FEATURE: When I need a soundtrack to get me through the work day, I typically log onto Pandora and let my psyche dissolve into my current customized radio station of choice. I applaud the entrepreneurial tech geeks who created it and thank the venture capitalists who backed the site for allowing me to enjoy anything from Motown’s greatest hits to songs “that have musical qualities similar to ‘Evacuate the Dancefloor’ by Cascada.” And what’s the most beautiful thing about the service? It’s free.
Well, at least it started off that way. A couple of weeks ago, Pandora sent me an email saying I had reached my monthly limit of 40 free hours and if I wanted to enjoy unlimited service for the rest of the month, I would need to fork over 99 cents. I was disappointed, but the request seemed reasonable—plus I was addicted to the service—so I paid the fee.
This experience got me thinking about a topic that I often consider: how does a service on the Internet become both popular and profitable? Great web sites are often launched, attract viewership, receive venture funding at high valuations, scale in popularity but ultimately struggle with monetization. There are a handful of pricing models used by these service providers and I think Pandora may be on to something with its approach. But first, a little bit of background.
Content publishers (anyone who provides a service, publication, or any other media content to consumers) face an uphill battle when it comes to creating a profitable online business. This is the case because of the historical evolution of online content pricing. In the 1990s, connection providers like AOL and Prodigy charged customers by the minute and paid publishers for their content in order to keep users online as long as possible. Publishers were compensated directly for their content and due to a relatively small online audience, suffered little cannibalization of print revenue. Once the World Wide Web was born, content providers could deliver content directly to consumers with the belief that online advertising would take the place of the distribution fees from AOL. For the first time, publishers saw advertising revenue as the path towards online profitability. The revenue model for the publisher had switched but from the consumer’s prospective, nothing had changed: fees still went to the service provider.
In reality, however, Internet advertising has not turned out to be as profitable as was originally expected. Moreover, as Internet access has become faster and more ubiquitous and content has become more robust, free online readership has siphoned revenue from print media. Last year, for the first time, more Americans turned to the Internet to read their news, rather than print newspapers.[1] In Time last year, Walter Isaacson pointed out the obvious problem for publishers: by giving content away for free online, rather than charge a subscription or newsstand fee, publishers are losing revenue streams while bearing the same costs and advertising revenue cannot cover this difference.[2] And if the digital model is not profitable, what is the incentive to create the content in the first place?
The music industry has run into the same problem. Services—like Pandora—give content away for free (albeit with some restrictions). If a consumer can access content for free, they are unlikely to pay for the same product. In turn, record labels lose money and are then forced to strike back by passing through their increased costs. This is why Pandora introduced the aforementioned 99 cent fee: it had to make up for royalty rates imposed by the record labels.[3] This model is reminiscent of the AOL / Prodigy days where a middleman still exists from which the content provider is able to extract revenue. However, direct-to-consumer content providers, such as newspapers, must charge the consumer directly.
In light of these circumstances, what options are available to content providers? There are four main strategies publishers can adopt:
1. Basic subscription model: The same way people have gotten newspapers for generations – every month pay a fee and you get the news delivered to your door (or laptop). A couple of publishers have been reasonably successful employing a subscription model. The Wall Street Journal, for example, uses this model and is the only national newspaper to do so. Rhapsody is an online service that allows unlimited access to millions of songs for a monthly fee. However, unless publishers are providing truly differentiated, high quality content, consumers simply will turn elsewhere. For instance, The New York Times tried a subscription model to get access to its premium content and archives but ultimately discontinued the plan as readership waned and people refused to pay for what they had once gotten for free. The low barriers to entry surrounding the Internet mean that it is easy to be undercut by a competitor at a lower (or non-existent) price point.
2. A la carte model: The best and most successful example of a la carte media pricing is iTunes. Apple has adjusted fees over the years but essentially charges a dollar for every song you want to buy with record labels getting a share of the revenue (It’s about a 30%-to-70% split between Apple and the content publisher, respectively).[4] While content providers are less profitable as compared to the heydays of album sales, this model still wins out over a situation with consumers illegally downloading songs for free. For their part, consumers buy music from iTunes because the software is so high quality and user friendly that the cost-benefit analysis seems logical. Plus, millions of Americans already rely on their iPods, which integrate seamlessly with Apple’s music store. A la carte pricing works in this scenario because iTunes simply has no peer.
Other content providers are not as successful as Apple. The iTunes Store is easy to sample, shop and buy from. For the entire World Wide Web to shift to an a la carte model, it would most likely also necessitate a simple, high quality, and ubiquitous payment system. These micropayment companies have been unsuccessful for a variety of reasons—legal issues, transaction costs, critical mass, etc.—but that is a conversation for another NBV article. Like with the subscription pricing model, a la carte media sales only prosper when something truly unique is being offered.
3. Ditch the traditional media: That is what the Christian Science Monitor and the Detroit News / Free Press have done. Rather than spend money on a distribution network and print production costs, many publishers have ditched hard copy all together—or at least drastically reduced it—to focus on online versions of their content. Instead of supplementing revenue as the subscription and a la carte models venture to do, this model focuses solely on advertising while eliminating costs associated with the traditional versions of their content.
As someone who still gets two hard copy newspapers delivered everyday, I would be sad to see them disappear altogether, but it is it really that not that hard to imagine a world where newspapers and DVDs no longer exist. However, we have yet to see this advertising-only sales model truly prove out and I question whether it is feasible for a publisher to provide high quality content with advertising as its only revenue stream.
4. “Bait-and-switch” subscription model: This is what Pandora has done. As mentioned above, once a Pandora user reaches a pre-set limit of free music within a month, the beats stop and you have to cough over a fee, which turns the music back on. The 40 hour stopwatch begins again at the start of the next month (In addition to this option, Pandora offers an ad-free, feature laden version of its site for an annual $36 fee – an example of the basic subscription model). Pandora is essentially following through with the initial pledge of the Internet to provide high quality content free to consumers, but with the understanding that the highest users should pay a little bit of the associated costs.
I think Pandora is on to something very interesting and I’m very eager to see how it takes off across the Web. It feels fair that I should have to pay for those sites I use frequently (Pandora, The New York Times, ESPN) while still receiving free content on those I visit less frequently (recipes from the Food Network or directions on HopStop). This model allows consumers to sample the goods before committing. And it is more appealing than a free 30-day trial period or something similar because in the case of Pandora, the free content resets every month for the lower-bandwith user. Pandora’s model will best resonate with consumers because it allows for free access to great content and only charges those customers for whom the service is deeply entrenched.
Ultimately, however, all of these models will struggle to overcome the sagging revenues many content providers are faced with as traditional sales dwindle and online advertising fails to keep pace. It is not implementing the right pricing model that will solve online content providers’ woes; rather a shift in the mindset of the consumer needs to occur. Simply put, people are not used to paying for anything online besides their connection fee and they don’t want to. They will not pay an additional fee for content at one site when another site offers similar content for free. Massive coordination will be necessary in order for traditional media providers to make money in a new media environment. Until then, only the craftiest of publishers will succeed. In the meantime, however, Pandora’s bait-and-switch model may help pave towards profitability.
[1] http://people-press.org/report/444/news-media
[2] http://www.time.com/time/business/article/0,8599,1877191-1,00.html
[3] http://www.wired.com/epicenter/2009/07/poll-would-you-pay-99-cents-per-month-for-unlimited-pandora/
[4] http://bits.blogs.nytimes.com/2008/08/11/steve-jobs-tries-to-downplay-the-itunes-stores-profit/
