CUSTOMER RELATIONSHIP

MANAGEMENT

Pandora Radio:
Fire Unprofitable Customers?

Prof: Michael Haenlein

Ashish Lodh

Gaganjot Singh

Kamran Ahmed

Shobhit Pareek

Shweta Bagrecha

Utkersh Sagreiya

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Key Elements of Pandora‟s Business Model

Figure 1: Business Model for Pandora

1. Competitive Positioning

Revenues and Price: Pandora initially started with a subscription model with initial free
hours. Later they switched to free model while keeping the subscription model. Another
source of revenue is affiliate fees that it obtains from the referrals to its partner online stores-
Apple and Amazon. The affiliate fees are quite low and are not a major source of revenue.
Advertising is the major source of revenue for Pandora and contributes 93% to the total. The
company has an extensive database about its customers including information such as gender,
age and zip code of the user. It can also get information on customer‟s music preferences and
streaming history. This allows it to provide precision targeting to the advertisers.

Quality of service: Pandora‟s quality if service can be rated high. It recommends new songs
based on expert analysis and suggest link to buy them online. It gives extra care to customer
service and communication. E.g. attending town halls and responding to every email.
Pandora‟s team acted swiftly in developing mobile application for iPhone with all the
sophisticated navigation tools.

Customer Segment Loyalty: About 65% of the customers‟ belong to the age group of 18-34
years, 54% of whom are males. Most of them are broadband users who listen to online radio.
Others use mobile phone applications and car radio. Pandora‟s customer loyalty is quite high,
largely due to the free ride it provides. Customers often return because of consistent new

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content. The customers prefer the free model, even when they sign up for the subscription
they use the free hours and then leave.

2. Customer Acquisition

Viral growth: Pandora relies on viral growth for its marketing thereby saving a lot on
marketing expenditures. As of now, this method is quite successful and user stations are
growing at the rate 10,000 a day. Its facebook application also became one of the most
popular applications within a small period of time.

Partnerships: Pandora has a partnership with online stores like iTunes and Amazon.com.
Although Pandora refers its customers to these stores, they also serve as a tool to market its
own product to a wider range of customers.

3. Core Capabilities

In late 1990s, Pandora started as a Music Genome Project by a film composer. The core
competencies were to observe people‟s music habits and taste, analyze the underlying musical
elements and invent or search something similar to cater them. A listener is not able to request
a song (as in radio) nor is he able to record the songs played by Pandora. Pandora employs
professional analysts who codify different characteristics that form a song‟s “musical DNA”
and use it to search its “musical neighbors”. The underlying assumption is that consumers are
lazy and they like customization. They want to listen to certain kinds of music they like but do
not want to go about looking for it. This is where Pandora fits in the market to satisfy this
previously undiscovered consumer need.

4. Costs

The fixed cost for Pandora includes technology, overhead and Genome Project operations.
Apart from the fixed costs, there are three major sources of variable cost. Pandora needs to
pay royalties based on company‟s revenues. It also pays 4% of its revenue to ASCAP and
BMI to compensate the songwriter. Streaming cost and other revenue based commissions
constitute the remaining for the variable cost.

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Indicators That the Model is Not Working

- Their business model is unable to generate positive cash flows; the company has not
yet observed a profitable quarter. They have 16 million users and 65 million stations.

- The subscription model is not working as anticipated and customers are quitting after
using the free hours.

- Only 60% of the available ad space is utilized given that ads are the major source of
revenue for Pandora. It is unsure how to structure and price the subscription model.

- Meanwhile their variable costs are quite high which results in unprofitable customers.

Should Westergen And Kennedy Follow The Advice Of The Junior

Partner? No.

The Junior Partner has advised Westergen and Kennedy to adopt a Direct and Unilateral “Fait
Accompli” strategy for disengaging with the unprofitable customers. Firing the unprofitable
customers will generate a lot of negative publicity for the business. Since Pandora does not
pursue any advertising or marketing campaigns in order to promote their business, there is a
high reliance on word-of-mouth in order to bring in the customers. Thus, they are highly
vulnerable to disgruntled customers who would have been ousted pro-actively. Moreover, the
advertising revenues and the reduction in fixed costs are directly related to the customer base.
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.

In order to avoid this risk, it makes more sense for Pandora to adopt an indirect approach, by
tweaking the business model to ensure that these unprofitable customers are discouraged from
being a part of the business. 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. Further the business model must ensure that if the customers
choose to stay on, they are profitable for the business. Thus, by adopting this indirect
approach, Pandora can solve the problem of unprofitable customers without falling prey to the
perils of negative word-of-mouth.

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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, when Walden Venture
Capital gave them money enabling Pandora to continue its operation. But as quoted by Tim
Westergren “We need money, but do you think we need theirs?”

The answer is No! The major problem with Pandora, as highlighted above, is their unfiltered
business model that leaves scope for a lot of unprofitable customers. With changes in the
Business Model as suggested in Part 4 of the report, they can accomplish relationship
disengagement with unprofitable customers through Cost escalation for them.

Also, as the world comes out of the economic crises (which it has) and Pandora gains more
popularity, 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.

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. 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. And the scale was increasing radically through their popularity as the Internet radio,
2nd most popular iPhone application and positive word of mouth. Also, Pandora cannot go for
selective acquisition as both Internet and iPhone applications can be accessed by everyone
online. Though its customers were loyal, it was not sufficient as a business metric.

Pandora‟s revenues also increased with this large scale of usage (the number of users and
clicks) with 93% of revenues coming from advertising. But it was not necessary that the
revenues would be generated by a user as one may never click an advertisement at all. Thus,
there could potentially be many unprofitable customers, and there were. Also, with the
ongoing crises, they could only fill up 60% of their available ad space which further inhibited
their revenue generation.

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So, the whole reason for getting into this situation was unprofitable business model which
attracted too many unprofitable customers. “While Pandora had evangelist users to thank for
explosive growth, these users were also the most costly”. They had 2 major problems in their
business model – “Leaky Faucet” and 9% of highly unprofitable customers, both as a result of
their Business Model.

Possible Options
The possible options for Pandora for their high usage customers, 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 „Cost to Serve‟ is larger than the proportion of fixed cost. Thus, in
such an industry, the importance of CRM and treating customers as they deserve is
accentuated. We must thus focus on addressing the issue of dealing with the customers that
are currently unprofitable for Pandora.

Weighing The Options

i) Add more advertising: We feel that Pandora should add more advertising as long as it is
non-intrusive. Pandora can leverage on the fact that they can provide targeted advertising
based on the information collected from their users. 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. 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.
ii) The “Freemium” model of offering Pandora‟s service is a good option to earn revenues
from customers. However, 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
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 same level of service. Certain additions must be done to the current service offering of
Pandora if this model has to be applied.
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. However, 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. 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.
iv) Capping the listening hours: The customers who listen to Pandora excessively, the
evangelist customers are also unprofitable. 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. Thus, to discourage such usage, 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. The fixed small payment amount would also not result in negative Word of
Mouth. We have already seen that a smaller cap of 10 hours did not work well for
Pandora. Even though this is a good strategy, 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. Still, this can
solve the current problem faced by Pandora to a large extent.

Quantitative Analysis:

1. Let us calculate the breakeven situation with the current scenario (data from exhibit 3):

Avg. contribution from a user/hour = $0.0294 - $0.0258 = $0.0036

Average hour per user per day = 2.5
 Average contribution from a user/day = 2.5*0.0036 = $0.009
Current fixed costs = $22 million
 Fixed costs/ day = $0.0603 million
 Breakeven would happen if the number of users/day reach = 0.0603/0.009= 6.7
million

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Thus continuing with the same business model, the same usage pattern by the users, the
company can only breakeven if the number of users visiting the website becomes nearly
quadruple to 6.7 million from the current 1.8 million. This much growth is huge and thus
we cannot continue with the current business model.

2. Since the management is looking at charging the customers having more than 40 hours
of usage, we assume that for customers having more than 40 hours of usage, there is
not sufficient activity on the screen and their contribution becomes negative.

Thus, we can assume that for any hour above 40, the cost remains intact but the revenue
generated through advertisements is zero. 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.

Total negative contribution eliminated/ month if hours of free usage reduced to 40 = $1.39
million

 Positive contribution generated per annum with this move= $1.39*12= $16.67 million

Since, current contribution from users is 0.009*1.8*365= $5.913 million

 If we curb the listening hours to 40, the total contribution will become $22.583 million
which will make the company breakeven with the current number of users.

But curbing the number of hours may turn a part of the customer base away, but as soon as
the organic growth in next few months compensates for the number of people who have gone
away, the company will breakeven.

3. If the company decides to take $0.99 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 $0.99 is eroded by the
negative contribution of the users (no activity after 40 hours usage)

 0.0258*(X-40)=0.99
 X= 78.3

Thus, in other words, even if the company takes $0.99 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, we thus adopt the Indirect &
Unilateral strategy of Cost Escalation. By doing this, we increase the cost of accessing our
services for the customers who were unprofitable for us, without affecting those who had a
positive effect on our margins. Moreover, the customers that do decide to incur the additional
price rise for the service will be covering the incremental cost.

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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.
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.
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. However this would not be for
unlimited usage and would be limited to 80 hours per month usage. The customers
using the radio for more than 80 hours are likely to be inactive for longer periods,
thus resulting in an increasing cost to the company. The aim thus should be to
minimize the number of customers going beyond 40 hours of listening. Thus, we offer
a higher price of $3 for usage above 80 hours to cover from the losses.
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. 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. This should be the way that Pandora can launch their “Freemium” model. The
Premium customers can also be offered other services like less advertisements. Thus,
by improving the customers‟ music experience and by offering unlimited access,
Pandora can plug the “Leaky Faucets” and at the same time generate revenues from
them for greater usage.
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. For the Premium
customers the inactivity service timeout duration would be 5 hours. Assuming, that
these customers generate revenue only for the first 40 hours of usage and then
become inactive, the $3 payment covers their variable cost for a further 110 hours i.e.
a total of 150 hours a month. 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.

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Appendix 1: Calculation of negative and positive contributions

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

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