Could This iOS 7 Feature Be a Pandora Killer?

September 10 marked Apple's (NASDAQ: AAPL  ) official product announcement of two new iPhones, the 5s and the 5c. While many articles have been written about the hardware, few have concentrated on the newest software updates; iOS 7's effects on the greater landscape should not be underestimated, and, in one case, may change the value proposition of one company.

Pandora should be afraid
Pandora
(NYSE: P  ) has a relatively simple business model -- it receives revenue dollars from advertisers for the right to broadcast ads in-between songs. For the fiscal year ended Jan. 31, this was 88% of the top line, and will continue to be the company's main revenue source.

The company's main expense is the cost of content; this is what they have to pay to stream that new Lady Gaga hit to your smartphone or desktop. This expense grew from around $70 million in 2011, to nearly $260 million in 2013. It now accounts for a whopping 61% of total revenue, up 10 percentage points from 2011.

Revenue growth has been phenomenal, but unfortunately, has been outpaced by content acquisition costs.

Pandora is a company that is growing revenue at a very healthy clip; however, these gains are being more than offset by the cost of content. Pandora's new CEO, Brian McAndrews, needs to focus on continuing to grow revenue, lowering content costs, or some combination of the two. Pandora appears to be focused on lowering content costs by its insistence on the Internet Radio Fairness Act, and recently scored a victory that could potentially pave the way toward lower royalty rates. However, one thing Pandora always had going for it was its market-leading position.

Enter the 800-pound gorilla
iOS 7 has the potential to change this. In addition to the high-optics hardware upgrades (5c's colored case, fingerprint scanner, etc.), Apple finally rolled out iTunes radio with a better value proposition at both the free and ad-free versions than Pandora. The ad-free version is free with a subscription to iTunes Match ($24.99 per year) -- which includes storage for up to 25,000 songs.

Also, iTunes radio is built into the iOS, and feels more intuitive. It is easily accessible from the music icon on your phone. And that is important; while there will be some switching costs due to users being accustomed to Pandora's algorithms and stations, many iPhone users (particularly ones with iTunes Match) will make the migration quickly, weighing on revenue for Pandora.

Apple doesn't have to win here...
It's important to look at Apple's motivation. Apple doesn't have to win here. Matter of fact, Apple is looking to create a "stickier" user experience and to bolster its fast-growing iTunes software and services unit that grew 25% year over year last quarter. iTunes radio should increase revenue from this unit, both directly by increased purchases of iTunes Match for commercial-free radio, and indirectly by users purchasing songs through the iTunes Match interface.

... but Pandora does
Pandora is a pure play on Internet radio -- it does one thing, which is currently unprofitable. Increased competition from a competitor that has 20 times its market capitalization in cash, and can afford to pay more for content, makes for a worthy competitor. Pandora is aware of this; the company announced it will issue more shares -- hopefully netting $280 million. The question is, will this be enough?

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Read/Post Comments (8) | Recommend This Article (9)

Comments from our Foolish Readers

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  • Report this Comment On September 19, 2013, at 8:22 PM, marv08 wrote:

    Well, just to add: iTunes Radio is also available on iTunes on Mac and Windows computers, and the Apple TV.

    So, it is a very interesting proposition for anybody not using Android, Windows Phone or a Blackberry. Without knowing how many of Pandora's users are on these platforms, it is pretty hard to estimate the effect.

    As an iTunes Match user, the choice is simple for me, as I will get it ad-free anyhow.

  • Report this Comment On September 19, 2013, at 8:35 PM, TMFJCar wrote:

    @marv08

    Thanks for the input! I have an iPhone, and removed Pandora's app from my phone within five minutes of listening to iTunes Radio.

    Jamal Carnette

    TMFJCar

  • Report this Comment On September 19, 2013, at 9:57 PM, bubudj wrote:

    I just upgraded to IOS 7 and love ITunes Radio...just removed Pandora as well. I think Pandora is going to die...just look at the twitters below

    https://twitter.com/search?q=itunes%20pandora&src=tyah&a...

  • Report this Comment On September 19, 2013, at 10:38 PM, TMFJCar wrote:

    @bubudj

    It's a rather small sample size, but I know at least two others that have removed the Pandora App.

  • Report this Comment On September 19, 2013, at 10:43 PM, ranchrfl wrote:

    I hate to say it but iTunes Radio kills Pandora. I set up a Mark Knopfler radio station on Pandora with a paid subscription. It was good and learned my tastes pretty quickly. Tried iTunes Radio today and the depth and breadth of different music the Mark Knopfler radio station delivered was amazing absolutely AMAZING! Sorry Pandora I really wanted you to win but with what I heard today and the fact that I can listen to it in Europe as well makes the decision to drop Pandora a no-brainer.

  • Report this Comment On September 19, 2013, at 11:19 PM, Doncorlown1 wrote:

    I love Ios7, iTunes and own the stock too. iRadio looks to be good. I'm a Pandora user as well, but unlike the other 4 of 5 posts here I don't hate Pandora that much that I feel compelled to delete the App that has been such a pleasure to date so far after 3 years of listening. Who does that? Why feel so compelled to state you are deleting something you have been enjoying for so long until now. How about I like both, prefer iRadio now after 24 hours and Pandora now takes a back seat to the 50 other crappy apps I have downloaded on my iPhone that I NEVER use and still have not deleted because it may come into play at any given time. Did you all delete your other flashlight too?

    Wow...only shows these comments must be from Apple employees who's stock has been crushed or something as it just simply is too in your face to state you had Pandora and now feel so compelled after a day to erase it from your existence. Classic whoopty attempt at slamming a company for other reasons than pure gain. Yeah, Pandora really sucks, I gonna erase it because iRadio is such a dominate platform now that I can never see myself having 2 options. You all it's be the same people who drive back on hwy 80 20 miles to fill up on chevron gas when you were afraid that the next chevron would not come up before you got to empty. Apple is like a Prius, a dent on every panel...

  • Report this Comment On September 19, 2013, at 11:48 PM, TMFJCar wrote:

    @Donclorown

    Thanks for your feedback, and for reading the article!

    For me (and the other two people I know), it's all about space. I have a 32GB phone and I only have about 2GB remaining. With apps taking more space, more pictures, and songs--space on many people's iPhones is at a premium. I have nothing wrong with Pandora as a product, but that doesn't make it a good investment. Also, Pandora doesn't get paid if you merely keep their app on your phone--so regardless if people use it half the time or two-thirds of the time they used to use Pandora--the company will witness reduced revenue.

    As far as the Apple employee comments go, I can't comment on the others--but I'm only paid by Motley Fool. I do own Apple, that is disclosed at the bottom of the article, but that doesn't effect my decisions. Matter of fact, I'd say I was pretty clear about this being rather immaterial to investing in Apple.

    Thanks for reading the article!

  • Report this Comment On September 20, 2013, at 1:02 AM, instabash wrote:

    Good bye Pandora!! I Tunes just took over!! apple for the win!! 25 yearly to pandoras 36.. lets see here Pandora has 1 million song pool to apples 27 million... Pandora lets you skip 6 songs per station to apples unlimited if you pay!! no annoying ads!! Pandora is done!! anybody buying this stock is a fool!

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