Why a New Paid Plan Won’t Save Pandora

November 18, 2015, 12:30 PM UTC
Pandora To Raise $231 Million With Sale Of 10 Million Shares
The Pandora Media Inc. logo is seen on an Apple Inc. iPhone displayed for a photograph in Washington, D.C., U.S., on Tuesday, Sept. 17, 2013. Pandora Media Inc., owner of the biggest Web radio service, filed to raise about $231 million by issuing new shares after its stock more than doubled this year. Photographer: Andrew Harrer/Bloomberg via Getty Images
Photograph by Andrew Harrer — Bloomberg via Getty Images

Poor Pandora. The popular music service is trying something new after a financial face-plant in October. But the plans are already falling flat, while Pandora’s larger problems are beyond its control.

The new gambit, which Pandora (P) announced on Monday, involves plans to buy Rdio, a failing online music service that competes with the likes of Spotify and Apple Music. The idea here is for Pandora to spend $75 million for Rdio’s assets in the hopes of expanding its paid subscription business.

This could mean more revenue. But, as some have pointed out, Pandora’s plans for Rdio are also part of an effort to make nice with the music industry by charging more people for music. An expanded subscription service could counter the industry’s claims that Pandora doesn’t pay enough for the songs it plays. It could also strengthen Pandora’s recent attempt to portray itself as more musician-friendly than rivals Spotify or YouTube.

So will the Rdio plan improve Pandora’s fortunes, which suffered a brutal stock collapse after its October earnings? Early signs aren’t encouraging: Investors shrugged at the news, leaving Pandora shares to fall back to recent lows. Analysts, meanwhile, said the plan “reeks of desperation” and doubted the company’s ability to execute.

This is no surprise since, in many ways, the fate of Pandora is mostly out of the hands of its executives. Instead, the company’s future is being dictated by a hostile music industry that has its foot on Pandora’s throat, and can determine if it will live or die. It is the industry that now controls Pandora’s core music costs and, by extension, what it can offer its customers. And unfortunately, what is good for the music industry is not necessarily good for Pandora, consumers or musicians.

As venture capitalist Chris Dixon explained in a thoughtful essay this week, music is unlike other forms of online media in that those who control most of it–the music labels–are largely indifferent to innovation or improving user experience. Dixon describes the video game industry’s burgeoning fan communities, and then writes:

“Contrast this to the music industry, which relies on litigation to aggressively stifle remixing and experimentation. Large music labels have effectively become law firms devoted to protecting their back catalog. Sometimes this means suing their peers, and sometimes this means suing communities of users.”

And this is Pandora’s dilemma in a nutshell. It is operating in an economic environment in which the most powerful players are more interested in extracting long-ago back rents than exploring new business models. It’s as if the video game industry decided to forsake most of its new game development in favor of maximizing revenue from legacy Pac-Man terminals.

Think this is an exaggeration? Consider the music industry’s recent legal campaign against Pandora and other digital services to demand new royalties for songs recorded prior to 1972. The justification for such royalties is dubious but, faced with an expensive state-by-state legal fight and appeal process, Pandora agreed to settle the claims for $90 million. This is no trifle for a company that is reporting a rapid rise in quarterly losses, including $150 million in Q3:

Pandora losses

Meanwhile, none of the $90 million windfall Pandora is paying will go to support new artists. Instead, most of it will be divvied up among the usual cabal of lawyers and music labels who call the shots in the music industry. Worse, it’s unlikely the payout will quell the industry’s refrain that Pandora (even as it bleeds losses) is somehow paying too little in royalty payments.

For those familiar with music licensing, such arguments are nonsense. Pandora pays far more than traditional radio because, unlike AM/FM stations, digital companies must pay not only songwriters to play a song but they must also pay to perform the sound recording as well. This means that, even though Pandora can avail itself of a licensing system to pay songwriters, the industry has it over a barrel when it comes to demanding sound recording payments–which is why Pandora’s royalty rates are so high, and could climb higher still.

In this context, Pandora’s pledges about signing up more paid subscribers may simply amount to a peace offering to persuade the music labels to stop suing. Indeed, a source close to the company says relations between Pandora and the industry have “thawed” in recent months, and the sides are poised for more partnerships.

But even if this is true, how long until the record labels move the goal posts and demand still more from Pandora? Many in the music industry still regard it as a scapegoat for lost CD sales, and not as a promising new business model that offers a wealth of new data and marketing opportunities. It would be naive to think any current goodwill survive the next royalty fight.

All of this just sums up the large problem for Pandora and the music industry: The music royalty system, as it is currently configured, is broken and creates incentives for copyright owners to “become law firms devoted to protecting their back catalog” instead of helping to build a future industry. And until Congress takes action, we’re stuck with the status quo.

So, don’t expect Pandora’s plans for a subscription service to improve its fortunes when those who control the music business are rooting for the company to fail.

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