The Exchange

Apple, Once Pandora’s Savior, May Become Its Destroyer

Apple (AAPL) has reportedly moved one step closer to unleashing a "Pandora killer" -- a streaming-music service that could trounce the industry leader, thanks to Apple’s marketplace might.

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The irony is that Apple unwittingly helped save Pandora (P) just a few years ago, when the upstart firm was desperate for revenue and struggling to find its footing. Though it pioneered Internet radio and remains the top service today, Pandora had several near-death experiences in its early days and survived largely because of the tenacity of its founder, Tim Westergren.

In 2007, when Apple’s iPhone was first unveiled, Pandora had about 7 million users. Westergren and his colleagues had envisioned the company as a computer-based service, not a mobile one. Still, they launched an iPhone app in 2008 and were stunned by the surge in subscribers.

"The iPhone changed everything for us," Westergren told me in 2010, when I interviewed him for my book Rebounders. "It almost doubled our growth rate overnight. More importantly, it changed way people think of Pandora, from a computer service to a mobile service." Pandora had similar success on the iPad, which Apple launched in 2010.

The accidental success of Pandora on Apple's "i" devices aligned the company with the hottest trend in computing, as mobile gizmos rapidly began to displace PCs and laptops. That put Pandora in the pole position as automakers began to incorporate music apps into the touch screens of new vehicles, the next logical venue for streaming music. Pandora now leads the industry with 200 million users, compared with 24 million for Spotify. Rhapsody, which only has paid subscriptions, counts 1 million users.

Pandora’s business model, however, still has some notable vulnerabilities, including licensing restrictions that limit users' ability to stream exactly the music they want. Instead of constructing their own playlists, Pandora users typically indicate the type of music they like, with the service then streaming music that fits their preferences.

Apple may be able to improve upon that if it can negotiate more favorable licensing agreements with musicians and labels, which seems to be its strategy. The company recently signed a deal with Warner Music Group under which Apple would pay twice what Pandora pays for advertising that runs against Warner Music. By paying more, Apple may gain more freedom to market the music as it wishes. The company still hasn’t announced when it will begin a streaming music service -- which Apple acolytes assume will be called iRadio -- but it is reportedly seeking similar deals with other labels.

In addition to a better experience for users, an Apple streaming-music service would benefit from the ubiquity of iTunes, the world's largest seller of digital music. Apple could promote iRadio to hundreds of millions of people it already counts as customers, instantly making Apple the market leader in streaming music.

Pandora’s stock fell by 11% on the news of Apple's deal with Warner, yet they're hardly playing a funeral dirge at the Internet radio pioneer. (Update) In a Yahoo! Finance online poll, only 16 percent of respondents said they'd subscribe to an Apple streaming-music service, while 53 percent said they wouldn't because there are already plenty of options available. The rest said they'd wait to see how good Apple's service turned out to be.

Meanwhile, iTunes has lost market share recently, coming under criticism for failing to innovate and stay hip. Apple has to grapple with competitors of its own, including Amazon (AMZN), Google (GOOG) and others aiming to boost their own share of the digital music market. Plus, Apple still has to finalize deals with several other labels before launching iRadio, and it's not clear they'll all agree to Apple's terms.

In other words, the Pandora-killer could be less deadly than expected once it finally arrives.

Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.

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