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Apple iTunes Radio Service Doesn't Leave Pandora Any Hope

Fresh reports that a long-rumored Apple iTunes Radio Service will arrive in February have caused shares of Pandora Media Inc. (NYSE: P) to swoon over the past two days.

Yesterday the selloff was so abrupt it triggered two circuit breakers that briefly halted trading in Pandora stock. Shares closed at $8.20 yesterday (Thursday), down nearly 12%, and have edged lower today.

The Bloomberg News report yesterday afternoon indicated Apple Inc. (Nasdaq: AAPL) is very close to a deal with the major record labels that will enable it to launch a very similar ad-based music streaming service.

Fears of such a service, possibly called iTunes Radio, drew the quick and nasty negative reaction on Wall Street.

"If the Apple radio rumors are true, Pandora has every reason to be scared – terrified, even," wrote Tom Cheredar in a commentary for Venture Beat.

Here's why.

The Beginning of Pandora's Demise?

Pandora, a user-customizable Internet-based music streaming service, already pays out about half of its revenue in licensing fees to the music labels, and these fees are expected to rise in 2015. It must have more users to survive.

In other words, Pandora – which has only posted a profit in one quarter since its June 2011 IPO – can't afford to have a huge chunk of its customers disappear. Any hope of future profitability hinges on continued growth.

"With Pandora, people have been patient, watching it grow listeners and revenue, and now this," James Marsh, who covers the company for Piper Jaffray, told Marketwatch. "The thought of listenership moving in the opposite direction would be very negative for them."

That's where an iTunes Radio service would cause a lot of damage.

About 40% of Pandora's listeners access it via an Apple device such as an iPhone or iPod. With an Apple iTunes Radio Service, those users could jump ship – if the iTunes Radio service was good enough to leave Pandora behind.

Unfortunately for Pandora, Apple already has most the tools required to make a service as good as or even better.

"If Apple offers a radio product, it will be far superior to anything else on the market," Rich Greenfield, an analyst with BTIG LLC, told Bloomberg News.

Apple's iTunes Radio Service Would Outdo Pandora

Here are the advantages an iTunes Radio Service would have out of the gate:

  • Apple brand: Apple has the most powerful brand in tech. Anything new it introduces gets an automatic lift just because it's an Apple product.
  • Built-in customer base: Apple already had 400 million iTunes accounts, and hundreds of millions of mobile devices in use. And because Apple controls the iOS operating system on these devices, it can automatically install its service on them just by including it in an iOS upgrade.
  • More songs: Because it's been selling music for nearly a decade, Apple already has a vast 26 million song library, ready to stream. Pandora's database has about 1 million songs.
  • Genius at work: Back in 2010 Apple added a little-talked about feature to iTunes called Genius, which can take a handful of songs and generate a customized playlist, much like Pandora does. Pandora's vaunted music genome may be more sophisticated, but the Genius technology means Apple is at least not starting from scratch.
  • Fewer limitations: The Bloomberg story indicated that Apple is trying to secure a licensing deal with the music labels that would avoid limits on the number of times users could listen to the same song or artist. Pandora's licensing arrangement requires it to set such limits. In exchange, Apple is said to be offering a percentage of the ad revenue, something Pandora can't afford to do.
  • Better sound quality: Back in February Apple announced it had developed a new higher-definition format that would enable it to deliver streaming audio at better-than-CD quality, bandwidth permitting.

Why Apple (Nasdaq: AAPL) Wants an iTunes Radio Service

Clearly, Apple can launch an iTunes Radio Service. But why bother?

As usual, it goes back to the ecosystem. Apple makes its money from selling hardware, gadgets like the iPhone and iPad. Its software and services – iOS, iTunes, etc. – make relatively little profit, but serve as the twine that binds the ecosystem together.

An iTunes Radio Service fits in perfectly, adding a differentiating feature to its iOS family that competing devices running Google Inc.'s (Nasdaq: GOOG) Android operating system will not have.

Better still, such a service will be better integrated with the iTunes Store itself, making it ever easier for Apple customers to buy more music from Apple.

Given that logic, and that most of the pieces are already in place, an iTunes Radio service is almost sure to do well for Apple while creating nightmares for rivals like Pandora.

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  1. Matthew Weber | October 29, 2012

    Pandora must tie its license fee to its user base. The more users, the higher the license fee (with some kind of cap to allow for profits to rise at some point), the fewer users, the less the license fee (with a floor that would be acceptable at even small membership numbers).

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