costs is completely understandable, as management has a fiduciary duty to the owners to maximize profits. However, Mr. Westergren’s attempt to mislead artists for the benefit of shareholders is unethical.

Speaking about the current royalty rates, Pandora’s chief financial officer, Mike Herring, revealed, “the rates that (Pandora) pay(s) are statutory rates that are fixed, they are set in stone through 2015. Based on those rates, we are confident we can build a really good company…It’s all about monetization.”19 Furthermore, the company has announced a change in leadership. Mr. Herring stated that departing CEO Joe Kennedy “recognizes that Pandora is at an inflection point from a business model perspective.”20

Essentially, this means that change is in the air and anything is possible. Pandora could become a paid service, or, end up generating  ten times its current advertising revenue over the next five years. Should Pandora-supported IRFA ideology end up reshaping the fundamentals of royalty computation in the new media environment by lowering statutory rates, this could easily become yet another misery scenario for artists and rights holders.

 

By Miguel de Braganca

 

Endnotes

1. Robertson, Michael. “Sadly, Pandora Is Still Going Bankrupt.” Web. 19 July 2013. <http://www.michaelrobertson.com/archive.php?minute_id=298>.

2. Westergren, Tim. “A Note to Our Listeners.” Pandora Blog. N.p., n.d. Web. 19 July 2013. <http://blog.pandora.com/2013/02/27/a-note-to-our-listeners/>.

3. “Annual Financials for Pandora Media Inc.” Marketwatch. N.p., n.d. Web. 19 July 2013. <http://www.marketwatch.com/investing/stock/p/financials>.

4. Pandora’s Q1FY14 Detailed Historical Financial Report

5. Walsh, Mark. “Pandora Teams With Strata, Mediaocean To Simplify Ad-Buying.” MediaPost Publications 03/05/2013. N.p., n.d. Web. 19 July 2013. <http://www.mediapost.com/publications/article/194937/pandora-teams-with-strata-mediaocean-to-simplify.html>.

6. Farrell, Michael B. “Pandora Competing in Local Radio Ad Market.” BostonGlobe.com. The Boston Globe, n.d. Web. 19 July 2013. <http://www.bostonglobe.com/business/2013/07/08/pandora-competes-for-piece-local-market/4FoY52oltBmgt61DjaH6tN/story.html>.

7. Sen. Wyden, The Internet Radio Fairness Act of 2012

8. “Rising Tides.” Future of Music Coalition. N.p., n.d. Web. 19 July 2013. <http://futureofmusic.org/issues/campaigns/rising-tides>.

9. http://thehill.com/blogs/hillicon-valley/technology/251037-lawmakers-introduce-pandora-backed-music-royalty-legislation#ixzz2Ys5dTkXf

10. http://www.billboard.com/biz/articles/news/radio/1566479/pandora-buys-terrestrial-radio-station-in-south-dakota-aims-for

11. http://www.digitalmusicnews.com/permalink/2012/121120pandora39

12. http://files.shareholder.com/downloads/SIRI/2588035120x0x652466/4D4285DE-D78E-4458-8F42-B10F67CB4795/SiriusXM_2012_Annual_Report.pdf

13. http://www.billboard.com/biz/articles/news/digital-and-mobile/1553823/pandora-cfo-predicts-better-scaled-royalty-payments

14. http://www.huffingtonpost.com/2012/12/04/pandora-artist-royalties_n_2239458.html

15. http://www.usatoday.com/story/opinion/2013/06/23/pink-floyd-royalties-pandora-column/2447445/

16. http://thetrichordist.com/2013/06/24/my-song-got-played-on-pandora-1-million-times-and-all-i-got-was-16-89-less-than-what-i-make-from-a-single-t-shirt-sale/

17. http://nadler.house.gov/sites/nadler.house.gov/files/documents/NADLER_153_xml.pdf

18. http://www.fmqb.com/article.asp?id=2537900

19. http://www.digitalmusicnews.com/permalink/2013/20130516pandora

20. http://www.billboard.com/biz/articles/news/digital-and-mobile/1553823/pandora-cfo-predicts-better-scaled-royalty-payments

 

 

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