How Pandora can swing to a profit

A week or so back Pandora announced their FY 13 results and the stepping down of their CEO. It was a bit of a shocker and curiosity came calling. Pandora is a great service and I use it personally – the near pervasive nature of the service is really compelling- available on one’s phone, home or car. So I went around looking for what was going on within their financials.

From the following presentation and Statement of operations– Here’s what I was able to see on the top line-

–       Most of their revenues comes from Advertising- actually about 87%. That was a revelation as I always assumed that they made their money mainly via subscriptions.

–       Revenue growth is running over 50% + year on year which is always good(almost required) for a startup of their size.

On the Cost side

–       it appears that content acquisition costs are shooting off the roof- across the last 3 years, content costs as a percentage of revenues have been 50%, 54% and 61% (current)

–       Net loss jumped by 3 times compared to last fiscal ie at 37.7Mil compared to 10.9Mn ( not a wonder anyhow given the trendline on costs)

So what can be done to right this ship. Here are a few thoughts-For starters,

–       Increase reliance on subscriptions. Ie Can Pandora move more towards becoming a Netflix?. There seems to be a clear over-reliance on advertising and getting some proportion into subscriptions will be really useful –say 50% of revenue from ads and 50% from subscription. Subscription revenues are also a measure of listener stickiness to the service. How that can be done is a matter of product strategy, pricing and value perceived by users but moving in that direction will surely help.

Unfortunately this also comes with issues. A user starts with a free ad supported service and then goes into a subscription based ad-free usage. So subscription revenue/user ends up cannibalizing ad dollars/user. So there needs to be a way to maintain revenues from both sources

–       If the path is to continue to rely on 87% revenue coming from ads, with 60% of content acquisition costs, ad dollars are really not the way to go. Consider how google serves makes money on ads.

Essentially google has free content- ie they have cool technology that uses the content/websites that other people create, but there isn’t any cost paid to the content providers. So one take away is that in an ad driven revenue model, content costs must be super low ( think leveraging own content or free)

–       How to rein in costs- Clearly content acquisition costs need to be brought down significantly – in fact Pandora should really target 25 to 30%. If that means offering users less choice, then so be it. For the short term they need to get a handle on the costs as the current numbers and it’s growth trendline are really a path to nowhere

–       Again on costs, take a page from how Netflix gets served up on Mobile devices- the growth platform of today and in particular iOS devices. One cannot buy a subscription for Netflix via the Apple app store. That part of the transaction is done on Netflix’s own site. They only serve the content via the Netflix app.

Now Pandora is different, they do allow one to buy a subscription. That means Apple keeps 30% of that revenue. Sure there is the ease of use factor and the advantage of not requiring to store credit cards as Apple takes care of that back end, but what could the true cost be in $? Is it a possibility that ‘the cost of revenue – Other’ line is actually that 30% to Apple at $32 Mn?.

To take this further,if true and if this single line was zero, Pandora would able to add to their revenue by $32 Mn. i.e. their subscription revenue % would be been close to 20% and more importantly total costs would be down by that much.

Which means they could have had a Gross Profit of $26 Mn in FY13!- ie ((427,145+ 32019) –(464847-32019))

So bottom line is that this business has a lot of promise, but without the required and urgent changes all that promise will vanish. Pandora refers to the Greek goddess of giving. Looks like it is indeed ‘giving’ more than ‘taking’.