Pandora – Let’s open the Box

There has been a significant amount of publicity since Pandora filed their S-1 to go public on 2/11/11.  Based on data available I have taken a deeper dive into their content acquisition, primarily Sound Exchange royalty rates and payment.

The bulk of Pandora’s revenue is generated from advertising.  Advertising is based on audience size.  In the most recent Ando Media, LLC (now rebranded as Triton Digital – Ando Media is the de facto standard for Internet radio audience measurement and for full disclosure a firm I co-founded) February 2011 Top 20 Ranker Pandora generated a 495,055 AAS for the time period Monday-Sunday 6 AM- Midnight  AAS or Average Active Sessions is defined as “The total listening hours divided by hours in the reported time period”.   The February report did not fully measure some of Pandora’s mobile streams so listening for February actually declined from January.  Taking the average for the last three months (Dec-Feb) results in an AAS of 520,083 for that time period.

So let’s assume the average song length is 3.5 minutes and assume promo/ads of 2 minutes per hour.  This would result in Pandora playing 16.6 songs per hour.  In the parlance of Sound Exchange, based on Pandora’s audience there would be 8.6 million performance per hour x 24 = 206 million per day x 30 = 6.2 billion performances monthly.  At the $.00102 performance royalty rate per song this equates to $6.3 Million per month in music royalties or $76 Million per year.  Pandora reported content acquisition costs for the 12 months ending 1/31/11 of $69,357,000.  While I believe the majority of this expense represents sound exchange royalties it most likely represents other expenses such as ASCAP/BMI.  My estimate is based on more recent and higher audience levels.  Also overnight listening is most likely lower than the 6 AM – Midnight daypart.

There is a linear relationship between audience and what Pandora calls Content Acquisition.  Over the next several years Pandora’s Sound Exchange rate will escalate as follows:

2012     $.00110

2013     $.00120

2014     $.00130

2015     $.00140

From January 2010 – January 2011 Pandora’s audience increased 103%.  If we assume Pandora’s audience grows by half this amount, 51.5%, Content Acquisition costs solely from Sound Exchange will increase to $96 Million  (average monthly 2011 audience 656,830 x 16.6 x 24 x 30 x $.00102).   Pandora was approximately break even for the period ending 1/31/11 with Content Acquisition costs of $69 Million.  Based on my assumptions Pandora’s content acquisition costs will increase by $27 Million.  Put another way net advertising revenue will have to increase by this amount to continue to break even.  I don’t believe break even is the goal.  Given the increase in royalty rates and assuming no increase in audience (probably not likely)  Content Acquisition costs may increase each year (by $29 Million in 2012 and a little over $11 Million each year thereafter).

One of the reasons Pandora has attained their position as the largest Internet radio service is their low ad spot load.  Pandora does not report sellout rates for its ad inventory and there is also the option of running more ad inventory although this may have a negative effect on listening levels.  Pandora is early in its life cycle and the optimal blend of ad inventory/size of audience to maximize revenue has not be determined.  Pandora also generates other revenue that does not result in higher Content Acquisition Costs, e.g. display revenue.