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Pandora's (NYSE: P ) building a scapegoat.
The leading music-streaming service revealed last night that it's cranking out meter maids to tax its heaviest data sippers. Pandora will cap free ad-supported mobile streaming at 40 hours a month. Users who hit that mark will be asked either to pay $0.99 to continue listening that month or to pay up to become Pandora One premium subscribers.
Pandora claims that just 4% of its users are currently streaming more than 40 hours a month through mobile devices, and it's pretty shocking to find people willing to put up with ads for that long without paying just $3.99 a month -- or $36 a year -- for the Pandora One platform that eliminates the ads and serves up better-sounding music.
However, this has always been Pandora's biggest problem. There are too many freeloaders among its 65.6 million active listeners and too few paying customers. Despite having so many fans, Pandora generated just $13.7 million -- or 11% of its total revenue -- in subscription revenue for its most recent quarter. Contrast that to Sirius XM Radio (NASDAQ: SIRI ) with a little more than a third as many accounts, yet the satellite radio darling delivered $842 million in revenue in its latest quarter.
It may seem odd that Pandora is pushing through this increase at a time when it seems vulnerable.
Pandora is coming off a January that saw a sequential decline in active listeners. Pandora had entertained 67.1 million active users in December. The number of hours streamed remained constant at 1.39 billion in both December of last year and January of this year.
If Pandora is actually peaking, is now the smartest time to introduce a tollbooth? The move may scare away its most active users, and it may also lead to others simply scaling back their usage so they don't bump against that 40-hour ceiling.
What if Pandora is doing this on purpose? What if it's timing the increase to mask the sequential dip? Pandora can always point to the new limit as the perfect excuse. Of course active users and listening hours slipped! We're sacrificing that in pursuit of the subscription revenue that Wall Street wants to see.
The move is interesting beyond Pandora. It will open the door for Sirius XM, Spotify, and other premium online music services. The sooner Pandora can wean itself off tens of millions of freeloaders, the sooner the industry can start generating the money that's necessary to tackle the escalating music royalties.
Pandora argues that its per-track royalties have risen 25% over the past years, rising another 16% over the next two years.
Until Pandora can convince advertisers to pay more to reach freeloaders out for free music, its best course to become a profitable growth darling is to drum up premium subscribers.
Tollbooths and meters aren't pretty, but they're necessary when a free model is tricky to monetize.
Pandora has won millions of devotees among music fans but few supporters on Wall Street. The online jukebox seems to be redefining the way we consume music, a transformation that's only likely to grow. But high royalty rates and competition from all corners threaten it. Can Pandora translate success with its listeners into a prosperous business model that will deliver for investors? Learn about the key opportunities and potential pitfalls facing the upstart radio streamer in The Motley Fool's new premium research report. Not only will you get the kind of insight normally found from high-priced Wall Street brokerages, but you'll also receive a year's worth of free updates. All you have to do is click here now to subscribe to this invaluable investor's resource.