Apple Planning Pandora Rival: Is Web Radio Ready for Prime Time?

Apple's interest in launching a web radio service represents a threat to market

leader Pandora, but it also validates the huge potential for streaming music.

They re the most terrifying words in tech, as AllThingsD s John Paczkowski

observed on Friday: Apple is entering your market. One can only imagine what

went through the minds of Pandora founder Tim Westergren, CEO Joe Kennedy, and

colleagues, when news emerged via The Wall Street Journal that Apple is in

talks with the major record labels about launching a streaming music service.

(Existential dread?) Web radio is a tough-enough business as it is: Despite its

huge popularity, Pandora is not profitable, in part because of the massive

royalties it must pay the labels and other rights-holders to stream songs. If

Apple enters the space, Pandora s already-uphill battle to make money could

become more difficult. Pandora shares fell nearly 17% on the news Friday.

For Apple, moving into web radio makes sense but this is not about money for

the tech titan, at least not in the short-term. In fact, Apple could launch a

streaming music service tomorrow that loses $100 million a year, and the

Cupertino, Calif.-based behemoth would barely notice. Let s recall that Apple

has booked over $50 billion in profit over the past 12 months. Pandora,

needless to say, does not have that luxury. Over the last year, the company has

lost nearly $30 million on $340 million in revenue. (Given Pandora s $1.75

billion market value, Apple, with over $100 billion in cash reserves, could

absorb the web radio company for breakfast and still be ravenous by lunchtime.)

For Apple, launching a streaming music service is about adding another piece of

the puzzle in its quest to control the digital media ecosystem, as CNBC s Jon

Fortt noted on Friday. From music to movies and TV shows, to smartphone and

tablet applications, to e-books and even digital magazines and newspapers,

Apple s strategy has been to build a digital environment in which the user

feels intuitively comfortable conducting transactions. Apple has had more

success in some of these areas, like iTunes, than others, like Apple TV. (That

s because the companies that control the rights to broadcast and cable TV shows

have little interest in helping Apple create a viable alternative to the

traditional, bundled cable TV scheme, as Pacific Crest s Andy Hargreaves

observed recently, via Fortune s Philip Elmer-DeWitt.)

In a clear indication of Apple s ecosystem-based approach, the new streaming

music service would work on all of Apple s familiar products, like its Mac

desktop computers, and well as the iPhone and iPad. But it would not work on

Google s Android mobile operating system, according to The Journal s report,

which cited people familiar with the situation. If Apple s web radio service is

successful, it could be a strong motivator for consumers to eschew Android

devices in favor of Apple s family of iOS products. And that is the name of the

game: Apple is, after all, in the hardware business.

For over a decade, the major record labels and the top technology companies

have been fighting for advantage as the music business undergoes a grinding

transition into the digital age. The labels used to consider Apple their b te

noire, but those days are over, as Peter Kafka observes. That s why the labels

might be amenable to Apple s apparent desire to strike individual licensing

deals that will grant users more flexibility than the generic, industry-wide

compulsory licenses utilized by Pandora. Such enhanced flexibility and features

for example, allowing users unlimited listens of a given song, something that

s curtailed under Pandora s current licensing scheme could give Apple s

service an advantage over its competitors.

For Pandora, news of Apple s desire to get into web radio, while likely

alarming, isn t all bad, as Wall Street blogger Downtown Josh Brown noted on

Friday. For one thing, Apple s interest in the space validates Pandora s model.

In other words, Apple wouldn t even be exploring web radio if it didn t think

the market was now worthy of its participation. In short, Apple s apparent

desire to get into streaming music suggests that the web radio space is finally

ready for prime time. The mere fact that Apple is discussing this business

underscores the value of the Pandora platform, Stifel Nicolaus analyst Jordan

Rohan wrote in a note to clients. For another, web radio need not be a zero-sum

game. This huge market has the potential to accommodate several players. As it

is, in addition to Pandora, there are several other buzz-worthy players in the

space, including Spotify, which recently introduced radio-like features,

Slacker, and Clear Channel s iHeartRadio. Then there s Songza, a mobile

application that delivers playlists based on your mood, which has attracted a

significant amount of buzz in recent months. And let s not forget Sirius XM,

the satellite music leader.

Wall Street analyst reaction to news of Apple s interest in web radio was

mixed. Citigroup s Mark Mahaney issued a note calling the report a negative

for Pandora. He expressed surprise at the news, given the trouble that

mobile-first services such as Pandora have had monetizing mobile usage, and the

high percentage of revenues that are must be paid back to record labels in the

form of royalties. Said another way, we didn t expect Apple to find the

ad-supported, radio streaming market to be interesting enough to warrant

pursuit.

On the other hand, Pandora does have some advantages, specifically its

estimated 75% market-share of the web radio space. The company also has deals

with over a dozen automakers, including BMW, Ford, Honda, and Toyota, to

provide in-dash functionality. Michael Pachter at Wedbush Securities is taking

a wait-and-see approach, writing: We believe Pandora holds certain key

competitive advantages that should limit market share losses, at least in the

near-term, upon the launch of Apple s service. He s maintaining his

outperform rating on Pandora shares, until we learn more about the features

and timing of the Apple music service.

Pandora has spent a decade working to become the web radio leader by building

on top of its original platform, the Music Genome Project, which pioneered

music recommendations based on taste. In digital music, it s all about

discovery finding new music. Apple s efforts in this area, specifically its

Genius iTunes integration, haven t been as successful. So why doesn t Apple

just buy Pandora, instead of diverting attention from its core products to

confront a much-smaller company with a dominant market position? After all,

Apple s market capitalization fluctuates on a daily basis up and down more than

Pandora s entire valuation. Apple could buy Pandora for a couple billion

dollars tomorrow. But that s not the Apple/Steve Jobs-style. Apple is not the

acquiring-type especially not big consumer-facing Internet companies like

Pandora. Steve Jobs preferred to build his own technologies in-house, and

although Apple could swallow Pandora and not even notice, there s little reason

to believe that Apple doesn t think it can build a better service and

negotiate more favorable licensing deals than Pandora.

Ultimately, Apple s interest in web radio is a positive development for

consumers. Users want to access music when and where they choose, across their

devices. In 2012, the technology exists to create a giant library of all extant

music in the cloud, accessible anywhere. Choose your business model:

ad-supported, subscription-based there need not be one answer. For years, the

major record labels have been fighting the future, hoping to preserve a

20th-century business in the face of technological disruption. It s high time

the labels get with the program and start thinking about satisfying the

consumer, not preserving an entrenched and crumbling legacy business model.

Streaming, web-based music is the future, and Apple s interest in the space