If you listen to Pandora Media Inc.'s (NYSE:P) music platform, you'll hear a change in its advertising format later this year. Pandora recently signed an agreement with U.K.-based advertising company A Million Ads to be the first in the industry to offer personalized and sequential audio ads on its ad-supported streaming music service.

Data-driven advertising is used to personalize video ads seen on various internet platforms, based on individualized information such as browsing habits. Pandora will be working on the same theory, providing advertisers the ability to seek out the most recpetive customers with the right message at the right time.

Two people listening to Pandora and having a good time.

Image source: Pandora Media.

Pandora knows a lot about each of its 81 million users and their listening habits. This data is valuable and gives the company the opportunity to increase its revenue from advertisers, who want to target those users. At the same time, it is rolling out new services like the ad-free subscription product Pandora Plus ($4.99/month), and the music-on-demand subscription service Pandora Premium ($9.99/month).

The company does not intend to push all users to subscribe to its paid services. Speaking at the Morgan Stanley Technology, Media, and Telecom Conference on Feb. 27, Pandora founder and CEO Tim Westergren explained that the company needs to look at where to position each user among its various product offerings and service levels.

Pandora's new audio ad format is a big step that will allow the company to have a profitable ad-supported platform that makes money from those who stay at that level and creates a funnel of users who might decide to become paying subscribers to a higher level of service, which will bring more money to the company.

Chart showing the money-making capabilities of Pandora's three levels of service. The Plus and Premium levels have a target average revenue per user of $60, and $120, respectively, compared to $26 for the ad-supported level.

Image source: Pandora Media. ARPU = average revenue per user. Cont. = contribution..Image source: Pandora.

The new ads

Here is some of what Pandora knows about its users: their ages, their gender, when they are listening, and their location. With the new partnership, it can do things like target ads that take into account your specific location, the weather, and the time of day. Compare this to normal terrestrial radio, which only knows the time of day when it plugs in an ad.

As an example, suppose Pandora's data shows that a user is 18 years old and frequents a location that is the site of a two-year community college. The data would indicate that the user is a community-college student. A likely advertiser wanting access to community-college students could be a four-year college in the area, hoping to get those students to enroll in a four-year degree program.

Another aspect of the new ad format will be storytelling over multiple ads to a given user. This will allow the advertiser to present ads that build on each other in sequence, good for advertisers, and more interesting for the listener.

These types of opportunities for advertising exist today for video ads; Pandora will be bringing this opportunity to advertisers in the audio ad space. As advertisers see results from the new format, Pandora may be able to increase the cost of buying ad time on Pandora. In the fourth quarter, Pandora reported that advertising jumped 16% year over year and made up 80% of total revenue. 

Pandora is making things happen

There have been rumors for the past few months about Sirius XM Holdings Inc. having interest in acquiring Pandora. I hope this doesn't happen. The Pandora story has been long in the making, and the next chapter is about to unfold with the introduction of Pandora Plus.

This is the year Pandora will be able to spread its wings and truly offer a complete suite of services to its audience. The addition of personalized digital audio ads is another example of the company's willingness to push innovation to its platform, and provide advertisers and listeners a better experience all round. As a shareholder, I will remain patient and let the story unfold.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.