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Q1: Compare Pandora’s original business model with its current business model. What’s the different between “free” and “freemium” revenue models?
In the beginning Pandora tried to get music subscribers by giving people 10 free hours, then asking them to pay $36 a month after that for the service. Of course no-one was willing to pay so much for a service that they could get for free by switching on an FM radio (Laudon and Traver 103).
After that model failed they tried several other options until they decided to use the “freemium” model they are using today. With a freemium service the basic service is available for everyone for free, but with strict limitations in bandwidth and ads between songs which results in a lower quality listening experience (Laudon et al. 103).
The premium service is priced at just $36 a year, 1/12 of their previous asking price. Three dollars a month is much more easy for a consumer to justify. The premium service offers higher bandwidth songs and no advertising (Laudon et al. 104).
Q2: What is the customer value proposition that Pandora offers?
Investopedia.com defines a value proposition as “A business or marketing statement that summarizes why a consumer should buy a product or use a service. This statement should convince a potential consumer that one particular product or service will add more value or better solve a problem than other similar offerings.” (Investopedia.com) So I went to the About page on Pandora to find the value proposition.
What Pandora does for its customers is provide access to music through the “Music Genome Project.” This project was started by the founders of Pandora and offers a way to classify music so that similar music by different artists will group together into what they call a personalized radio station (“About”).
The music is evaluated by professional musicians for genre, and then within each genre 200-500 different data points are set for each song by the music professional. A function is used to identify the distance between songs so that similar songs can be included in a customer's playlist. A user can apply additional weights to promote or demote certain bands so they will play more or less often on their radio station. This really is impressive technology that would be almost impossible to replicate by another company (“Music Genome Project”).
Q3: Why did MailChimp ultimately succeed with a freemium model but Ning did not?
The case study claims that freemium works best when there is a very large audience for your service and you can offer paid upgrades to make it worthwhile for people to pay to get the additional added value (Laudon et al. 104).
MailChimp works as a free service because anyone that sends the same email to multiple people is a prospective client. The light user might be someone sending out a church newsletter as an email every week, with a volume of just dozens of emails. A high end user could be a corporations using the service to send a hundred thousand emails to its customers and needing to track the conversion rate of the emails, or now many of the people clicked a link in the email, and how many actually purchased something because of the email (Laudon et al. 104).
Ning didn't work as a freemium service because not everyone needs to start their own targeted social networking site. If you need something like that then you are willing to pay for the services up front in order to get the features you need to grow your site (Laudon et al. 105).
Q4: What’s the most important consideration when considering a freemium revenue model?
This is really the most important part of the case study and the section where I learned the most about what makes a business model a possible freemium candidate.
Large potential audience.
This is the most important thing. In order to grow as a business you need to attract many people, millions of people, to your service. These free users are the pool of people you will be converting to paying customers (Laudon et al. 105).
Low variable cost to add additional free users.
One of the amazing things about the Internet is that you can provide service to people at a cost approaching zero dollars. You can do this with automation and by pacing the computing power you are using to spread it across all the free users. If you have to buy a music license or a new computer for each user you add, then you are not going to stay in business for long (Laudon et al. 105).
Easy to use.
Let's say you do attract people to your web site by the millions, in order to get people to use your service, it has to be easy to use. You can't afford to have each new customer call customer support in order to use your service. The service must work “out of the box” for each new user and walk them through every step automatically. This is one of the things that Google plus did wrong. At first the service was very simple and easy to use, but it rapidly grew in complexity until now I can't even see my own lists of posts anymore and have no clue what 90% of the selections even are anymore (Laudon et al. 105).
Network effect helps to add and keep users.
If you can get your service spread by word of mouth, so that one person gets all their friends to sign up too, and then it is very difficult to leave a site because all your friends and business associates are there, then that is the network effect in operation. This is something that social media sites like Facebook really key into (Cornell.edu “... in Terms of Network Effects”).
High customer retention rates.
It doesn't help you if you get a million people to try your free service and then never visit your site again. You want to make your site “sticky” so that when someone visits the site it is so easy to use and offers so much convenience that users keep coming back, keep using the service, and enthusiastically tell all their friends about your site (Laudon et al. 105).
Value of service to customer grows over time.
Once people are on your site and using your service, you want the value of what you are doing for them to increase over time, so that the longer someone is on your site, the more difficult it is to leave and the more likely they are to use your site for their primary portal to the Internet (Laudon et al. 105).
Q5: Pandora’s stock (P) has dropped 27% since its initial public offering (IPO) in 2011. What recommendations do you have for the Pandora management?
I hate to have to say this, but I do not believe that playing music over the Internet is a viable long term business that can sustain itself. The license costs and bandwidth costs are just too high when you reach a billion freemium users (Pandora Media 15).
I think that what they need to do is to position themselves as the alternative to the apple store on android devices. By becoming a music store that only provides brief snippets of music they will eliminate both the license fees and most of the bandwidth costs.
They can also license their music classifying database through a web interface to other companies that have a need to provide music recommendations to their customers.
The patent they hold is a very interesting general method of using experts to classify items and then using automation to see what is most like that item. This could be used for many other categories. Either by licensing the technology to other people, or doing the tech in house and providing web service access to the information (Glaser, “Consumer Item Matching...”).
Q6: Would you recommend Pandora’s stock to future potential investors? Why or why not?
Pandora is paying more and more for it's music licensing as it adds additional free users. At some point in the future these variable costs will rise above the amount of money the company makes from advertising and subscription fees and the company will have to convert as much of its existing user base to the premium service as it is able to do so. Its ability to convert existing users to the premium only service will determine the company's ultimate success or failure (Pandora Media 6).
Additionally Pandora has never had a year where it has made a profit, and it has accumulated a lot of debt from losing money every year of operation. It would take years of profitability before it could do more than just pay off its backlog of debt (Pandora Media 15).
There has never been a business like what Pandora is attempting to do on the Internet. The business model is unproven. A traditional radio station has decades of experience that investors could relate to in order to evaluate how well the company is doing (Pandora Media 6).
So based on these three key facts, I would not recommend purchasing stock in Pandora.
Cornell.edu. Freemium Services in Terms of Network Effects. 11 Feb 2013. Web. 16 Nov. 2011. <http://blogs.cornell.edu/info2040/2011/11/16/freemium-services-in-terms-of-network-effects/>.
Glaser, William T. Consumer item matching method and system. Google Patents. 10 Feb. 2013. Web. 21 Feb. 2006. <http://www.google.com/patents?id=LI54AAAAEBAJ&dq=7,003,515>.
Investopedia.com 10 Feb. 2013. Web. <http://www.investopedia.com/terms/v/valueproposition.asp>.
Laudon et al. Kenneth C., and Traver, Carol, Guercio. E-commerce 2012. Pearson Prentice Hall. 2012.
Pandora Media, Inc. Security and Exchange Commission. Prospectus. 2011.
Pandora.com. About. 10 Feb. 2013. Web. <http://www.pandora.com/about>.
Pandora.com. Music Genome Project. 10 Feb. 2013. Web. <http://www.pandora.com/about/mgp>.
Additional interview about the startup and evolution of Pandora: