No longer an underdog, Pandora gets a powerful ally

By Erin Griffith , written on October 25, 2012

From The News Desk

For years Pandora has played up its underdog status, fighting government regulators, evil record labels, and incumbent radio stations in its valiant mission of bringing radio online. Now it's become allies with one of its biggest competitors in an attempt to save its own business.

Perhaps you remember founder Tim Westergren's 2007 appeal to users to "save Internet radio" after the Copyright Royalty Board threatened to triple the company's licensing fees. Pandora has done well to position itself as a disruptive underdog as crippling royalties have constantly threatened to put it out of business.

Disrupting traditional radio hasn't been a smooth ride. The company has consistently said it's going after traditional radio's ad dollars, hiring away their salespeople, and (to the chagrin of the Radio Advertising Board and Arbitron) measuring its listenership in ways that stack up with terrestrial radio's audience metrics. "Broadcast radio companies are clearly afraid of what an accurate apples-to-apples measurement with Internet radio will show to radio," a Pandora spokesperson said at the time.

This underdog act has disgusted the suits at Clear Channel and Cumulus Media, the country's two biggest radio conglomerates. They refuse to admit that traditional radio is on the decline, choosing to point to their high audience penetration (true), while hiding the fact that hours spent with traditional radio are shrinking amid a growing buffet of online music options. Cumulus CEO Lew Dickey has called the online services a niche, rattling off a laundry list of reasons it would never truly disrupt their business. There was the bandwidth problem, the distracted driver problem, the local news problem, he argued.

Not helping tensions is the fact that, while Pandora shells out more than half of its revenue in royalties, the traditional guys pay next to nothing for the rights to play music. Making matters worse, some members of the traditional radio world are still lobbying to require smartphone makers put FM chips into their phones, which just seems absurd.

Today things got even more absurd -- the two sides of the fence are now teaming up. Clear Channel and Pandora have formed the Internet Radio Coalition, which supports a piece of legislation called the Internet Radio Fairness Act of 2012. The goal is pretty obvious in its name -- they want to lower the rates that Pandora and its streaming ilk have to pay for digital streaming rights.

It seems crazy to me that after years of tensions, Clear Channel and Pandora would share a common goal. Clear Channel makes it clear that its streaming product, iHeartRadio, isn't a high priority. “[iHeartRadio] is not a business. It’s a feature, one part of what we can do,” Clear Channel's head of radio John Hogan told me in January.

That's because of the small amount of revenue it brings in: Radio represents half of Clear Channel's revenue, even as the company removes the word "radio" from its radio division. The company is highly leveraged (thanks Bain Capital!) and can't afford to cannibalize its biggest revenue driver. It's the classic Innovator's Dilemma: Clear Channel must protect its traditional radio ads business from turning into a less profitable streaming business.

And yet, here we are today, with Clear Channel lobbying on behalf of Pandora and streaming competitors. I imagine that iHeartRadio's adoption -- and the royalty payments that come with growing listening hours -- are what changed Clear Channel's tune. The company, which is the only traditional player to offer any kind of digital streaming, has to pay royalties in the same way Pandora does. (It has managed to negotiate just a few separate deals with labels.)

To me, Clear Channel's joining up with Pandora signals a shift in both Clear Channel's future as a stodgy old industry dinosaur and in the radio world's fight between old and new. Nothing erodes old grudges like a shared enemy: Both Clear Channel and Pandora fear a different bill in Congress.

The Nadler bill, with full support of the record labels, proposes that satellite radio and cable radio pay the same rates as webcasters. Naturally, Pandora opposes it, saying such a law would keep the "astonishingly unfair" digital royalty rates in place. After years of discounting digital, Clear Channel does too. Goliath is now on the side of the Davids.

Update: Make that two allies: Reports that Apple will launch a streaming service in 2013 sent Pandora's shares into a downward spiral today. Investors not excited about the competition should consider this: Apple's product will reportedly be ad-supported, and Apple will need to pay licensing fees as well. While this may hurt Pandora in the short term, it will buoy the entire sector in the long term. Apple, like Clear Channel, will fight to lower royalty fees, and even though Apple hasn't ever been terribly strong in advertising, another large player will help legitimize the online audio as a place to spend ad dollars (it only brought in around $800 million last year). The more Goliaths on team digital audio, the better chance it has at becoming a sustainable business for startups, too.

[Illustration by Hallie Bateman]