Does Pandora Media Inc (P) Have a Competitive Advantage?

Depending on the day, Pandora Media Inc (NYSE:P)‘s shareholders have felt either Sweet Emotion or an Appetite for Destruction.

The company’s stock has been on a rollercoaster during the past year, from a low of $7 to a high of $15.  Bulls and bears tend to point fingers at different drivers to explain this extreme volatility:

1). The Bulls tend to focus on the incredible adoption of the Pandora service.  In December, Pandora reported a 60% increase in revenue, driven by a 67% year-over-year increase in listener hours.  Pandora streamed a total of 3.6 billion hours in just the past three months.  That’s the equivalent of putting Stairway to Heaven on repeat for 27 billion times, which would run over the next 406 millennia (sorry, couldn’t help it).  Pandora streams a LOT of listener hours.

2). The Bears tend to focus on Pandora’s cost of publisher royalties, which is the money they must pay for every song that is played.  Pandora’s cost of royalties is really out of whack with its competitors.  Pandora paid out roughly half of its revenues as royalties in 2012, whereas Sirius XM Radio Inc (NASDAQ:SIRI) paid less than 10% and terrestrial radio even less.  The company has championed the Internet Radio Fairness Act to try to get everyone on an even playing field.  But at this point, it has been to no avail.  Pandora is still at the mercy of content royalties.

Much discussion has arisen about whether Pandora has any true staying power.  Sure, they came up with a creative idea and have grabbed a lot of popularity.  But are they just going to bow out as the opening act when a large competitor like Apple Inc. (NASDAQ:AAPL) or Spotify takes the stage?  After all, Apple already launched its iTunes Genius service, which recommends songs to you based on what is saved in your iTunes account.  With many users already a part of the Apple ecosystem, it’s a compelling argument that more could turn to Genius.

And Spotify allows users to immediately add songs to Playlists and showcase them via Facebook Inc (NASDAQ:FB).  Some of these competitors are big companies that could be really intimidating.

Dream On?

To determine whether Pandora can hold their own, we can run the company through a thorough Competitive Analysis.  In this, we should analyze four distinct categories, with particular company-specific attributes to look for in each:

1) Intangibles – Brand recognition, Patents, Leadership and Vision, Culture

2) Stickiness – Recurring/Habit Forming, High Switching Costs, Distribution Network

3) Customer Experience – Network Effect, Word-of-Mouth Advertising, NPS Positive

4) Cost Advantage – Resource Location, Process/Scale

We can then award points for advantages in any of the sub-components, for a total possible score of 12 points.  We can consider a company that scores at least 3 points to have a competitive advantage, and at least 5 points to have a strong competitive advantage.

Intangibles

Pandora’s very essence is built upon the Music Genome Project, which the company describes aptly on their website:

“Pandora is based on the Music Genome Project, the most sophisticated taxonomy of musical information ever collected. It represents over ten years of analysis by our trained team of musicologists, and spans everything from this past Tuesday’s new releases all the way back to the Renaissance and Classical music. Each song in the Music Genome Project is analyzed using up to 450 distinct musical characteristics by a trained music analyst. These attributes capture not only the musical identity of a song, but also the many significant qualities that are relevant to understanding the musical preferences of listeners.”

It’s very clear that there is a source of competitive advantage in this.  The MGP took a decade of work and employed some very highly trained music analysts.  That’s something that’s not easily replicated.  The vision of the company to dedicate this amount of work and time upfront should pay off for them down the line.