Pandora Caps Free Mobile Listening as Royalty Costs Soar

Another supply chain internet disruptor; Pandora watch the effect of this company on people like Apple and others. Aivars Lode

Pandora Media Inc. (P), the Internet radio service, is capping free mobile listening at 40 hours a month in the absence of sufficient advertising sales to pay for rising music costs.

The change, which begins in March, applies to U.S. users and will affect about 4 percent of the 65.6 million listeners, Chief Executive Officer Joe Kennedy said in an interview. Fans can pay 99 cents to continue listening on mobile devices, the Oakland, California-based company said yesterday on its website.

Pandora is seeking to contain music expenses that climbed 81 percent in the nine monthsended Oct. 31, outpacing a 59 percent increase in advertising sales. The company pays for each song streamed, with costs ballooning as usage grows, and collects revenue through subscriber fees and ad sales.

“At this moment in time, this is the right lever to pull,” Kennedy said. “We see this as a smart way to manage monetization and growth.”

Listeners who exceed the mobile threshold can still use Pandora for free on computers, or pay 99 cents for unlimited mobile use for the remainder of the month. Pandora One subscribers, who pay $4 a month or $36 a year to skip commercials, aren’t subject to the limit.

Pandora, scheduled to report fourth-quarter results on March 7, fell 4.2 percent to $12.20 at the close in New York. The stock has climbed 33 percent this year. Excluding items, analysts forecast a loss of 6 cents a share, the average of 20 estimates compiled by Bloomberg, on revenue of $122.3 million.

Ad Shortfall

“It is a statement about their inability to monetize,” Michael Pachter, an analyst with Wedbush Securities in Los Angeles, said in an e-mail. He has a neutral rating on the stock. “If they could sell ads for the extra hours of listening, they wouldn’t have to do this. Their costs are rising faster than revenues.”

The company is sending out e-mail messages today to users who regularly exceed the 40-hour mobile limit, Kennedy said. Going forward, Pandora will also send e-mail alerts to users who reach 85 percent of the limit, he said.

“Limiting listening is a very unusual thing to do, and very contrary to our mission,” Tim Westergren, co-founder and chief strategy officer, wrote on the website. “This is an effort to balance the reality of increasing royalty costs with our desire to maximize access to free listening on Pandora.”

User Options

The cap isn’t expected to create meaningful revenue, Kennedy said. Some users will pay the 99 cents or sign up for Pandora One, he said.

“Some will choose one of those options, but we would be surprised if most people did that,” Kennedy said.

More than three-quarters of Pandora listening occurs on mobile devices, which includes smartphones and tablet computers, with most not exceeding the cap, the company said.

The mobile cap doesn’t apply to factory auto-sound systems or consumer electronics devices, such as Web-connected television sets and a Samsung refrigerator, the company said. Pandora is available in 85 car models from Toyota, Honda, Ford, Mercedes-Benz and others, and 760 consumer electronics products.

Pandora is increasing mobile ad sales, Kennedy said. In the quarter ended Oct. 31, mobile advertising revenue more than doubled to $73.9 million, outpacing the 85 percent gain in mobile listening for the first time.

“We continue to grow mobile at a rapid pace,” Kennedy said. “We expect to maintain and grow the size of our mobile audience while managing the growth in hours.”

Royalty Rates

The company supports federal legislation that would lead to lower royalty payments. Rates for music used by over-the-air, online, satellite and pay-TV radio stations are determined every five years by a three judge panel at the Copyright Royalty Board, part of the Library of Congress.

Pandora and other online radio services paid 0.11 cent per song in 2012, a fee that will rise to 0.14 cent in 2015. The royalty board has yet to set rates for 2016 and beyond.

Those costs added up quickly, Kennedy said. The company reported its 65.6 million active users streamed 1.39 billion hours of programming in January, a 47 percent rise from a year ago. Pandora has estimated royalty costs of $250 million for the year ended last month, about 25 percent of all payments by made radio companies worldwide, Kennedy said.

In July 2009 the company set a 40-hour limit on desktop listening that was lifted in September 2011. During that time, the company held music costs steady while building advertising sales, Kennedy said. Pandora may remove the mobile cap when mobile ad revenue catches up, he said.

“We look forward to the day, just as with desktop, that the monetization rate rises and we can lift this cap on mobile, too,” Kennedy said.