Apple App Subscription Terms, Pandora IPO Point To Divergent Paths For Online Music

Recent moves by Apple and Internet radio company Pandora have raised fresh questions about the promise and pitfalls of making money from streaming music.

Just days after Pandora filed for an initial public offering (Billboard.biz, Feb. 11), Apple announced it would take a 30% cut of any revenue that content-based apps receive through subscriptions they sell within iTunes' App Store (Billboard.biz, Feb. 15).

On the surface, both actions mark important steps in the maturation of the streaming music market, with Pandora's IPO providing a key test of investor confidence in the webcasting business and Apple's long-awaited app subscription service giving record labels and other content owners a new monetization channel.

But while Pandora's plans to go public could help the market-leading Internet radio service invest in expanding its business, Apple's onerous revenue-sharing terms threaten to kneecap emerging subscription music services that are counting on mobile platforms to drive customer growth.

Currently, consumers who want to subscribe to mobile music plans offered by MOG, Rhapsody, Napster and Rdio have to go to the companies' respective websites to sign up. Under its app subscription service, Apple would simplify the process by enabling these companies to sell subscriptions through iTunes' App Store, but at the cost of keeping 30% of the revenue in exchange for processing payments.

Services like MOG, Rdio and Napster already charge twice as much for their smart-phone subscriptions as their online-only streaming plans because labels charge higher licensing fees for mobile streaming than online streaming.

As a result, Apple's steep revenue cut is likely to prompt subscription music services to either pull their iPhone apps or raise their mobile subscription rates, either of which will severely stunt growth.

Rhapsody president Jon Irwin says his company will be conferring with other music services to determine "an appropriate legal and business response" to Apple's subscription terms, which he says are "economically untenable."

A senior executive at another music service insists that labels must provide concessions on licensing terms if subscription services are to maintain a mobile presence. "We need to speak with one voice to the labels and say, 'If you don't absorb this, we're all shutting our apps off,' " the executive says, requesting anonymity. "They need all of us in the marketplace. They're betting a big part of their future on subscription businesses."

Meanwhile, Pandora's planned IPO will shine a more positive light on a different side of the streaming music business. As an Internet radio service-that is, an online service that doesn't allow consumers to play a specific song on demand-Pandora generates the vast majority of its revenue through advertising and is thus less threatened by Apple's move than companies that rely heavily on subscription revenue.

The company also pays a lower per-stream rate set under a settlement between webcasters and SoundExchange (Billboard.biz, July 7, 2009) than the negotiated rates paid by subscription services.

In a registration statement that it filed with the Securities and Exchange Commission for its IPO (Billboard.biz, Feb. 14), Pandora provided a preview of the financial transparency it will be required to maintain as a publicly traded company.

The SEC filing includes a detailed income statement that suggests the company's business model is working. Through the first nine months of its fiscal year ended Oct. 31, Pandora's revenue totaled $90.1 million, nearly tripling from $31.4 million during the same period in 2009, while its net loss attributable to common shareholders significantly narrowed to $7.1 million, from $24.9 million a year earlier.

During that same period, Pandora said that its "content acquisition costs" (i.e., royalties paid to labels) totaled $45.2 million, doubling from $22.5 million a year earlier, due to its growing user base. But thanks to surging advertising, which accounted for 86% of its revenue in the nine months ended Oct. 31, royalty costs as a percentage of total revenue fell to 50% from 72% a year earlier.

David Pakman, a partner at venture capital firm Venrock and former CEO of digital music retailer eMusic, believes Pandora's IPO will be well-received on Wall Street. Pandora, which was founded in 2000 by Tim Westergren, can expect to benefit from the strong appetite that investors have for premium Internet brands, Pakman says.

Social network LinkedIn also recently announced plans to launch an IPO, while speculation continues to swirl around when or if Facebook, Twitter and Groupon will go public. "There is a hunger among investors to participate in high-growth companies," Pakman says.

Rhapsody's Irwin is bullish on Pandora's prospects as a public company partly because much of its recent growth stems from its mobile app, the same arena that's been driving subscriber growth at Rhapsody and other paid services.

Mobile is "the one thing that keeps subscribers around, keeps them happy and keeps them engaged," Irwin says. "If they're not using it, they're not going to stay around and help you build a business."