The financial realities of Internet radio showed up recently when Pandora announced it would cap at 40 hours per month the amount of time listeners could stream music on mobile devices. Web radio has gone mobile, but mobile isn't where the ad money is.
To manage its costs, Pandora will let people listen for free on computers, pay 99 cents for extended listening once the 40-hour cap is reached (through in-app purchases) or subscribe to Pandora One, the company's ad-free product that costs $3.99 per month or $36 per year. It estimates 4% of users will be affected.
Founder Tim Westergren calls the cap "a very unusual thing to do" but explains that Pandora's per-track royalty rates rose 9% in 2013 and are scheduled to rise an additional 16% during the next two years. Pandora has placed a cap on listening before: A monthly 40-hour cap on desktop listening was implemented from July 2009 to September 2011 when Pandora was privately held. CEO Joe Kennedy called the first cap "a smart lever to impact royalty costs."
The tactic has rankled investors. Pandora shares dropped 4.2% to $12.20 on nearly twice the daily volume the day after news of the latest cap was released. Shares fell another 3.3% to $11.81 during the next three trading days.
One might have thought a cap on unlimited mobile listening would cause Pandora's share price to rise. After all, the biggest knock against the company is its inability to generate advertising revenue to match its growing listener hours. Capping mobile listening hours, or simply rerouting them to the desktop where they bring in more revenue, seems like a good cost-management tactic. But the immediate 4.2% drop in share price shows investors think the mobile-listening cap will be a net negative rather than a net positive.
Investors are likely overestimating how much the mobile-listening caps will affect the company. The mobile cap only fails if Pandora has misjudged its impact on the user experience. That would be somewhat surprising. From design and user experience points of view, Pandora's website, mobile apps and even its Roku app are arguably the best Web radio products on the market. The user experience extends to the hundreds of town-hall meetings Westergren has held through the years. It's created a sticky product that people care about.
The big question: How will the 4% of listeners most likely affected by the cap react? Pandora has more competition now than it did when it implemented its first cap, but it has also built more brand equity through the years. Listeners who reach their 40-hour limit may find breaking up will be hard to do.