Abstract
Pandora provides personalized Internet radio stations to its customers. Pandora provides this customized radio free of charge to its users. In combination with other business models, Pandora has successfully implemented the freemium business model in which 99% of its users receive a free service and 1% of the users pay for premium services. This business model is not appropriate for every type of business but can be profitable for some types of businesses with a planned implementation process and a clear understanding of customer values. Analyzing the success of Pandora provides information on the necessary requirements in order for business to earn a profit using the freemium business model.
Pandora Case Analysis
Pandora offers an Internet radio service, which tailors the music played, based on user preference. Pandora began as a free service to its consumers, while they found a way to earn a profit. Pandora utilized several different business models before implementing the freemium model. The freemium business model provides free services to 99% of the customers and expects 1% of the customers to pay a fee for premium services (Laudon & Traver, 2011).
This business model can be very effective and profitable for certain types of business when managed correctly.
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Analyzing Pandora’s successful use of the model provides insight on which conditions need to be present in order for the freemium business model to be effective and profitable. The freemium business model is appropriate to use when the product or service is widely available and there are low variable costs in providing the product or service to each customer. It is also important that the business takes into consideration the timing of implementation and understands their customer’s values.
History of Pandora
The foundation of Pandora began with the creation of the Music Genome Project in 2000 and the service officially launched in 2005 (Westegren, 2009).
Pandora’s founder Tim Westegren set out to create an on-line radio station that categorizes music based on 400 different attributes such as melody, rhythm, instrumentation and harmony (Westegren, 2009).
In order to accomplish this task, Westegren hired musical analysts who listened to music and created a database which links songs together based on similarity of those attributes (Shelly, 2009).
This database provides the foundation for users to log into Pandora and enter an artist or a song that they want to hear. The search is a “seed” and the database creates a station based on the features of the song entered on the search. The station contains artists and songs that are similar to the search, but does not actually play the exact song or artist entered (Shelly, 2009).
Pandora is interactive as users provide feedback to the database by giving a song thumbs up, thumbs down, or skip the song entirely (Shelly, 2009).
The more the user listens to Pandora, the better the system understands their preferences (Shelly, 2009).
In other words, by frequently interacting with the database, users receive a more customized radio station.
Pandora Business Models
Pandora continues to explore different revenue building business models in order to maximize monetization. These models include monthly subscription fees, advertising, contracting with on-line retailers and the freemium business model. When Pandora launched in 2005, their first business model was to provide 10 hours of free music and then require users to pay a monthly fee of $36. Pandora found that users listened to their 10 hours of free music, but were not willing to pay the monthly subscription fee (Laudon & Traver, 2011).
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When this subscription model failed to produce a profit, Pandora modified the model and provided 40 hours of free music for a month and after those hours were used, customers could either pay $.99 per song, sign up for the premium service, or do neither of these and not hear any more music (Laudon & Traver, 2011).
Even with this modification, Pandora struggled to earn a profit.
Pandora continued to improve their business model by adding advertisements to the site and radio stations. At the time, Pandora had almost 100,000 users; so many companies were willing to pay for advertisements on the site (Laudon & Traver, 2011).
While the advertisements helped Pandora financially, it was still not enough to make a profit. Pandora then started contracting with Amazon and other on-line retailers and included an option for users to purchase songs. Users can click the “buy” button, which redirects them to the retailer’s website. Pandora receives a fee for providing business to the retailer (Laudon & Traver, 2011).
In addition, Pandora began contracting with Apple allowing users to listen to music on their iPhones (Laudon & Traver, 2011).
The current model of Pandora combines advertising, contracts with retailers and the freemium business model. It is common for established businesses to earn a smaller percentage of its revenue from the premium model (Hung, 2010); therefore combining multiple revenue models maximizes monetization. Pandora continues to earn revenue from businesses paying to advertise on the site and through contracts with Amazon and Apple when users purchase music. Pandora implemented the freemium model in which 99% of users receive the service free and 1% of users pay for additional services. Approximately 1% of Pandora users pay $36 per year for premium services, which includes no advertisements and higher quality content (Laudon & Traver, 2011).
As Pandora is a popularly used site, that 1% amounts to approximately 500,000 customers paying $36 per year which equates to almost 17 million dollars in revenue.
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Business Requirements
Pandora’s effective use of the freemium business model provides insight on which conditions need to be present in order for the freemium model to be successful including the type of business, timing of implementation, and understanding customer values. The freemium business model is not appropriate for all types of businesses. It is most effective when the business provides a product or service that is widely available, has a customer base of over one million, and the variable cost of providing the free product or service must be low or close to zero (Laudon, & Traver, 2011).
Pandora meets both requirements of having a large customer base and low variable costs.
Currently, Pandora has approximately 47 million users (Statista, 2012), which is a large audience and exceeds the preference of one million. The cost of Pandora providing the service to one person is close to the cost it takes to provide the service to 47 million people. The variable costs per user are relatively low, as the main cost come from software to provide Internet radio and the database to create radio stations. Once the software and database are created, they can be used multiple times without adding additional costs.
Timing of Implementation
Businesses who meet the criteria of having a large enough customer base and low variable costs also need to consider the timing of implementing the freemium model. Customers become accustomed to receiving a free service and expect that services to remain free. Requiring customers to pay for the service may result in the customer no longer being interested in the service. Research shows that waiting at least a year after offering the free service and a month after growth of the free usage slows is the most effective time to move to a fee service (Pauwels & Weiss, 2008).
The wait period allows the site to gain popularity and customers to realize the free service’s value (Pauwels & Weiss, 2008).
When Pandora first became available, customers were not willing to pay the subscription fees, as they had not yet determined the value of the service. Users listened to their free music until it ran out, and then waited until the next month when the free service was available. As the website gained popularity and customers realized the value of having a personally tailored radio station, they became more willing to subscribe to premium services. Pandora successfully implemented the freemium model almost six years of offering the free service.
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Customer Values
One of Pandora’s strengths is the perceived value of its service to customers. Research shows that the perceived value of free content versus fee content determines if users will choose to pay for the service (Pauwels & Weiss, 2008).
Pandora strives to provide each individual user a radio station that only plays their favorite songs. Most businesses fail to customize their products to each individual customer, so Pandora brings a personalized service to the customer (Westegren, 2009).
An added benefit to the fee content is no advertising. Most other streaming radio stations and traditional radio stations play many commercials, which can result in listeners changing the station. Pandora’s premium services provide commercial free, advertising free, personalized radio for only $36 per year. The benefit of the fee content encourages some users to pay the annual subscription.
Pandora also allows users to connect with and recommend stations to their friends. This connection with friends through social media can be just as effective as receiving a review from a professional critic (Shelly, 2009).
Most people have similar tastes in music as their friends and value their opinions. The personalized customization, no advertising and connection with friends increases customer value resulting in subscribers who are willing to pay for the service.
Conclusion
Analyzing Pandora’s successful implementation of the freemium business model provides insight on how other businesses can also benefit from this model. The freemium business model is not appropriate for all types of businesses. Two criteria that businesses must have are a large customer base, preferably in the millions, as well as low variable costs of providing a free service to customers (Laudon, & Traver, 2011).
Businesses that meet these criteria must also take into consideration the timing of implementing the model and understand customer values. Pandora currently has well over a million active users and relatively low variable costs in providing the service.
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Reviewing Pandora’s history shows that timing plays an important role. Customers were not willing to pay for the service until they understood the value of the service. Pandora is aware that customers value individual customization and sharing their music with their friends. By offering a service that creates individual radio stations based on the user’s preferences and allowing them to share that music with their friends, has resulted in users who are willing to pay for premium services. Businesses interested in implementing the freemium business model can benefit from analyzing Pandora’s success in the model.
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