That increase will put significant pressure on a company that is already unable to keep its operating expenses below it revenues, in large part because its music license costs are pegged to its listeners, who in turn are pegged to the amount it can charge advertisers. Pandora made a loss of $9.1 million on revenues of $51 million in Q1 2011.
Currently, every time Pandora plays a song for you it costs the company 0.102 cents. That doesn't sound like much, but its total content acquisition costs in Q1 were $29 million. By 2015, the price per song will have increased to 0.14 cents. For listeners who subscribe to the service so they don't hear the ads, the cost will rise 47 percent to 0.25 cents per song.
Pandora, therefore, must increase its ad revenues by at least that much to keep pace if it has any hope of becoming a viable business.
The fact that Pandora must play a per-song fee every time an individual activates the service underlines a central inefficiency in the company's business model. Terrestrial and satellite radio stations pay a single fee for a single play of a song. Of course, all their listeners get the same song at once. But that turns out to be a lot cheaper than serving up an endless stream of songs on demand to as many individual listeners who want them.
Sirius does it cheaper
A look at Sirius XM (SIRI)'s programming and content costs bears this out. In Q1 2011, Sirius spent $73 million, or about 13 percent of revenues, on content costs. Pandora spent $29 million on its content -- about 57 percent of its revenues.
Pandora warned that its content costs may rise even further after 2015, depending on the outcome of a series of negotiations with music licensing bodies called "the Webcasting IV proceedings":
If the Webcasting IV proceedings establish rates applicable to us that represent incremental increases in the per performance rates set forth as "CRB Rates" in the table above for the 2016-2020 period and there is no percentage of revenue option available to us, then our content acquisition expenses could substantially increase, which could materially and adversely affect our operating results. ...In fact, based on Pandora's current numbers, if there were significant increases after 2015 and Pandora was unable to match those increases with even greater spikes in ad revenue, then the company will eventually go bankrupt. Given that Pandora has already promised to increase its marketing costs in the next year to buy growth, the pressure to convert free listeners to paying subscribers will be intense.