Pandora Radio: Fire Unprofitable Customers?

Prof: Michael Haenlein

Ashish Lodh Gaganjot Singh Kamran Ahmed Shobhit Pareek Shweta Bagrecha Utkersh Sagreiya


The affiliate fees are quite low and are not a major source of revenue.g. The company has an extensive database about its customers including information such as gender. Pandora‟s customer loyalty is quite high. 54% of whom are males. It recommends new songs based on expert analysis and suggest link to buy them online.Key Elements of Pandora‟s Business Model Figure 1: Business Model for Pandora 1. Most of them are broadband users who listen to online radio. Customer Segment Loyalty: About 65% of the customers‟ belong to the age group of 18-34 years. Pandora‟s team acted swiftly in developing mobile application for iPhone with all the sophisticated navigation tools. Later they switched to free model while keeping the subscription model. Competitive Positioning Revenues and Price: Pandora initially started with a subscription model with initial free hours. Customers often return because of consistent new 2 . It gives extra care to customer service and communication. Advertising is the major source of revenue for Pandora and contributes 93% to the total. largely due to the free ride it provides. age and zip code of the user. Another source of revenue is affiliate fees that it obtains from the referrals to its partner online storesApple and Amazon. This allows it to provide precision targeting to the advertisers. It can also get information on customer‟s music preferences and streaming history. Quality of service: Pandora‟s quality if service can be rated high. Others use mobile phone applications and car radio. attending town halls and responding to every email. E.

3 . Pandora started as a Music Genome Project by a film composer. Although Pandora refers its customers to these stores. Customer Acquisition Viral growth: Pandora relies on viral growth for its marketing thereby saving a lot on marketing expenditures. The customers prefer the free model. Apart from the fixed costs. The core competencies were to observe people‟s music habits and taste. even when they sign up for the subscription they use the free hours and then leave. This is where Pandora fits in the market to satisfy this previously undiscovered consumer need. 2.content. Partnerships: Pandora has a partnership with online stores like iTunes and Amazon. Pandora employs professional analysts who codify different characteristics that form a song‟s “musical DNA” and use it to search its “musical neighbors”. It also pays 4% of its revenue to ASCAP and BMI to compensate the songwriter. overhead and Genome Project operations. Core Capabilities In late 1990s. they also serve as a tool to market its own product to a wider range of customers.000 a day. analyze the underlying musical elements and invent or search something similar to cater them. 4. Streaming cost and other revenue based commissions constitute the remaining for the variable cost. Its facebook application also became one of the most popular applications within a small period of time. The underlying assumption is that consumers are lazy and they like customization. A listener is not able to request a song (as in radio) nor is he able to record the songs played by Pandora. there are three major sources of variable cost. Pandora needs to pay royalties based on company‟s revenues. They want to listen to certain kinds of music they like but do not want to go about looking for it. As of now. this method is quite successful and user stations are growing at the rate 10. Costs The fixed cost for Pandora includes technology.

They have 16 million users and 65 million stations. Pandora can solve the problem of unprofitable customers without falling prey to the perils of negative word-of-mouth. the company has not yet observed a profitable quarter. by tweaking the business model to ensure that these unprofitable customers are discouraged from being a part of the business. Thus. Thus. they are profitable for the business. The subscription model is not working as anticipated and customers are quitting after using the free hours.Indicators That the Model is Not Working Their business model is unable to generate positive cash flows. Should Westergen And Kennedy Follow The Advice Of The Junior Partner? No. Firing of unprofitable customers and the possibility of a resultant deterioration in the image of Pandora will have an adverse effect on the customer base and the associated advertising revenues and will result in a higher component of the fixed costs needed to be covered from every user. It involves raising the cost of this relationship from the perspective of the unprofitable customers to a point where they decide that it would be better to terminate the relationship. Meanwhile their variable costs are quite high which results in unprofitable customers. the advertising revenues and the reduction in fixed costs are directly related to the customer base. there is a high reliance on word-of-mouth in order to bring in the customers. Further the business model must ensure that if the customers choose to stay on. Only 60% of the available ad space is utilized given that ads are the major source of revenue for Pandora. Firing the unprofitable customers will generate a lot of negative publicity for the business. it makes more sense for Pandora to adopt an indirect approach. Since Pandora does not pursue any advertising or marketing campaigns in order to promote their business. they are highly vulnerable to disgruntled customers who would have been ousted pro-actively. Moreover. 4 . The Junior Partner has advised Westergen and Kennedy to adopt a Direct and Unilateral “Fait Accompli” strategy for disengaging with the unprofitable customers. In order to avoid this risk. It is unsure how to structure and price the subscription model. by adopting this indirect approach.

and there were. there could potentially be many unprofitable customers. they could only fill up 60% of their available ad space which further inhibited their revenue generation. it was not sufficient as a business metric. But as quoted by Tim Westergren “We need money. 2nd most popular iPhone application and positive word of mouth. Thus. with the ongoing crises. Pandora cannot go for selective acquisition as both Internet and iPhone applications can be accessed by everyone online. With changes in the Business Model as suggested in Part 4 of the report. Also.Should Westergren and Kennerdy want funding from the VC that they just visited? While a VC can bail them out like on the previous occasion in 2004. they can accomplish relationship disengagement with unprofitable customers through Cost escalation for them. Though its customers were loyal. 5 . as highlighted above. But it was not necessary that the revenues would be generated by a user as one may never click an advertisement at all. Also. And the scale was increasing radically through their popularity as the Internet radio. when Walden Venture Capital gave them money enabling Pandora to continue its operation. They had very high Fixed Costs and also unavoidable proportionally large cost to serve (the variable cost) which increased as the scale of usage increased. as the world comes out of the economic crises (which it has) and Pandora gains more popularity. How did they get into this situation? Pandora Radio had a very good business concept with “Music Genome Project” but did not back it up with a great Business Model. Also. but do you think we need theirs?” The answer is No! The major problem with Pandora. Pandora‟s revenues also increased with this large scale of usage (the number of users and clicks) with 93% of revenues coming from advertising. combined with Pandora‟s higher than average CTR (Click Through Rate) it would generate more revenue from advertisement by attracting more advertisers to fill the remaining 40% of ad-space. is their unfiltered business model that leaves scope for a lot of unprofitable customers.

Weighing The Options i) Add more advertising: We feel that Pandora should add more advertising as long as it is non-intrusive. ii) The “Freemium” model of offering Pandora‟s service is a good option to earn revenues from customers. this cannot be applied on the current service level alone as the customers who are used to getting their service for free won‟t be willing to pay for the 6 .So. both as a result of their Business Model. They had 2 major problems in their business model – “Leaky Faucet” and 9% of highly unprofitable customers. Pandora can leverage on the fact that they can provide targeted advertising based on the information collected from their users. The success of the iPhone Application of Pandora is another reason for laying more stress on advertising as this has led to a huge increase in customer base providing more options for advertisers to reach consumers more frequently and in a more precise and innovative manner. Pandora should maintain their policy of not inserting audio ads as doing so would spoil the user experience which must be avoided so as to not drive away customers. However. Currently only 60 % of their advertising space is being utilised and so Pandora has a lot of scope of increasing its revenues by simply placing more visual advertisements. “While Pandora had evangelist users to thank for explosive growth. the „Cost to Serve‟ is larger than the proportion of fixed cost. Thus. We must thus focus on addressing the issue of dealing with the customers that are currently unprofitable for Pandora. Possible Options The possible options for Pandora for their high usage customers. in such an industry. these users were also the most costly”. as mentioned in the case are:  Increase in advertising  Go in for the “Freemium” concept  Implement a subscription model  Cap the listening hours by charging customers a fixed amount for exceeding a particular limit In the case of Pandora. the importance of CRM and treating customers as they deserve is accentuated. the whole reason for getting into this situation was unprofitable business model which attracted too many unprofitable customers.

0603/0.0603 million  Breakeven would happen if the number of users/day reach = 0.009 Current fixed costs = $22 million  Fixed costs/ day = $0. Even though this approach may seem fair as customers would be paying for the cost of streaming the music but chances are that a lot of customers would simply stop using the services as has been the past experience of Pandora. Let us calculate the breakeven situation with the current scenario (data from exhibit 3): Avg.same level of service.0258 = $0. it is still not completely foolproof as customers might pay the additional 99 cents and still remain “Leaky Faucets” by using the service excessively without any activity for more than 80 hours a month. this can solve the current problem faced by Pandora to a large extent.5  Average contribution from a user/day = 2. the evangelist customers are also unprofitable.5*0. Still.0036 Average hour per user per day = 2. iii) Implement a subscription model: Asking for a subscription fee from all customers for using Pandora‟s services presents the advantages of spreading the costs on the wide customer base lowering the cost per user which can be easily paid by them. Thus.009= 6. iv) Capping the listening hours: The customers who listen to Pandora excessively. Quantitative Analysis: 1. Even though this is a good strategy. the cap of 40 hours of free usage per month and then charging a meagre amount of 99 cents for further use seems like a good strategy. this again leads to the issue of hesitation on the part of the customers to pay up for services that they have become used to enjoying for free.7 million 7 . However. The users who didn‟t have to pay for streaming the radio left it on even while they were away from their computers generating no revenues as they didn‟t perform any activity on their computers and generating streaming costs for Pandora.0294 . The fixed small payment amount would also not result in negative Word of Mouth. Certain additions must be done to the current service offering of Pandora if this model has to be applied. to discourage such usage.0036 = $0. We have already seen that a smaller cap of 10 hours did not work well for Pandora. contribution from a user/hour = $0.$0.

Moreover.7 million from the current 1. even if the company takes $0.Thus continuing with the same business model.99 is eroded by the negative contribution of the users (no activity after 40 hours usage)  0. there is not sufficient activity on the screen and their contribution becomes negative. Total negative contribution eliminated/ month if hours of free usage reduced to 40 = $1. the same usage pattern by the users. without affecting those who had a positive effect on our margins. So in the excel sheet (Appendix 1) we have calculated the negative contribution that can be eliminated if we limit the hours of usage at 40 and thus positive contribution generated. we assume that for customers having more than 40 hours of usage. the company will breakeven.3 Thus.67 million Since. But curbing the number of hours may turn a part of the customer base away. current contribution from users is 0.0258*(X-40)=0. 3. the customers that do decide to incur the additional price rise for the service will be covering the incremental cost. the total contribution will become $22. we thus adopt the Indirect & Unilateral strategy of Cost Escalation.99  X= 78.8 million.39 million  Positive contribution generated per annum with this move= $1. the cost remains intact but the revenue generated through advertisements is zero. the company can only breakeven if the number of users visiting the website becomes nearly quadruple to 6. in other words. we can assume that for any hour above 40.913 million  If we curb the listening hours to 40. Since the management is looking at charging the customers having more than 40 hours of usage. 2.8*365= $5. If the company decides to take $0. Thus.009*1. By doing this. but as soon as the organic growth in next few months compensates for the number of people who have gone away.99 by users the customers who use for greater than ~ 80 hours per month contribute negatively In order to avoid negative publicity and word-of-mouth. This much growth is huge and thus we cannot continue with the current business model.39*12= $16.583 million which will make the company breakeven with the current number of users. we increase the cost of accessing our services for the customers who were unprofitable for us.99 from users above 40 hours of usage then we calculate the amount of usage that can be allowed with it: Let us calculate the optimum X number of hours at which the company can curb the usage Optimum X would be when the positive contribution by receiving this $0. 8 .

Assuming. Pandora can plug the “Leaky Faucets” and at the same time generate revenues from them for greater usage. a total of 150 hours a month. iii)We feel that Pandora should place the cap on usage beyond 40 hours a month by charging the customers 99 cents for further usage. ii) Pandora must make efforts to better utilise its advertising inventory so as to earn better revenues via placing targeted advertisements both online and on their iPhone Application. The 5 hour inactivity service timeout would ensure that the customers do not remain inactive for more than 5 hours at a stretch and even if the customers follow such usage pattern they would be using Pandora for 150 hours a month. However this would not be for unlimited usage and would be limited to 80 hours per month usage. The Premium customers can also be offered other services like less advertisements. The aim thus should be to minimize the number of customers going beyond 40 hours of listening. the $3 payment covers their variable cost for a further 110 hours i. by improving the customers‟ music experience and by offering unlimited access. The customers using the radio for more than 80 hours are likely to be inactive for longer periods. Thus. Thus. iv) Customers who want to experience Pandora for greater than 80 hours a month would be given the offer of subscribing to the Pandora Premium service by paying $3 per month. that these customers generate revenue only for the first 40 hours of usage and then become inactive.Our Suggestions: i) We suggest a combination of the above strategies in addition to some extra steps to ensure that the “Leaky Faucets” are plugged. we offer a higher price of $3 for usage above 80 hours to cover from the losses. For the Premium customers the inactivity service timeout duration would be 5 hours.e. thus resulting in an increasing cost to the company. v) Another important step that needs to be taken to solve the “Leaky Faucet” problem is to have service timeouts on the service provided if there is inactivity for greater than one hour so as to ensure that customers do not leave the computers and remain active on Pandora thus generating revenues from advertisements. 9 . This should be the way that Pandora can launch their “Freemium” model. These customers would be able to enjoy better quality of music streaming at high speeds so that there is no buffering time and they are able to enjoy non-stop music.

Appendix 1: Calculation of negative and positive contributions 10 .

.) 11 .Appendix 1: Calculation of negative and positive contributions (cont.

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