Tech

Shira Ovide is a Bloomberg Gadfly columnist covering technology. She previously was a reporter for the Wall Street Journal.

For years, Pandora's backers and detractors have had this week circled on their calendars. In what was billed as a moment of clarity for the company’s viability, a government tribunal on Wednesday set a fee that the digital music service has to pay for each song it plays to listeners. Shares popped about 18 percent in after-hours trading in relief that the fee --  which swallows nearly 50 percent of Pandora’s revenue -- was much lower than expected.

Worries about the rate ruling have dogged Pandora. At least there is a resolution, even if it means Pandora’s music fee is going up 21 percent for next year. The big victory for Pandora is that the tribunal also said annual rates until 2020 would be adjusted modestly higher in line with inflation. Typically those rates have increased each year. So congratulations,  Pandora! Do a little jig. Play "We Are the Champions" on repeat all night. 

And then the tough slog and doubts for Pandora begin anew. 

Pleasant Tunes
Pandora and a music industry consortium proposed sharply different rates for Web radio song fees. The rate set Wednesday was higher than Pandora's current costs -- at least for next year -- but lower than what the music group had proposed.
Source: Bloomberg Intelligence and filings with the U.S. Copyright Royalty Board
* Rates for 2017-2020 will be adjusted in line with inflation.

Pandora must now rewire its business model by striking song-licensing deals directly with music industry participants -- a direction in which the company has already been tiptoeing. On the other side of the negotiating table are many of the same people who have grown to loathe Pandora, in part because of feuding over the music rates announced Wednesday. The outcome of deal talks with prickly adversaries is just as uncertain as the whims of a government tribunal.

To recap how we got here, Pandora is distinct among digital music services in business structure and how it functions. YouTube, Apple Music and Spotify allow people to search for and play a particular song at their whim. Pandora is like a radio station, in that listeners can’t pick the next song. The distinction has allowed Pandora to opt into U.S. law that sets a music royalty rate for Web radio services. In contrast, Spotify and the like have each struck individual agreements with the record labels for song rights. 

Pandora’s oddball status has downsides. One, its business health relies on the whims of judges appointed by the U.S. Library of Congress. The statutory rate -- which increases to 17 cents per 100 songs next year, from 14 cents this year -- cost Pandora more than $400 million last year. Two, Pandora has battled, often publicly, with music industry interests to keep rates low, and that has bred resentments among industry executives and even Pink Floyd. Third, the company's licensing arrangement has helped limit Pandora’s availability to the U.S., Australia and New Zealand.

Play, Skip or Pause?
The royalties for music that Pandora streams to its listeners cost the company nearly 50 cents of every dollar in revenue. The music fees are a big reason Pandora is unprofitable.
Source: Pandora SEC filings
The figures for 2012 and 2013 are for 11 months.

As the downsides piled up,  Pandora has been inching toward becoming much like the other digital music services. That means knocking on doors of the record labels to strike licensing deals to obtain cost predictability and the ability to operate globally. But to do this, a company that grew up fighting the music industry has to become a kinder, gentler Pandora.

“The industry has no more dependable ally than Pandora,” CEO Brian McAndrews said last month in a conference call that doubled as an olive branch to the music business. Hear that, record companies? Pandora likes you. It really, really likes you. And it wants to make deals with you.

Making nice has already meant Pandora is paying up to resolve different disputes over songwriting rights, including one this week, and to settle a lawsuit over music royalties for decades-old songs. Pandora has offered data for music companies and musicians to better understand their fans. McAndrews has bashed the free on-demand music services like YouTube, piggybacking on grumbles from some in the music industry. 

Put yourself in the (Italian leather) shoes of a record industry executive. You believe Pandora is a digital robber baron and treated the industry like garbage. Now Pandora wants to work out music rights agreements. Wouldn't you relish the chance to make Pandora pay through the nose? The two sides have “been enemies or at least unhappy partners for so long, now you’re going to do business together. How is this going to work?” said Robert Jacobs, co-chairman of the entertainment litigation practice at Manatt, Phelps & Phillips.

Upside Down Pandora
Pandora shares are trading below the company's IPO price.
Source: Bloomberg

The shift to negotiated rates could cost Pandora more than paying music fees decided by judges. In the risk factors section of its annual report, Pandora called direct licenses with music companies “a time-consuming and expensive undertaking that could jeopardize our ability to stream a significant percentage of the music currently in our library and result in royalty costs that are prohibitively expensive.”

The timing of Pandora's switch isn't ideal, either. When Pandora cemented its current song royalty fees in 2009, it was before Apple, Google and Amazon made a serious push to use music services to sweeten their consumer services. The tech big dogs can subsidize the costs of their music service forever, if necessary. For a company like Pandora that has to make money (but doesn’t) on music, it’s hard to compete on those terms.

It's true there are constant battles between companies that make entertainment programming and those that distribute it. See cable TV (or Netflix) versus television networks. Each side needs the other, so they grit their teeth and make deals. The trouble for Pandora is its dealmaking will most likely be more painful now that the music industry likes Pandora less --and needs it even less -- than it used to.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Shira Ovide in New York at sovide@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net