British investment firm leaks Beats 1 plan; speculates on Pandora impact

A piece in Inside Radio tipped us to a research note by a British investment analyst, Richard Windsor of Edison Investment Research. In it, Windsor cites internal research indicating that Apple is developing spinoff Beats stations to complement Beats 1, the global online streaming station master-hosted by ex-BBC jock Zane Lowe, widely regarded as the most agreeable feature of newly-launched Apple Music.

We don’t know to what extent Edison Investment’s research on this point lands on the rumor/fact continuum, but as RAIN News founding editor Kurt Hanson posted on the day Beats 1 started, creating Beats 2, 3, 4, etc. could be a smart pivot.

The ad-supported model

Of particular interest in Richard Windsor’s investment note are the number of stations in development, and their business model. “Furthermore, our research indicates that radio stations Beats 2, 3, 4 and 5 are in development and the plan there is to have them advertising funded.”

Apple is not new to the streaming audio advertising market; iTunes Radio has been ad-supported since its September, 2013 launch. Beats 1 does not carry spot commercials, though it does offer sponsorship opportunities. Edison Investment positions its research as an advisory that Apple is setting up to compete directly with broadcast radio, and therefore directly with Pandora. “Apple is competing against broadcast radio which is a much softer target than its much bigger and better rival in streaming. As the opportunity is three times the size of recorded music and 30 times the size of the streaming market, the scope for returns is much higher […] for Pandora and Sirius XM, this is an extremely worrying development.”

Is Pandora impacted?

The note has a bearish tone when it comes to Pandora. The first sentence refers to Pandora’s recent earnings report, in which Pandora reported a slight drop (1.5-million listeners, to 78.5-million) in its active audience compared to the previous quarter. Pandora did not attribute that loss to Apple Music, the impact of which CEO Brian McAndrews called “muted.” But Edison Investment boldly claims that Apple took those listeners. “Pandora reported bad Q315 results and guided weakly, mostly as a result of losing users caused by the launch of Apple Music.”

Whether or not Edison’s speculative assertion is true, it’s worth observing a historical precedent. When iTunes Radio started, proclaimed by many as a “Pandora killer,” Pandora’s audience dropped a bit for one month, then bounced back. During that time Pandora executives referred to “tire kicking.” Remembering that example could be why Pandora execs are blithe about Apple Music now, even if they believe that its launch had any impact at all.

How powerful is Apple’s mobile distribution?

Richard Windsor’s investment note certainly isn’t complacent on Apple’s behalf. “Pandora has attempted to brush this off as a one-time blip, but it is at a massive disadvantage compared to Apple. Every iOS device with iOS 8.4 or better is now set up for Beats 1 and its descendants making it the default streaming radio station on over 400m devices. History has shown that being the default setting or option on a device confers a huge and often insurmountable advantage.”

Indeed, Apple’s mighty distribution power is an obvious and universally recognized advantage, but examples abound throughout the history of digital media where that assumed advantage did not conquer. (Are you reading this article in a Microsoft browser?) Putting iTunes Radio into iOS as a default and un-removable feature certainly did not “kill” Pandora as many media pundits warned.

Bearishness vs. reality

“Hence, we suspect that Pandora’s user numbers are not going to recover,” Richard Windsor’s note continues, “and that over the next year or so may establish a downward trend.” That is definitely bearish investment advice, driven deeper into a poetic sort of gloom by this: “Failure to act immediately will result in Friday’s correction being just the beginning of a long and painful kiss goodnight.”

That is sadly grim, and also misleadingly one-sided. The note does not responsibly separate the two services in features, or success metrics. RAIN never offers investment advice, but here is our view of market reality:

• Nobody knows how many listeners are tuned into Beats 1.
• Nobody knows whether Pandora’s small audience dip was caused by Apple Music/Beats 1.
• Pandora and Beats 1 are substantially different experiences. Pandora is customizable radio with an infinite number of user-built stations. Beats 1 is lean-back radio in the terrestrial model.
• Pandora has a gigantic early-mover advantage in building an advertising sales force in dozens of American markets, and is grossing close to a billion dollars a year in ad sales.
• The real battle for streaming radio listenership will transpire in the car to some extent. There, Pandora started early and has established a hefty entrenchment. Apple is entering the digital dashboard operating system arena, where it could develop a positioning advantage.

The upshot? Pandora and Beats 1 are both good products on the front end. We have no idea whether Beats 1 has any kind of substantial audience. We don’t know whether the audience is growing or fading. We think developing a suite of Beats stations would be smart diversification. And we suspect that the competitive pressure on Pandora comes from a general crowding of the field and multiplying consumer choices, not particularly from a brand new, largely untested service whose audience metrics are hidden.