Pandora Bought Rdio Because Ads Aren't Enough to Offset Content Costs

Content Acquisition Costs Growing at Faster Clip Than Ad Revenue

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Pandora is acquiring key assets of Spotify rival Rdio for $75 million.
Pandora is acquiring key assets of Spotify rival Rdio for $75 million.

Pandora plans to open a subscription-based, on-demand version of its music-streaming service because advertising revenue may not be enough to offset its ballooning content acquisition costs.

On Monday Pandora announced that it has agreed to acquire technology from streaming music service Rdio for $75 million in cash. The internet radio company plans to use that technology to launch an on-demand version of its service in order to better compete with rivals Spotify and Apple Music, both of which offer radio and on-demand music-streaming services, and to be able to afford all the music people listen to on Pandora.

"We intend to be the go-to music destination," Pandora CEO Brian McAndrews said in a conference call on Monday afternoon to announce the acquisition. He added that the company's business will span "radio, on-demand and live music." Pandora entered the live music business last month through its acquisition of online ticket sales company TicketFly.

In addition to keeping pace with its competition, Pandora is buying Rdio's technology in order to keep up with the growing cost of doing business. In the third quarter of 2015, Pandora shelled out $211.3 million for all the songs its 78.1 million active users played. That's nearly as much as the $254.7 million that Pandora generated in advertising revenue for the quarter, which accounted for 82% of the company's total revenue.

More problematically for Pandora's bottom line, its advertising revenue only grew 31% year-over-year while its content acquisition costs soared 90%, and it failed to turn a profit after deducting operating expenses. Those content acquisitions may continue to skyrocket, depending on whether the Copyright Royalty Board receives approval to charge more money for music licensed from major labels compared to music from smaller independent labels.

That looming possibility factored into Pandora's decision to buy Rdio, CFO Mike Herring said during Monday's conference call. If the Copyright Royalty Board is able to charge Pandora more money for major labels' music -- the type of music likely more popular with Pandora's listeners and therefore more important to its business -- then the profits Pandora can reap from its advertising business "will obviously decrease," he said. "In this scenario, having other revenue streams to focus on such as subscription businesses and live events promotion gains importance."

Pandora already has a subscription business called Pandora One that charges people $4.99 a month to listen to Pandora's radio service without ads. However its non-advertising business would need to grow significantly in order to reduce the company's reliance on ad revenue to book a profit. With Rdio and TicketFly, Pandora's hope is that it will.

Variety had reported earlier on Monday that Pandora was in talks to acquire Rdio.

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