Pandora at Ten: The Changes It Lived Through in the Music Business — and the Ones It Caused | QDaily Business History

Pandora's decade has been the decade the traditional music business collapsed. It filled the space records left behind, yet it still hasn't found a path of its own.

What decides and shapes a person's taste in music? That is the question music producer Tim Westergren has spent the past 20 years trying to answer.

Last week, Pandora, the streaming music company he founded, turned ten. To mark the day, Pandora stripped the annoying ads off the platform so users could listen in peace all day long — a decision that, by Billboard's estimate, cost the company more than US$3.8 million.

Even for a company with annual revenue above $900 million and more than 80 million active users, that is a lavish birthday present, especially for one that has been losing money the whole way. But Pandora's decision makes sense: for the company and for the music industry, this was a day worth marking.

"How people discover music, and the channels music travels through, have both changed enormously. We were standing right in the path of that wind, and what we did sped the change up," Westergren wrote on Pandora's official blog on September 5.

The change Westergren is describing shows most plainly in the physical record business, which the internet has battered beyond recognition over the past 15 years. Westergren came up through the traditional music industry, ran into the internet more or less by accident, founded Pandora, and in doing so redirected his own career while both witnessing and pushing the industry's shift from physical to digital.

Wouldn't it be cool if a tool existed that played me only the songs I love?

When Tim Westergren built the Music Genome Project, Pandora's predecessor, he was not trying to make a streaming radio station. He was trying to make a music database.

That was 1999, and Westergren was still scoring films for a living. "Sometimes listeners couldn't find the songs they liked, musicians couldn't find their listeners, and even retailers didn't know which songs to sell to which audience," he said in an interview, describing the bind he thought the whole industry was in. He decided to do something about it.

So he set to work on a music database and gave it a grand-sounding name: the Music Genome Project. He wanted to sort songs by genre and similarity so that music could be recommended to listeners with some precision, and so that a link could be built between musicians and the people who might listen to them.

To do it, he recruited a crowd of people who knew music and started taking songs apart one by one. "Dancing Queen," by the Swedish band ABBA, was among the first. "We spent half an hour on it and pulled out nearly 200 tags we could classify it by. We wrote them down on paper and then typed them into an Excel sheet. At the time we thought we were idiots — we had no idea what any of it was for," Westergren wrote on the blog. Years passed before he understood how important that work had been.

If you had to explain what Pandora has done over the past ten years in one word, the word is "recommendation." It rests on algorithms and listening habits. The more attributes you pull from a song, and the bigger the catalog of analyzed songs, the better your chances of finding what makes different songs move the same person. And the longer a user listens on Pandora, the sharper the platform's recommendations get, guided by what that person likes and dislikes.

Ten years on, Pandora has amassed a huge database: 200,000 songs analyzed in detail, 8 billion personalized stations, 3.75 billion trait analyses, and 55 billion thumbs up or down. Westergren believes he is getting closer and closer to the smart recommendation system he first imagined.

We Lost in Court, But... Are You Still Going to Buy a CD?

That is a line spoken by Sean Parker, played by Justin Timberlake, in the film The Social Network.

In 1999, just as Westergren was starting the Music Genome Project, a website that let users upload and download music free — Napster — went live. Its founder was Sean Parker.

It was the first time the music industry felt the force of the internet. People swarmed to Napster to share and download music, and by February 2001 the site had 26.4 million active users, even though everyone knew it was piracy. The big labels, furious, sued Napster together and demanded enormous royalty payments.

So Sean Parker breezily announced that Napster was bankrupt. And then came that line. He was right: nobody was buying CDs anymore.

In 1998, physical record sales hit their all-time peak of 3.271 billion units, equivalent to half the world's population at the time. By 2005, the year Pandora launched, that figure had dropped to 705 million.

The way people consumed music had been changed for good, and Pandora arrived on the eve of the change.

Steve Jobs Destroyed the Record, But the iPhone Saved Pandora

In the first years of digital music, the download model led by iTunes was dominant. So Pandora radio did little of note in its first two or three years. Two obstacles held it back.

First, Pandora could only play on a computer, which left it with no real advantage over more portable devices like the iPod or other MP3 players. Second, as a streaming service, Pandora ate up a lot of data and bandwidth, while downloading from stores like the iTunes Store cost far less.

The turning point came in 2007, and the star of the story was that remarkable device, the iPhone.

In 2007, Steve Jobs and Apple launched the iPhone. That June, the iPhone platform opened to third-party apps. In 2008, Pandora moved quickly and built an iPhone app.

Stephen Phillips, founder of Wonder.fm, another site that helps users discover music, says Pandora made the move from the computer to mobile better than anyone else, and that this is what turned it into a star of the past decade in music.

Having taken the mobile platform and solved the portability problem, Pandora expanded fast, with daily sign-ups doubling. The New York Times called the iPhone a godsend for Pandora.

Meanwhile, the bandwidth and data problems were being solved as internet infrastructure improved. By 2010, global bandwidth had grown more than tenfold from 2005. Over the same ten years, the cost of internet data transmission in the United States fell more than 120-fold.

On one side, faster internet and cheaper access. On the other, the fast growth of mobile music. Together the two changed how people consumed digital music: streaming, which you could simply press play on, was more convenient, and it began to replace downloads as the main engine of digital music's growth.

Carried by that trend, Pandora went through a stretch of very fast growth. In the five years from 2008 to 2012, revenue grew twentyfold and active users fivefold.

As one of the earliest streaming services, Pandora changed the music industry

Whenever we talk about how music has changed over the past decade, Pandora is impossible to skip. Its ten years are essentially the ten years traditional music collapsed, and almost everything that happened in the industry ties back to Pandora in some way.

For one thing, Pandora is the only survivor of the first wave of streaming services. In today's market, the independent streaming brands like Spotify and Tidal, and the ones attached to big companies like Apple Music and Google Play, are all its juniors. So Pandora's own history is a miniature of how streaming has developed over these ten years.

Streaming services led by Pandora also pushed the industry to care more and more about rights, so much so that managing music rights became a business of its own.

The logic is simple. As streaming rose, the physical-record arms of the traditional labels took a heavy blow. There were only two ways to change course: put more money into digital music, or drop the physical record business entirely. Bertelsmann Music Group (BMG) took the second road.

In 2008, BMG's parent, the Bertelsmann Group, sold all of BMG to Sony Music. Bertelsmann then used the BMG name to set up a new rights-management company. All it does is buy music rights and collect fees from the companies that use the music — McDonald's playing background music, television commercials, films and TV shows, talent contests, and so on.

Finally, streaming changed how people consumed music. When physical records still ruled, you could only hear songs in the order a label had arranged them on an album. On streaming, Pandora broke the album's boundaries and grouped songs of similar style together, a way of listening that fits a listener's taste better.

All of this change is still under way. Pandora's ten years have also been ten years of overall decline for the music industry, and for the record business above all. Records sell worse and worse, and even digital downloads started falling in 2013.

Pandora did something cool, and it is also working hard to make money

Advertising has always been Pandora's most important source of revenue. In 2014, its ad revenue was almost four times its subscription revenue. In 2012 and 2013, ad revenue ran more than seven times subscription revenue.

Pandora has its own approach to advertising. David Wade, once an executive at imeem, a rival streaming service, thinks Pandora was very good at hiring ad salespeople away from local radio stations to build unusual ad products, while imeem ran campaigns with big national brands. "That's probably why Pandora is still alive today and imeem vanished after Myspace bought it."

Pandora's chief financial officer, Mike Herring, confirmed as much at an analyst meeting. Local advertising now accounts for 26% of all ad revenue and is growing at 67%.

Lizzie Widhelm, Pandora's senior vice president of ad sales, offered another secret of its success: "What's good for the listener should also be good for the advertiser."

That idea shows up in a new ad format Pandora recently introduced. Under it, users can choose to watch a 15-second video, swipe through a few ad images, or drag a 360-degree view of a product. Once they have finished, they get an hour of music with no ads.

For users, an hour without interruption is a good deal. For advertisers, the new format raised brand awareness by 12% and purchase intent by 30%. In other words, these ads help companies sell more.

But advertising alone may not be enough. We did the arithmetic for Pandora: if every active user became a subscriber, its 2014 revenue would have been $2.934 billion. Pandora's actual revenue was $920 million. A subscriber, in other words, is worth much more than a free listener, so making more money means attracting more subscribers.

So on September 9, Pandora's tenth anniversary, the company ran its all-day ad-free celebration and, alongside it, launched Pandora One, a package that buys a single ad-free day for $0.99. The point is to get more people to try listening without ads, and eventually to coax them into spending $36 a year on a full-year subscription to Pandora radio.

Ten years on, Pandora is still "poor," because the labels take the money

Even so, Pandora faces one enormous problem: for all its users, it still does not make money. In 2008, its net loss was more than $18 million. By 2014, the figure had grown to $30 million.

Pandora's published financial reports show the main reason is that royalty payments are too high. Royalties account for more than 50% of all expenses and, since 2008, have grown at an average of 200% a year.

In fact, Pandora has been fighting music rights holders since the day it was founded.

At first, Pandora obtained the rights to the music it played through the rights agency SoundExchange. In 2007, SoundExchange demanded that royalty rates double. For a company that was barely profitable to begin with, this was one blow on top of another.

Founder Tim Westergren objected loudly and in public more than once: "That increase would bankrupt Pandora outright, and it would bankrupt every internet radio station too."

The royalty fight ran for two years, and at one point the US Congress stepped in to mediate. In July 2009, Pandora and SoundExchange finally reached an agreement. According to Westergren, it held royalty rates within a reasonable range and let Pandora stay in the business.

From then on, Pandora saw clearly that its fate lay in the hands of the people who manage music rights. Its efforts to get out from under them have never stopped.

In September 2012, both houses of the US Congress began reviewing a bill that, if passed, would cut the royalties paid by music services like Pandora by 80%.

Westergren was thrilled when he heard. That night he published an open letter: "This is a hugely important bill for Pandora. For the first time since 1998, internet radio would be treated fairly." He then called on Pandora's users to petition the members of Congress who represent them to support it.

Two months later, Pandora dropped its support for the bill. Westergren never explained why, but the general assumption was that Pandora had come under heavy pressure from several directions.

Earlier, 125 musicians, among them Rihanna, Katy Perry and Maroon 5, had signed a joint letter demanding that Pandora abandon the bill. Some independent labels had also made their displeasure with Pandora's position known.

Three years later, Pandora launched another campaign to cut its music royalty costs, this time recruiting big companies — Google, Amazon, iHeartMedia and NPR — as allies.

But history repeats itself with striking fidelity, and this alliance fell apart as well. Amazon left first, and rumor had it that NPR would follow. Pandora's second attempt did not work either.

At bottom, the royalty problem is a question about how to divide the money now that the digital era has overturned the whole music industry.

In the old music business, sales of physical records were the biggest slice of the pie. But as physical records collapsed and piracy spread, total music sales across the industry, physical and digital together, began to fall.

For the traditional labels, records stopped selling and revenue fell with them. Holding the rights, they leaned on the digital music platforms and demanded a larger share.

Musicians see it the same way. Their reasoning is that since digital music has replaced records, digital music ought to pay them what records once did.

But the total revenue of streaming services like Pandora has never reached the scale of the record industry's golden age, so they cannot produce enough money to pay the labels and the musicians back in kind. Everyone wants to make money, and more of it, which makes the quarrels among labels, musicians and streaming services unavoidable.

Pandora is only a music platform, and it carries little weight in negotiations with labels and musicians. To see this, look at how Taylor Swift forced her music off Spotify, and how she forced Apple Music to change the way it pays musicians. In this war over royalties, Pandora's chances of winning remain slim.

The old system has collapsed, but new rules have not been built to replace it. So streaming services like Pandora, the new players in this industry, are still feeling for their place in it. What is their relationship with the labels? With musicians? With the live music market? These are the questions Pandora, and the whole streaming industry, still have to answer.