Pandora, Spotify Face Off In Free Online Music Market

It took decades for music delivery to evolve from vinyl records to CDs and years to go from CDs to MP3 players.

Now Internet radio is shaping up as competition for digital audio players by providing free online music streaming from websites such as Pandora and Spotify.

Singer-songwriter Theresa Andersson had just wrapped up a set at the New Orleans Jazz and Heritage Festival, and new fan Dana Spanierman was already planning how she could hear similar bluesy harmonies.

"I'm going to put her into Pandora and see who else I've been missing," the Santa Cruz, California resident said.

Spanierman is one of 125 million registered users of Pandora Media Inc, a service that lets listeners create their own playlists, or "stations."

Using a single genre, artist or song title that users type into an app downloaded to their computer or smart phone, it compiles and streams songs by a variety of artists who share musical attributes with the one requested.

"It's a great way of putting in a genre that I like and hearing other bands that I'm not that familiar with," Spanierman said.

Pandora produces these customized playlists by using technology from the Music Genome Project, an intensive analysis and cataloging of music based on some 450 distinct markers related to tonal quality, rhythm, instruments and style.

The publicly traded company has close to a million songs in its database and streams the music free of charge to listeners, which for Spanierman - who hates paying for music - is a big plus. "It really works for me. I don't even really mind the commercials," she said, touching on Pandora's primary revenue stream.

New Revenue

Founded in 2000, Pandora racked up $274 million in revenue last year, largely from the 10- to 30-second advertising spots the company sprinkles into its radio streams and advertising partnerships with platforms such as Google.

But financial pressures have risen in tandem with advertising sales, because the firm operates under a license that requires paying royalties to the artists played by its listeners.

Last year, it paid almost $150 million in royalties, according to information from the company. Most are funneled through Sound Exchange, a firm which pays half the rights to the artist and half to the label.

At a royalty rate of 0.1 to 0.2 cents per track per listener, most artists receive less than $5,000 annually, Sound Exchange communications manager Marie Knowles told Reuters.

While Pandora is not making musicians rich, Knowles said many are happy to receive the money. "This is not a revenue stream that artists had before," she said.

Kevin Wortis, director of label services for Girlie Action Media in New York, which provides management services to Andersson and more than 130 other musicians, said it also helps promote artists.

"It's all about momentum and multiple impressions," he said.

"I think Pandora has had a positive impact. People can get turned on to new music with that format, and a lot of people love it."

Famished For Great Music

Pandora founder and Chief Strategy Officer Tim Westergren is a musician and composer. He was in New Orleans for the Sync Up industry conference held in conjunction with the Jazz Fest - an event which he said puts Pandora in "perfect context."

The seven-day bash presents hundreds of bands, "some well-known, and some young, new bands that people haven't heard so much," he said. "You have hundreds of thousands of people who are just famished for great music."

Like the festival, Pandora puts those lesser-known artists on equal footing with big names and gives the audience broad choices in genre, Westergren says.

As Pandora grows its music database, its costs have increased. While the firm posted a $16 million loss in its latest fiscal year, which ended January 31, Westergren believes the growing number of users will boost revenue.

"As we've started to reach scale, that's really fueled advertising sales," he said, adding that "we're absolutely confident" they can sell enough advertising to afford the music.

Pandora estimates it will take in $410 million in revenue during the coming year, according to filings with the Securities and Exchange Commission, but losses likely will continue while the it pursues new advertising, particularly in the mobile device market.

Increased Competition

The firm also faces ongoing competition from other online music providers, including the increasingly popular Spotify, a digital music service that holds streaming rights to some 18 million tracks.

Unlike Pandora, Spotify makes music available to listeners on demand, meaning users can select the artist or album they want to hear. To do this, the company must conclude licensing arrangements with each artist it offers.

Also, while Pandora's license currently limits it to U.S. operation, Spotify is available in 13 countries. Both services are mostly free, but both offer a service upgrade to paying subscribers.

Spotify, which now claims 10 million active users and about 3 million paying subscribers, has partially hooked its star to Facebook, now requiring users to register for the music service using their Facebook accounts.

The social network posts Spotify listeners' music choices on their personal pages for friends to see.

While the Facebook partnership has increased Spotify's exposure, not everyone appreciates it.

"What I don't like about Spotify is, what you listen to shows up on Facebook, and I don't need everyone knowing what I'm listening to, so I don't use it," festival-goer Spanierman said.

Despite the differences in their formats and services, Spotify likely will continue nipping at Pandora's heels. The company is rumored to be developing a Pandora-like music discovery service that could launch later this year.

Pandora shares, which debuted at $16 when it made its initial public offering in June 2011, closed at $8.75 on Friday.