Internet service finally turns profit, eyes fresh horizons

Founded nearly 11 years ago, Internet radio service Pandora has weathered a number of seismic changes in the online music scene, and survived its own brushes with near closure, to emerge as the definitive leader in the business.

While its advantage in its own field is solid, the company, which finally turned its first profit in the first quarter of last year, is now training its sights on traditional radio through deals with carmakers and stereo manufacturers, even while competitors and the specter of on-demand streaming point to an uncertain future.

Starting as an Internet-only service in 2000, Pandora patented the Music Genome Project — a system that determines playlists and cycles listeners through a chosen artist, playing songs by what it determines to be compatible acts.

After several rough years, the company truly took off in the late-2000s when it began offering apps for smartphones and other mobile devices. At present, the site boasts 65 million registered users who spend an average of 10 hours per month on the service, half of that on mobile devices.

Several companies offer dedicated Pandora tabletop stereos for home and office listening, with Panasonic and Sony offering connected TVs and Blu-ray players. But half of all radio-listening occurs in the car, a statistic of which the company is well aware.

“That’s the holy grail for us,” says Pandora founder Tim Westergren. “We just have to figure out a solution to get Pandora into cars that’s as easy as radio is now.”

To that end, the company has partnered with Ford (which intends to have Pandora functionality on its cars’ dashboards by year’s end), Mercedes-Benz (which will feature a dedicated digital plug-in) and GM, which announced intentions to have Pandora in its new model cars, though the timing has yet to be determined. Alpine and Pioneer are offering after-market in-dash radio decks with Pandora functionality, and voice-activated music searching is in the cards as well.

(Any further deals with other carmakers have yet to be disclosed, though Westergren claims the company “will be announcing a host of things publicly” in the coming months.)

The attempt to break onto car dashboards is a stab to the heart of AM/FM radio, which, while still dominant in the field to the tune of a 90% share of all radio listening, has seen troubling signs in the behavior of young consumers.

Terrestrial radio has attempted to adapt to tech changes by streaming its programming on the Internet, but according to a study by Edison Research in September 2010, trends are not in its favor. According to the study, 20% of respondents aged 12-24 had listened to Pandora in the past month, with all online streams of AM/FM radio reaching only 6%. Significantly, those respondents reported spending nearly three hours a day on the Internet and a little over one hour listening to terrestrial radio — nearly the exact inverse of 12-24’s habits from 10 years ago.

In other words, Internet time is replacing radio time for youngsters, and Pandora owns the Internet space. If the younger generation retains those habits, and if Pandora is successful in translating to the auto environment, the consequences for AM/FM could be severe.

“Terrestrial radio has nowhere to go but down,” says Jim Cady, CEO of Slacker, Pandora’s nearest competitor in the Internet radio field. “The only question is the steepness of the slope. Satellite radio seems to have plateaued, and even iTunes downloads have started decreasing. These are three pillars of the business.”

Slacker — a relative newcomer to the field, having launched in 2007 — boasts a much higher total number of songs in its database (between 3 million and 4 million, according to the company, in contrast with Pandora’s total catalog of 850,000), as well as the ability to cache songs for playback when wireless service drops off, though its user base is significantly lower.

As for the automotive connectivity issue, Slacker expects integrated in-dash hookups with mobile devices to soon become a standard feature, regardless of service-specific alliances, and is hence betting on its deals with mobile carriers as a way to compete.

“It’s all about walking into the car with your phone, and having the dash display the apps that you have on your handset,” says Jonathan Sasse, Slacker’s senior VP of marketing. “And the bandwidth of your phone powers all those connections. So I think if you win on mobile, you have a great chance of succeeding in the automotive sector as well.”

While they continue to expand their reach, however, both companies face an uncertain future in terms of the online music environment, which could change dramatically depending on the fortunes of on-demand music-streaming services.

While existing subscription services like Rhapsody, MOG and Rdio don’t seem to be harming Pandora’s bottomline, the possible U.S. launch of Spotify, the European service that offers free on-demand listening, could change things. There are still huge hurdles for Spotify in the form of music licensing agreements — the far less intrusive Pandora, for example, only solidified favorable licenses in 2009, and had to petition the federal government to do so — but the company’s massive 10 million song library, and its offer of playback on any of these numbers at any time, gratis, could be troubling for competitors.

Slacker’s heads seem skeptical that Spotify will win the licenses it needs to launch in the U.S. in its current form. Westergren sees Spotify and Pandora as operating in fundamentally different spaces, emphasizing that Pandora’s intended competitor is traditional radio, rather than any download or on-demand service, which requires significant time on the part of the listener to curate.

“The average person listens to somewhere between 17 and 19 hours of music a week,” Westergren says, adding that it’s unlikely listeners regularly would be willing to program that amount of music themselves.

Indeed, despite the next-gen nature of its Music Genome Project, services like Pandora bear remarkable resemblance to the general attributes of old-school radio. Pandora is overwhelmingly ad-supported (“and we think we will be forever,” Westergren says), and while Slacker is looking to develop on-demand functionality, Sasse mentions that the ad-model is healthy for them, and they “have no intention of trying to shovel users into subscriptions.” And judging from Slacker’s recent deal with ABC News to provide skippable news content, it also looks to be encroaching into other traditional AM/FM strongholds.

Ironically, compared with such one-size-fits-all approaches as the DJ-less Jack FM (the fastest-growing format in FM), which essentially functions as a 1,000-song iPod set on “shuffle,” these Internet services offer considerably more human curatorship than many terrestrial stations, with Pandora’s researchers spending “between 15 minutes to over an hour” on each uploaded song, per Westergren, and Slacker employing a corps of programmers often culled from broadcast backgrounds.

“In a couple years, you’re not going to recognize radio anymore,” Westergren predicts. “Internet radio is going to be everywhere.”

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