Opening Pandora's Box

Problem/Issue Statement

Pandora is facing multiple issues, the essence of which appears to be the inability to turn revenue into profit. There are multiple symptoms of the problem including the fact that at the current growth rate, the company will exhaust its cash by the end of the following year. The chief strategist and founder of Pandora.com, Tim Westergren needs to decide whether the company should take a more conservative path, pull back on the growth levers such as search engine marketing (SEM) and general marketing spend, slow the headcount growth, and raise the minimal amount of new investment to reach an exit, potentially through acquisition. Or should it go full force, fan the flames of viral growth, top out SEM, hire aggressively, and take advantage of the first-mover advantage. Another symptom of the problem recognized by Westergren was the fact that the company did not have a professional manager in the second round of financing and that he did not possess the required skill set to assume that role and effectively lead the company.

Situation Assessment

Pandora emerged as a music industry phenomenon that as of 2007 attracted over 8 million customers with online hours growing at an average rate of 50% year over year. Nevertheless, the company is not producing enough revenue to sustain operational profitability. It faces substantial challenges including a serious threat on the licensing costs. Investors are viewing the company as risky and each one of them has different idea as to what direction should the company follow. Furthermore, other service providers are able to meet customer demands creating competition for Pandora. 
The scope of the problem includes the entire company, the founder’s vision, sustainability of the business model and ability to attract investment necessary for future growth.  

The advantage that Pandora has over competitors is a rapidly growing, interactive and devoted customer base. The company earned revenue in three ways: via advertising on its website, via subscription fees from consumers who wanted to opt out of advertising, and via partners who leverage Pandora’s customer base. The largest revenue contributor was advertising, which made up 93% of the total. Pandora entered into affiliate agreements with iTunes and Amazon.com according to which customers could purchase a song or an album though a link. Despite a growing customer base, by 2007 revenues began to catch up with run-rate cost for employee salaries. After all administrative and other costs associated with playing music (royalties and streaming) the gross margin that the company received per listener was approximately 0.69 cents per hour.

The new CEO, Joe Kennedy proposed a strategic change making the company a direct-to-consumer Internet radio service (Pandora.com).

List of Plausible Alternative Courses of Action and Evaluation of Alternatives

People who wanted to listen to music had various options, including terrestrial radio, Internet radio stations, Satellite radio, consumer-owned collections etc. Music recommendations come from all of those sources as well as from friends, concerts, recommendation from sites such as iTunes.com, Amazon.com, or on the radio stations. As mentioned above, Pandora should utilize the subscriber advantage to increase its revenue stream. Following are some of the potential courses of action: 

• Do not change current business model and strategy and continue with the current state - this option would not require any additional investment or risk of decreased productivity due to process changes. Nevertheless, it would also not solve the company’s problem of stagnant revenue and therefore would halter Pandora’s growth potential. This option would also fail to provide additional capital to fuel future development. In this scenario Pandora would have to seek external funding and yet again be threatened by potential changes to its vision and business model.  Due to these reasons this option does not appear to be sustainable.
• Begin charging musicians for playing their songs on Pandora and upstarting their career.  Pandora receives hundreds of CD's per week from all sorts of artists looking to get into the business. These songs, in order to be placed in the library, need to be analyzed and decoded by Pandora's employees, who should be compensated for their effort. Let's assume that the company receives an average of 300 CD's per week (conservative interpretation of several hundred). Each analyst at Pandora spends around 30 minutes to analyze a song. If a typical album includes 14 songs, that translates to 7 working hours per analyst. If they were to be compensated, say at $25 per hour, the cost to just cover the labor would be $175 per CD. If Pandora applied this methodology to each CD and have the aspiring artist pay for the analysis, it could potentially make $2,730,000 per year (300 CD's x 52 weeks in the year x $175 per CD) to cover the labor cost of developing musical DNA. Although the stereotype presents new artists as usually lacking any funding sources, I would expect little drawback to this option as $175 per CD is a very insignificant expense when compared to $350,000 for recording, marketing and producing cost referenced by a music label. While using Pandora does not guarantee the artist's success, it is a very low price to pay for keeping their musical integrity that is often sacrificed to the cost of success. Additional funding would certainly help the company's bottom line.
• Automate the musical DNA coding process, focus on more direct-to-consumer relationship by offering premium services, and increase advertising on free-access site. This option would allow the company to generate more revenue and partner with advertising companies that are looking to take advantage of the active and growing customer base. By pursuing this possibility Pandora could potentially evolve its customer feedback collection and make improvements to the music genome project by soliciting customer feedback on a more elaborate basis than thumbs up/down and also allow for customer suggestions in order to expand the music library. If Pandora were to charge customers $5 per month for premium service (with no advertising) although they would loose the advertising revenue, they could potentially make additional $20 million if, say, half of customer base signed up for the service. Furthermore, automating the development of musical DNA would lead to reduction in workforce. The initial cost of developing the program that would be capable of analyzing as many as 400 different attributes to determine the song's DNA would be offset by the first year's savings, and from then on, the money saved on labor would be added to the bottom line to generate profit. Pandora should consider this option carefully as potential software development costs may be significant. Furthermore, the application would probably need periodical maintenance. The downside of this option could be customer dissatisfaction with increased amount of advertising at free user level. In order to reduce the frequency of advertisements customer would need to pay a subscription fee, which can have an adverse effect in terms of subscriber growth.

                                                                        Recommendation

Based on the analysis of the alternatives mentioned above, I would suggest that Pandora pursue a mixture of option 2 and 3. I believe that some revenue should be generated from new artists as there is significant time and expense invested in decoding their music and playing it on the station. I also believe that Pandora should charge various subscription rates based on customization and end user preferences. Free access should still be offered with increased advertising and limited listening time. I see the development of an automated solution as an effective, efficient and sustainable option that will escalate the availability of various songs, including new hits and new artist work. The increased speed of assigning the song its musical DNA and being able to play it to the listener would increase the service appeal in the eyes of new artists and further substantiate the initial fee.

Presentation
In my opinion, presenting this case would need to focus on business model and strategy choices. I would therefore start with outlining the current state and SWOT analysis of the business environment. I would ensure to include all possible threats of substitutes as well as alternatives to the service offered by Pandora. I would also explore various decision criteria to be potentially considered by management when implementing a new business strategy.

Presentation of different alternatives and their effect on the bottom line would help make the decision clearer. Furthermore, analyzing the subscriber basis and segmenting it would help establish the target and future positioning of the service offered. I would utilize various analysis and market share graphs to depict the size of the market. I would also provide visual graphs depicting customer trends in music purchase (shift from CD purchase to digital albums and singles).