Case study 1 | Pandora | The Freemium Business Model | | Christian Ortiz | E-COMMERCE MODELS AND ITS APPLICATIONS MKT 640GEORGE ACKERMANOCTOBER 2013 |

Pandora

Pandora Radio started as Savage Beast Technologies and was founded by Will Glaser, Jon Kraft, and Tim Westergren. Later on after nearly failing, the company was renamed Pandora Media and launched Pandora Radio on July 21, 2005 (Arrington, 2005). Pandora is an internet radio service, recommendation service, and the custodian of the Music Genome Project. Pandora works by users entering a song or artist that they like, and the service responds by playing selections that are musically similar. Users provide feedback on approval or disapproval of individual songs, which Pandora takes into account for future selections (Crunch Base, 2013). The Music Genome Project is the backbone of Pandora Internet Radio. The goal of the Music Genome Project is to take music and boil it down to quantifiable data. Every song in the Genome’s library is analyzed by a musicologist, which is usually a musician with a strong backgrounds in music theory. The musicologist then breaks down and rates over 400 attributes of every song, from the “soulfulness” of the vocals to the rhythmic and key changes in a given song. These 400 attributes are combined into larger groups called focus traits, and there are 2,000 focus traits. Some examples of these focus traits are rhythm syncopation, key tonality, vocal harmonies, and displayed instrumental proficiency. Once this is done, Pandora uses the music’s DNA and constant listener feedback and crafts personalized stations from its more than 800,000 songs that have been analyzed since January 2000 (Layton, 2013). In this paper I will cover Pandora’s original business model and differences from its current business model, the difference between those revenue models, and the reasons some companies succeed and others don’t using that revenue model. Pandora’s original business model was to provide users with 10 free hours of access to their website contents. Once the 10 hours had been used, they will then ask the user to subscribe to Pandora for $36 per month for continual access. Obviously, this was way too expensive and nobody was willing to pay that much for something that they could get for free on FM radio (Laudon & Traver, 2012). Now, Pandora’s current business model is designed to where users can access their online radio for free as long as they sign up for an account, but they have strict limitations in bandwidth and ads between songs, which lower the quality listening experience. Users can then opt to sign up for Pandora One premium service for $36 a year and receive premium service that offers no advertising, higher quality streaming music, a desktop app, and fewer usage limits (Laudon & Traver, 2012). Pandora could have also been successful if it had started with a different business model, but sooner or later it was going to have to change to freemium service and advertisements for revenue. The reason for that is because Pandora’s original business model requires that digital selling of products over the internet needs to be equal to or close to zero. And Pandora’s business model is not like that. Pandora actually loses money with every transaction, because the more customers that listen to free music, the more money it has to pay in royalties to the music companies and producers. Pandora it is still growing and acquiring a large customer base, as well as paid subscribers, but it is still reporting loses every year. Hopefully, with prolonged used and with a large network, Pandora is able to covert a larger customer base to paid subscribers and become profitable. To better understand Pandora, it is easier to identify the difference between free and freemium revenue models, since Pandora started as a free revenue model and later on had to change to a freemium revenue model. These two models are two basic revenue models that help a company generate a profit, and it is a choice a company needs to make once it plans to offer its services to the public. The free revenue model is used when a company offers a service or product absolutely free of charge, in turn the company generates income from targeted advertisements displayed to users while they use the product or service (Laudon & Traver, 2012). A good example of this are many mobile games or programs for cell phones, which are free to use or play, but they have a constant stream of advertisements on certain areas of the screen. These games or programs make their revenue from targeted advertisements only. On the other hand, the freemium revenue model works by offering simple and basic services for free for the user to try and more advanced or additional features at a premium. This is a common practice also for mobile and online games and software. A good example of a freemium business model is Skype, who allows users to make calls over the internet and basic functions for free, and then for more advance services and calls users have to pay a premium (Investopedia, 2012). Although, the freemium model allows a company to rapidly acquire a customer base, and then from those users obtain some subscribers and increase revenues, the free revenue model it is still prominent in the e-commerce marketplace. There are a number of e-commerce sites that provide free products and services to their customers, but that is because many of these companies already made a reputation in the market. Additionally, these companies have a really low cost near zero for providing these products and services, and are able to generate revenue from other means and still be profitable. In my opinion, a good example of this was google. Google started providing its service free of charge, and there was no option to upgrade. Google was able to maintain cost per user really low or close to zero, and was able to generate revenue from providing people the opportunity to be findable easier and faster. Many of Google’s products are free of charge to the user. Lastly, there is the question of why some businesses are successful with the freemium revenue model and others are not. For freemium to be successful it must take into consideration and meet the following criteria; it must have a large potential audience; it must have low variable costs to add additional free users; must be easy to use; and value of service grows over time (Bekkelund, 2011). Looking at MailChimp’s business model, it does meet all criteria; it has a large potential audience – everybody uses mail; it has a low cost for adding new users; it is easy to use – everybody knows how to use e-mail; and as high end customers need to send more mail and track the conversion rate of their emails, then they turn into paid subscribers. On the other hand, Ning meets most of the criteria, except that it does not have a large population to target. Most of the users do not want to create their own social site, they already have all their friends on Facebook. And the few that do want to create their own site, then they are the only ones that are willing to pay for the features offered by Ning. In summary, companies have to make sure that the services they are offering are unique, there is not much direct competition, or have a competitive advantage, and meet the criteria to use freemium successfully. In conclusion, I believe that Pandora has become partially successful thanks to switching to the freemium revenue model, but it is not all clear out of the water. It is still not making a profit, and the reason for that is because the licenses or royalties it pays for its music represent a high cost, and the cost increases as the number of users increases. The future of Pandora depends on its success in converting free users to paid subscribers, which is really hard to do, due to the fact that there are a lot of radio stations out there that provide almost the same service for free.

Bibliography

Arrington, M. (2005, August 20). Dig into the Music Long Tail – Pandora. Retrieved from Tech Crunch: http://techcrunch.com/2005/08/20/dig-into-the-music-long-tail-pandora/
Bekkelund, K. J. (2011, march 7). Succeeding With Freemium. Retrieved from Kim Joar net: http://kimjoar.net/files/succeeding-with-freemium.pdf
Crunch Base. (2013, September 16). Pandora Media. Retrieved from Crunch Base: http://www.crunchbase.com/company/pandora
Investopedia. (2012). Freemium. Retrieved from Investopedia: http://www.investopedia.com/terms/f/freemium.asp
Laudon, K. C., & Traver, C. G. (2012). E-commerce: Business. Technology. Society. Prentice Hall.
Layton, J. (2013). How Pandora Radio Works. Retrieved from How Stuff Works?: http://computer.howstuffworks.com/internet/basics/pandora.htm