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An Unexpected Challenger to Pandora and Apple Music

By Andrew Tonner - Jan 28, 2016 at 6:21AM

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A surprise announcement from iHeartRadio places the service amid the ranks of Apple Music, Spotify, and Pandora. However, the service is unlikely to challenge any of the digital-music powers over the long term.

Source: Pandora.

With each of the major powers in the music-

streaming wars consolidating share, 2016 looks to be the year where things reach a fever pitch.

In the year ahead, industry leader Spotify will look to accelerate its subscriber growth strategy as larger tech rivals continue to target this important content vertical. Case in point: Apple's (AAPL 1.00%) ongoing efforts to convert its legions of iTunes accounts into Apple Music users are sure to remain as fierce as ever. Pandora (P) finally has a workable growth strategy, and Alphabet remains a force amid a convoluted product strategy.

However, the discussion of the so-called streaming big four could possibly now involve a fifth member, as a previously overlooked radio power just released its own impressive user numbers.

In a recent press release, iHeartRadio, a streaming subsidiary of iHeartMedia -- formerly Clear Channel -- announced that it has surpassed 80 million registered users. Though it's often overlooked in the media, the news immediately vaulted the online-radio product into the ranks of the largest streaming services in the United States. The news becomes all the more impressive considering the company's claim that its registered user base only surpassed 70 million users as recently as last summer.

Source: iHeartRadio.

iHeartRadio largely appears to be its parent company's attempt to push its radio service into the digital age, and the transition seems to have proved successful in the years since its 2011 launch. In terms of functionality, iHeartRadio operates very much like Pandora, with an added mix for live programming. Leveraging iHeartMedia's portfolio of 858 radio stations, the largest in the United States, iHeartRadio allows users to create custom radio stations as well as listen to live radio broadcasts. The service is totally free to its users and operates under an ad-supported business model. However, as far as iHeartRadio's threat to other digital-music properties such as Pandora, Spotify, and Apple Music, investors should approach the service with some skepticism.

A new force in digital music?
While iHeartRadio's registered user number appears impressive, there's an important lesson in semantics here. Specifically, registered users and active users aren't necessarily the same thing.

When they report user metrics, streaming services such as Pandora typically present them in terms of either monthly active users or daily active users, a more accurate benchmark of the number of people who regularly use a given service. So comparing iHeartRadio's 80 million registered users to, say, Pandora's 78.1 million monthly active users doesn't necessarily tell us much. It's an apples-to-oranges comparison. However, also because of the increasingly global nature of the streaming music business, investors and industry enthusiasts shouldn't worry that iHeartRadio's sudden prominence will disrupt the growth strategies of Apple Music, Pandora, Spotify, or Alphabet.

No international threat
Because of the sheer complexity of music licensing law, non-interactive services such as Pandora and iHeartRadio have relied on what are called "compulsory" royalty rates, which the U.S. government's Copyright Royalty Board sets. However, interactive services such as Spotify and Apple Music, in which users can actively manipulate the playback, operate under "non-compulsory" licensing laws and thereby must obtain licensing rights directly from the major music labels.

Source: Apple.

Historically, Pandora's and iHeartRadio's refusal to move away from compulsory licensing, for fear of higher royalty rates that could result from direct negotiations, has kept them from obtaining the requisite international streaming rights required to expand their services globally. However, with Pandora's purchase of Rdio's on-demand assets, the near certainty that Pandora will launch its own interactive on-demand service will require it to negotiate directly with the major labels. Though it's not certain, it's fair to expect Pandora will finally obtain international streaming rights in the process. This byzantine distinction is the key reason Pandora operates in far fewer countries than Apple Music or Spotify, though it's by far the oldest streaming service in operation today. It's also why iHeartRadio is unlikely to prove to be a substantive competitive threat.

Since iHeartRadio simply leverages its parent company's terrestrial-radio assets in a digital format, the service will remain, like Pandora before it, constrained to the United States. As such, the service will probably present a competitive threat only to streaming services such as Pandora, Apple Music, and Spotify in the United States., even as each of these services seeks to tap into the appreciably larger global music market.

So while it's worth noting for Apple and Pandora investors that iHeartRadio indeed has 80 million registered users, the surprisingly popular product is unlikely to threaten either company's digital-music strategy in the years to come.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Andrew Tonner owns shares of AAPL. The Motley Fool owns shares of and recommends GOOG, GOOGL, AAPL, and P. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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