Music-streaming company Pandora (NYSE:P) finally launched an on-demand subscription service in early 2017. Pandora Premium, priced at $9.99 per month, directly competes with Spotify and Apple Music. The company's goal is to convert a significant chunk of its ad-supported listener base into subscribers. In addition to the new on-demand service, Pandora offers an ad-free version of its core internet radio experience for $4.99 per month.

Pandora's business model of relying mostly on advertising revenue just doesn't work. The company has never turned a profit, and it lost an astonishing $518 million last year on $1.47 billion of revenue. The core problem is simple: Content costs eat up such a high percentage of revenue that there's just not enough left over to cover other expenses.

Three screen grabs of Pandora's mobile app.

Image source: Pandora.http://blog.pandora.com/us/introducing-pandora-plus/

Pandora pays rates based on direct license agreements in some cases, and it pays rates set by the Copyright Royalty Board in other cases. Becoming bigger hasn't helped Pandora at all -- the bottom line has only sunk deeper into the red despite the company's increased scale. Subscriptions could turn things around, at least in theory. A more stable source of revenue coupled with potentially higher revenue per listener compared to the ad-supported model might be enough to start moving the needle in the right direction.

Or it might not be enough. So far, the content costs situation has only gotten worse, despite impressive growth in the subscription business.

No improvement

In 2017, Pandora's subscription revenue jumped nearly 40%, driven by the new subscription offerings. Fourth-quarter subscription revenue soared 63% year over year, with the total number of subscribers rising 25% to 5.48 million. Meanwhile, advertising revenue declined slightly for the full year.

This mix shift toward subscriptions didn't change anything about Pandora's content costs problem. In fact, content costs as a percentage of revenue actually increased in 2017.

A chart showing Pandora's content acquisition costs as a percentage of revenue.

Data source: Pandora. Chart by author.

This increase is despite subscription revenue accounting for 22.7% of revenue, excluding the divested ticketing service, in 2017, up from 17.4% in 2016.

Things looked even worse in the first quarter of 2018. Subscriptions accounted for 32.8% of revenue, up from 22.5% in the first quarter of 2017. But content acquisition costs soared, eating up 68.2% of revenue. That's up from 65% in the prior-year period.

Maybe things will start to look better as the subscription business grows. But the early results are not encouraging.

A terrible business

No one has figured out how to make money streaming music. Pandora has been drowning in losses since its founding. Spotify, which recently sold shares to the public, posted an operating loss of 378 million euros on 4.1 billion euros of revenue last year. That's despite having 75 million subscribers.

What about Apple Music? Apple CEO Tim Cook said in an interview earlier this year that the company is "not in it for the money." That's because there is no money. Apple Music adds to Apple's ecosystem of products and services, but it's never going to be a profit center for the company.

Spotify is much bigger than Pandora and losing money. Apple isn't even trying to make money. It's hard for me to see any reason to believe that Pandora has a real shot at becoming a sustainable, profitable company, barring some drastic change in how it pays royalties for songs.

Pandora has had some success growing its subscription business, and the stock has jumped as a result. But I don't see a good reason to be optimistic.

Timothy Green has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends AAPL and Pandora Media. The Motley Fool has the following options: long January 2020 $150 calls on AAPL and short January 2020 $155 calls on AAPL. The Motley Fool has a disclosure policy.