Watch CBSN Live

Pandora's Business Model Looks Like a Suicide Pact

Every time Pandora updates its financials ahead of its June IPO, it gives those who love the service hope that perhaps one day this company can turn a profit and become a real business, rather than a delightful sinkhole for venture capitalists who believe that you can make money by giving music away for free.

It was deja vu all over again last week when Pandora released its Q1 2011 accounts. The good news was its revenue more than doubled to $51 million for the quarter. Advertising sales were $44 million of that -- an even larger increase. (Its subscription revenue was negligible.)

So why is this company taking on another $30 million in debt and showing a loss of $9.1 million? Because its business model seems to keep its costs for playing music in lockstep with its revenues. Here's a chart showing how Pandora's operating expenses always seem to be one step ahead of its revenues, no matter how successful it becomes:

Pandora is locked into a Catch-22: The more users it has, the more advertising it can sell against those pairs of ears. But at the same time, the more ears that are listening and the longer they listen, the more songs they hear and the more Pandora must pay out in music license fees. The company seems to realize that its business model, for the next 18 months at least, is a mutual suicide pact between its music costs and its revenues:

Content acquisition expenses increased $16.5 million due to increased royalty payments driven by increased listener hours and by higher revenue.
While we had net income in the fourth quarter of fiscal 2010 and the second and third quarter of fiscal 2011, we expect to incur losses on an annual basis through at least the end of fiscal 2012.
The company also increased its admin costs by hiring a new CFO and general counsel, and by beefing up its infrastructure.

The way to profitability for Pandora is, as I've noted before, to reduce the amount of music the service offers its listeners. The problem is that it costs the same to play one song 50 times as it does to play 50 different songs one time. So the only way Pandora can become profitable is by selling more ads, or by charging more for the ads it sells, and hoping those increases outstrip its music costs. Unfortunately, the opposite is happening. This chart shows the growth Pandora is getting from its ad sales, quarter by quarter, compared to the total increases in its costs:

Remember, these are just the operating costs. None of these numbers account for the costs that come after that -- taxes, interest and so on. Those are irrelevant if it emerges that Pandora's underlying business model is nonfunctional. As long as its operating cost increases remain larger than ad revenue increases, it will be almost impossible for Pandora to ever become profitable.


Image by Jules Joseph Lefebvre: Pandora, 1882, Wikimedia, CC.
View CBS News In
CBS News App Open
Chrome Safari Continue
Be the first to know
Get browser notifications for breaking news, live events, and exclusive reporting.