DENVER (Billboard) - During a recent taping of the Comedy Central show "The Colbert Report," host Stephen Colbert took Pandora founder Tim Westergren to task for the name of his Internet radio service.
"Why Pandora?" Colbert asked, reminding him that Pandora's box from Greek mythology released evil into the world. "Is that what the Internet is? You click open the box and evil comes out your speakers?"
"Surprises come out," Westergren responded, "and at the bottom of that box was hope."
To be sure, Pandora is full of surprises and hope. For almost 10 years, Pandora operated on the verge of collapse. In the early years, while it labored to build the Music Genome Project that powers its music recommendation engine, Pandora struggled to find both a business model and funding, to the point where it had to ask employees to work without pay for almost two years.
Then came the infamous March 2007 Copyright Royalty Board (CRB) decision that raised the performance royalty rates for Internet radio to a degree that Westergren said would put Pandora out of business. It led to a two-year fight to reduce those rates, culminating in a compromise reached last July.
Today, Pandora is for the first time on solid footing. It's about to reach the milestone of 60 million registered users and reported its first profitable quarter at the end of last year. At any given time, there are 500 simultaneous targeted advertising campaigns on Pandora, with 45 of the nation's top 50 advertisers spending money on the site. And the company is now expanding into automobiles and TV sets in an effort to turn Internet radio from the redheaded stepchild of the radio industry into a legitimate competitor.
SEEKING RADIO DOLLARS
"In the last year, I feel like we've finally cracked the nut on how to effectively monetize a streaming radio service," Westergren says. "Our intention is to build a radio business that looks a lot like the traditional radio business, with a scalable mechanism for selling national and local advertising so we can do everything from big, branded national campaigns to local pizza joint specials. They can be delivered as graphic ads, as audio ads, as video ads. We're pitching big ad agencies who have historically bought broadcast radio and pitching them to shift that money to the Web."
This isn't mere bravado. Westergren, 44, may be the poster boy for the laid-back startup executive, but he's a passionate believer that Pandora will one day change the way the world thinks about radio. His town hall meetings with users nationwide typically draw hundreds of fans whom he quickly charms with his down-to-earth casualness and genuine enthusiasm. Yet as the CRB copyright dispute proved, he's not afraid of a fight. Taking on the terrestrial radio establishment may seem like tilting at windmills, but Westergren's fervor -- which president/CEO Joe Kennedy molds into a business plan -- has helped build a growing team of believers.
Pandora hired 70 of its 190 employees last year and plans to hire another 70 this year, 80 percent to 90 percent of whom will be in ad sales or sales support. Its largest office outside its home base in Oakland, California, is in New York, where a staff of 25 focus exclusively on sales and support, with additional offices in Chicago, Dallas, Los Angeles and other cities. For the first time in the company's history, its ad sales team outnumbers the music analysts that keep the Music Genome Project database up to date.
REVENUE VS. ROYALTIES
Despite all this momentum, it's not enough to sustain the kind of growth Westergren hopes to achieve. Pandora raked in $50 million in revenue in 2009, which the company hopes to double by the end of the year. Of that, it paid $30 million in royalties to the music industry as agreed to in the CRB rate settlement with performance rights organization SoundExchange.
That agreement calls for Pandora to pay either a per-stream rate for each song it plays or 25 percent of all revenue, whichever is greater. Pandora needs to generate 8 cents per user per hour to shift the royalty burden to the revenue-share model. Currently, it's bringing in only 2 cents per user per hour.
"Pandora can't survive on network advertising," Westergren says. "The site's too expensive to run because of the licensing. We have to command premium rates."
To do that, Pandora has to rely on more than its sheer numbers, which, while impressive when compared with other digital music services, pale in comparison to traditional radio. Web measurement firm comScore says 13 million unique users interact with Pandora every month, which Westergren says increases to 20 million when taking into account the mobile users that comScore doesn't track. That's only about 1 percent of the audience that traditional radio commands.
Instead, Pandora is relying on its unique position as a source of music discovery. Pandora users enter the name of an artist or song they like, and Pandora's technology builds a custom radio station around that "seed." Users can further fine-tune the stream by voting on each song the service recommends (selecting either "thumbs up" or "thumbs down"). In addition to driving engagement (the company claims users interact with the service seven to eight times per hour) this activity generates user data that can be enormously useful to both artists and advertisers: age, gender, music preference and -- when paired with information compiled during the registration process -- zip code.
Pandora's strategy is to work more directly with artists, convincing them to provide exclusive content to the site that Pandora hosts and sells to sponsors at premium rates. The first iteration of this came last year with the Dave Matthews Band, which hosted a listening party on Pandora, sponsored by Brita. Pandora streamed the group's "Big Whiskey and the Groogrux King" album for a week before its release date from a special landing page on Pandora. It also sent a message to all users who either seeded or voted positively for a DMB song, alerting them of the stream.
According to the band's manager, Bruce Flohr at Red Light Management, the promotion resulted in more than half a million streams, with 8,000 linking through to buy the album on iTunes. The band later teamed with Pandora again to drive awareness of its tour, filming interviews with Matthews discussing his green touring initiative. All told, the entire campaign resulted in more than 21 million impressions.
"It was designed to make sure our fans heard the record in an environment where they were getting turned on to music," Flohr says. "It's harder and harder to find things that move the needle in this business. If done correctly, Pandora moves that needle."
More artist managers and label executives have begun to share that point of view. Last December, Pandora posted several video interviews with John Mayer discussing his musical influences, along with a customized playlist of his favorite songs. Pandora brought in AT&T as a sponsor, and the campaign generated 81 million impressions between the two, according to Mick Management founder Michael McDonald.
"There was more exposure from this than any of (Mayer's) other campaigns," he says. "In a world where things are fragmented, it's difficult to find people. So their targeting works. These new models and new ways of reaching people are the ways we're going to survive going forward."
Pandora now has close to 20 similar campaigns either completed, active or in the works for this year, featuring such acts as Jack Johnson, Jewel, Miley Cyrus, Switchfoot, Miranda Lambert, the Walkmen, Mason Jennings and Rogue Wave. The campaigns can include any combination of a prerelease listening party, a series of video interviews or a custom mixtape.
Participating brands, it seems, couldn't be happier. Brita, for example, has since transitioned its involvement with the Dave Matthews Band from Pandora to participating directly as a sponsor of the group's tour.
That's an important shift because at least for now, artists and labels don't make any extra money if they participate in these sponsored campaigns, other than their cut of the CRB royalty payments Pandora makes to SoundExchange.
LEVELING THE FIELD
The $30 million in performance royalties paid by Pandora last year represents 60 percent of its revenue. Compare that with satellite radio, which pays 15 percent of royalties for the same content, and terrestrial radio, which pays nothing.
"For the first time, artists are going to get to participate in the radio advertising revenue business," Westergren says. "It's a huge business that has been walled off for musicians."
Westergren has emerged as a vocal supporter of the Performance Royalty Act, which would force terrestrial radio broadcasters to pay performance royalties for the first time. While beneficial for labels and artists, such a requirement would also help put Pandora and traditional radio on more equal footing.
To achieve the kind of scale that Westergren envisions would require expansion to new platforms, particularly to TV and the automobile. Most of Pandora's daily traffic -- about 60 percent -- still comes from computers, according to the company. Of the other 40 percent, the majority comes from mobile phones (3 percent comes through its early forays into Internet-connected TVs).
The biggest potential rests in the car. Pandora has the opportunity to change the way people perceive radio much like DVRs changed the way people view their TV. Once users discover the ability to skip a song they don't like on Pandora while driving, the model could be permanently altered.
Pandora already has a deal with Ford to include the service in cars carrying its Sync entertainment system and has deals to make Pandora-capable after-market car stereos from Pioneer and Alpine.