Internet streaming radio, which has been around since the 1990s, has become a crowded market in recent years, thanks to the increased adoption of smartphones and tablets. In fact, streaming services accounted for approximately 10% of all digital music revenue last year, according to the International Federation of the Phonographic Industry (IFPI).
Yet is this market, currently dominated by companies such as Pandora Media Inc (NYSE:P) and Spotify, really as important as financial media makes it out to be? Now that tech giants Apple Inc. (NASDAQ:AAPL) and Google Inc (NASDAQ:GOOG) are rolling out their own Internet radio services, will smaller competitors be pushed into obscurity? Let’s take a look at the factors fueling the growth of Internet radio, the challenges it faces, and the possible future of the industry.
In an increasingly fragmented Internet radio industry, Pandora Media Inc (NYSE:P) is the market leader, with 70.1 million active users at the end of the first quarter – a 35% gain from the prior year quarter. It also added 700,000 paying subscribers to its commercial-free Pandora One service, which costs $3.99 per month or $36 annually, to reach a total of 2.5 million paid listeners. By comparison, Spotify only has 20 million total users, but boasts 5 million paid subscribers.
Pandora Media Inc (NYSE:P)’s total listener hours also rose 35% to 4.18 billion. More importantly, Pandora’s total revenue per thousand listener hours, which is generated by advertising and subscription revenue, rose to $30.01, up from $26.09 last year. Revenue generated by mobile devices nearly doubled to $83.9 million, fueled by a 47% rise in total mobile listening hours.
As a result, Pandora Media Inc (NYSE:P)’s revenue spiked 55% to $126 million in the first quarter, but the company still posted a net loss of $0.16 per share, or $28.6 million, down from the loss of $0.12 per share, or $20.2 million, it reported a year earlier. The problem is simple – royalties and bandwidth costs are still crippling its bottom line growth. 56% of Pandora’s 2012 revenue went towards royalty payments – which doesn’t leave much room for bandwidth and expansion costs.
Pandora Media Inc (NYSE:P) reportedly pays $0.12 per 100 songs streamed from its site to record companies. By comparison, smaller services such as iHeartRadio pay an average of $0.22, and its main competitor Spotify pays a whopping $0.35 per 100 songs streamed.
Considering that Pandora pays the lowest royalty rate in the industry and still has trouble squeezing out a profit, then it stands to reason that a business model solely based on streaming Internet radio is fundamentally flawed. While Pandora Media Inc (NYSE:P) has expressed faith that its newly introduced 40-hour listening cap will encourage more free listeners to sign up for its premium service, that new strategy remains untested.
In addition, larger companies, such as Apple Inc. (NASDAQ:AAPL) and Google Inc (NASDAQ:GOOG), can afford to pay higher royalty rates to undercut Pandora Media Inc (NYSE:P). Apple and Google can easily offset losses in their Internet radio businesses with their respective core businesses of hardware and display advertising.
Despite this apparent advantage, Apple Inc. (NASDAQ:AAPL) initially only offered record labels $0.06 per 100 songs streamed on its upcoming iRadio service. At first, record companies appeared to accept Apple’s low offer, due to the appealing idea of allowing its streaming content to promote iTunes purchases. Eventually, record companies demanded higher royalties and Apple relented, reportedly raising its royalty rate to $0.12 per 100 songs, in line with Pandora’s royalties.
However, having the same royalty rate does not shield Pandora Media Inc (NYSE:P) from Apple Inc. (NASDAQ:AAPL)’s real weapons – iTunes and iAd. Apple’s iRadio app will be integrated with iTunes, allowing direct purchases of streaming content. Record labels generally take a 70% cut of iTunes purchases, which means that they will not only enjoy a constant stream of royalty payments, but also profit from higher purchases of its digital tracks.
Second, Apple Inc. (NASDAQ:AAPL) is reportedly offering record companies a 10% cut of ad revenue generated by the app – twice the payment offered by Pandora Media Inc (NYSE:P). Although iAd is still in its infancy, it could evolve into a major source of revenue farther down the road for both Apple and the record labels. iRadio also reportedly has some additional features, such as rewinding a song and one-click iTunes purchases, which Pandora completely lacks.
Thanks to this lucrative package, Vivendi‘s Universal Music and Access Industries’ Warner Music Group have now inked deals with Apple. Universal Music has granted Apple its recorded music rights but not its publishing rights, while Warner Music Group has granted both.
A radio app fully integrated into iTunes is a harrowing thought for Pandora Media Inc (NYSE:P). iTunes has approximately 500 million users compared to Pandora’s 70 million. However, Apple Inc. (NASDAQ:AAPL) needs one more major record label – Sony – to successfully launch iRadio. Sony and Apple are reportedly still at odds regarding the future of streaming content.
At this rate, Apple Inc. (NASDAQ:AAPL)’s iRadio could actually arrive at the same time as Google’s streaming radio product, which is scheduled for a summer launch. Google Inc (NASDAQ:GOOG) intends to finally transform its YouTube video streaming service into an audio one as well, and has already inked deals with Universal Music, Time Warner and Sony. Although not much is known regarding its streaming royalty rates, Google is likely to be able to net rates in line with Pandora Media Inc (NYSE:P) and Apple. However, if Google Inc (NASDAQ:GOOG) really plays its advertising card right, then it could get an even lower rate if it guarantees higher ad revenues via its Android app.
Google’s streaming radio, which would merge with YouTube and Google Play Music, has similar strengths as Apple Inc. (NASDAQ:AAPL)’s iRadio – by building new services on top of a massive existing user base. With YouTube apps available on all major mobile platforms, the addition of streaming music could immediately generate an active user base much larger than Pandora Media Inc (NYSE:P) and Spotify combined.
According to Google, YouTube has over a billion unique users per month, with 70% of its traffic originating from outside the United States. Moreover, 64% of teens surveyed in Nielsen’s Music 360 report stated that they listen to music through YouTube rather than other sources. These factors indicate high growth potential for Google’s Internet radio service.
When push comes to shove in the Internet radio business, I don’t want to be a Pandora shareholder. Both Apple and Google Inc (NASDAQ:GOOG) have massive active user bases with the means to permanently silence Pandora and Spotify. In the future, record labels are more likely to accept lower royalty payments from Apple Inc. (NASDAQ:AAPL) and Google, which can generate stronger ad revenue than Pandora or Spotify. Meanwhile, Pandora Media Inc (NYSE:P) and Spotify will be stuck paying higher rates that will keep their businesses unprofitable, despite constant revenue growth.
It will be very difficult for these smaller companies to escape this negative feedback loop, which could ultimately bury them. I believe that the only way for Pandora and Spotify to avoid this fate is to be acquired by a tech giant such as Microsoft or Yahoo. With that kind of backing, these two companies could have considerably more clout against record companies. Until then, however, the future does not look bright for stand-alone Internet radio companies such as Pandora Media Inc (NYSE:P) or Spotify.
Leo Sun owns shares of Apple. The Motley Fool recommends Apple and Google Inc (NASDAQ:GOOG). The Motley Fool owns shares of Apple and Google.
The article Pandora Flees From the iMonster and YouTunes originally appeared on Fool.com.
Leo is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
