Pandora Radio:

Fire Unprofitable Customers?

By Chih-Hsin Chen and Pinar S. Ozer
11.10.11
Management Information Systems -INFO 503
Prof. Ross Malaga
Fall 2011
Online Radio History Before 2000

The beginning of online radio could trace back to the
1990s.
Arround year 1996, Nullsoft and Microsoft released
streaming audio players as free downloads.
Internet radio attracted significant media and
investor attention in the late 1990s and the early
2000s.
Pandora Radio
Started back in the year 2000.

Main feature: Music Genome Project

A system that learn from feedbacks and become
more precise in making music suggestions.
Screenshot
Business History
After Music Genome Project established, they tried
selling to both online & offline music stores first.

In 2004, Pandora.com was created.

Test of subscription model.
Business History (continued)
Switched over to a free model but still offered a
subscription during 2005.

In 2007, the Copyright Royalty Board announced a
new fee schedule for internet radio.

2008, Congress passed the Webcaster Settlement Act
Business History (concluded)
In 2008, Apple released the second-generation
iPhone and allowed a 3
rd
party to distribute apps
though Apple App Store.

In 2009, Pandora reached an agreement with
SoundExchange.


SWOT Analysis
Strength:
1. User basis.
2. Music Genome Project.

Weakness:
Lack of ability to create sufficient revenue.

SWOT Analysis(concluded)
Opportunity:
1. High customer recognition.
2. Number of user basis.

Threat:
The competition is getting worse in the industry.

Problem Statement
Should Pandora Fire their unprofitable customers?
Obviously, this is not the REAL problem here.

The REAL problem is, how do Pandora maximize their
revenue with current or alternative business model?


Analysis of Pandora Radio

THE BUSINESS MODEL of PANDORA
In Pandoras Business Model, there are three main sections which are

User Methods: Annual Subscribers
Partnering Platforms: Mobile Devices, Home Entertainment and
Car Radios Applications
Ad Partners: Affiliate Marketing


The Business Model of Pandora
Revenues and Price
Subscription Model
Freemium Model
Affiliate Marketing (Fees are low)
Advertising Revenue (93%)




Competitive Positioning
Service Quality
Tim Westergens musical background
High service quality
The Music Genome Project: Satisfied customers
iPhone Application: Emerging Mobile Market



Customer Loyalty and Segmentation
Pandora has satisfied customers;
therefore they are loyal.
After Joe Kennedy joined Pandora, the
company became a customer oriented
company. They started to do customer
segmentation analysis.






Competitive Grid in the Music
Market

ASSETS and COMPETENCES PANDORA GOOGLE SPOTIFY iHEARTRADIO
K
e
y

F
o
r

S
u
c
c
e
s
s


WEBSITE
CONTENT
MUSIC ARCHIEVE
ADVERTISING/PROMOTIONS
NUMBER OF USERS
S
e
c
o
n
d
a
r
y


MARKET SHARE
FINANCIAL CAPABILITY
MANAGEMENT
BRAND IMAGE& ENVIRONMENTAL
FRIENDLY PRACTICES

Point Scale
3= High
2=Average
1=Low

What Did Pandora Do in the Last
Year to Differentiate Their Product?

Fast moving market
The most important change is HTML5 usage instead of
Flash. HTML5 is better than the Flash because it makes
Pandora website more user-friendly and flexible.
Creating A New Station box, a drop-down appears to
help the users. Its not just keyword-based. Pandora will
dynamically serve the customers recommendations based
on the music genome core, customer own voting and
listening history, and social elements of the site.
Customer Acquisition
Viral Growth: Pandora has been
using word-of-mouth (WOM) as an
advertising tool so their marketing
expenditure isnt so high.
Additionally, Pandoras iPhone
application is one of the most
popular applications. WOM and
applications helped Pandora to
become highly recognized and they
had not much need to spend their
money on advertising.




Partnership: Pandora had developed
partnership with iTunes, Amazon,
MySpace, Twitter, and Facebook. It
is a mutual affair because Pandora
has conducted its customers to
iTunes and Amazon. Furthermore,
iTunes and Amazons customers
have seen Pandoras internet radio
link in those online stores. It helps
Pandora to market Pandoras
internet Radio.




Satisfying Consumer Needs
The Music Genome Project has been used in order to understand peoples
music habit and taste, analyze the musical elements and find out the songs that
they would probably like to listen. Understanding their customers need is one of
the most important core values of Pandora, because it provided a way to
understand the peoples desires in the music industry and offer them what they
really want.

Core Capabilities I

Customer Segmentation
Pandora has 29.5 million users with their information.
It is the other competitive advantages and Pandora can
use it as an asset to get the attention of advertisers.
The advertising revenue increased 5.5 times since 2009;
therefore, advertising has been their important revenue
(Edwards, 2011).




Core Capabilities II


Core Capabilities III

Retrieved from www.bnet.com
Pandoras fixed cost

Technology
Overhead
Genome Project
Costs
On the other hand, Pandora
has three major variable costs;

Revenue based royalties
Streaming
Commissions constitute
Pandoras Business Model didnt work and had to be improved.
They were not able to generate positive cash flow.
The subscription model didnt work. However their customers
accepted and started to use free hours, they quitted when the
free hours were done. They didnt continue to be subscribers
because they could use freemium option.
Although the paying users of Pandora are 500,000 whereas the
free users are 29 million, the paying user(36,000 $) create nine
times more revenue than the free user(4,000 $).


Pandoras Business Model Analysis I
Pandoras Business Model Analysis II
Retrieved from www.thepricingjournal.com
According to the Pandora case study, only 60% of the available ad space was
been used. It is the major source of the revenue(TR); it is a good idea to
increase that ratio because it helps to increase TR.

The variables costs(VC) are high because of the free users (unprofitable
customers). In order to decrease TVC, free users should be used more efficient
to create advertising revenue.




Pandoras Business Model Analysis III

Should They Leave Their Unprofitable Customers?

Although the paying user create 9 times more revenue than the
free user, WOM in order to bring in new customers is very
important.
Pandora doesnt spend lots of money on advertising because
Pandora uses WOM as an advertisement; therefore, Pandora cant
risk losing the customers even they are unprofitable.
Additionally, the competition has been increasing. According to
Tim Westergen the three most important competitors are Google,
Spotify and iHeartRadio.



Discussion of The Situation
Should They Leave Their Unprofitable Customers?

The advertising revenue has been increased 5.5
times since 2009. As seen in the graphic below, the
revenue line does seem to be rising faster than the
total costs line. It shows Pandora has changed its
future by increasing its advertising revue (Edwards,
2011)

Therefore, Pandora should try to utilize their
unprofitable customers effectively instead of just
leaving them and losing them.

Discussion of The Situation
Should Pandora Need The Venture Capitals Money?
As Tim Westergen mentioned they dont need their money.

What they need is to create new income or increase the current one.

One thing needed to change their future is switching their business model as
mentioned in the analysis section.

Pandora has higher CTR (Click Through Rate) and it will help to get more
revenue from advertisement through attracting more advertisers to fill-in the
remaining 40% of ad-space.

Discussion of The Situation
The VCs were very high. Furthermore, the scale of the unprofitable customers
had been increasing VC.
Although it affected negatively VC, it was increasing the popularity of Pandora as
an Internet radio.
On the other hand, their customers were loyal for the freemium model. Therefore,
they are not sufficient for the subscription model. According to Shih and Tecco, it
was Leaky Faucet problem (p. 6).
Pandoras revenue also increased with this large scale of usage. The 87 % of total
revenue came from the 98 % of Pandoras users (Lazaro, 2011).
Although it had a large amount of users, they couldnt use them efficiently in
order to increase pay-per click based advertising revenue.
In conclusion, they had two main problems in their business model, which were
the Leaky Faucet and 98% unprofitable customers.
Key Points in Pandora Music
Increasing in Advertising: The scale of its customers is very important; therefore,
Pandora should add more advertisements to increase their CTR(click through rate). In
the affiliate marketing when Pandora gets more click rate, Pandora can get more
advertisements and gain more money from those digital advertisers.

Furthermore, Pandora should find a way to increase the usage percentage of ad space.
Pandora would be able to earn more money and increase its revenue by achieving
these goals.

Going with the Freemium Model: The Freemium model is attractive option to
capture the new and keep the current customers. Pandora should add specific service
in order to get money from the customers who are free users.
Possible Solutions
Implementing A Subscription Model: This model requires getting payments from all
customers. Spreading the costs on the wide customer base lowers the cost per user. It
might cause losing customers. There is possibility that a lot of customers would stop
using Pandora.

Charging Money According to Listening Hours: In this solution, there shouldnt be any
charge to the customers who listen to Pandora less than 40 hours per month.

Pandora could charge 0.99 $ per month on their customers who listen to the music 40
hours to 80 hours during the month.

Furthermore, Pandora could charge more than .99$ to the customers who used the
system more than 80 hours during a month because the variable cost from these
customers is high and .99$ isnt enough to cover it.
Possible Solutions
First of all, we should find the breakeven situation with the current scenario
(Shih and Tecco, 2011)
* Average contribution from a user/hour= $0.0294-$.0258=$0.0036
Average hour per user per day=2.5 (p.11)
* Average contribution from a user/day=2.5*0.0036=$0.009
Current fixed cost=Head Count + Other Fixed Cost = $ 22 million
* Fixed Costs/day= $ 22 million/365=$ 0.0603 million
Breakeven would happen if the number of users/day ratio reaches
0.0603/0.009=6.7 million users. With the same business model, Pandora has
to have at least 6.7 million users which were 1.8 million. Therefore, the
business model should be changed.
Quantitative Analysis to Find The Best Solutions
Second of all, if Pandora decides to take $0.99 from users above 40 hours of
usage;

Total Variable Cost/Hour = $0.0258

0.0258*(H-40) = 0.99H=78.4 this is the breakeven point. After this point, the
positive contribution switches to negative. If the customers who listen to
Pandora internet radio more than 80 hours per month are charged $0.99,
Pandora will lose money. Therefore, the customers who use Pandora more
than 80 hours should be charged more than $0.99.
Quantitative Analysis to Find The Best Solutions
All of the above suggestions should be used with the extra Leaky Faucets
awareness.
Pandora should improve affiliate marketing team. They also should manage
affiliate marketing by using their customers and iPhone application powers.
The best fit proposal for Pandoras customers;
If the monthly usage of Pandoras customers is less or/and equals to 40 hours
than there wouldnt be any charge for service.
If the monthly usage of Pandoras customers is between 40 and 80 hours,
Pandora charges 0.99$ to its customers.
If the monthly usage of Pandoras customers is more than 80 hours, Pandora
charges 2.99$ to its customers.

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