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Please click here to read Part I.

"Never stop testing, and your advertising will never stop improving." - David Ogilvy

If you are invested in Pandora (NYSE:P) or Sirius XM (NASDAQ:SIRI), you are probably painfully aware of the ongoing debate: Does Sirius XM compete with Pandora? And if so, is either company a better investment than the other? I have come to the conclusion that yes they are indeed competitors. However, it is unlikely that the success of one would spell doom for the other. They both afford a better potential to produce returns far greater than the debt-laden, terrestrial behemoth Clear Channel (CCMO.PK). Clear Channel is the king of radio, but it is slowly and steadily losing favor over its dominion.

In the way that I view and use both Sirius XM and Pandora, I am glad that both services exist. They have both challenged and changed forever the ways in which we can now consume "our" radio. With either company, we are afforded much more control over the radio's presentation and variety of music and other programming. No longer is our choice of radio station limited by our proximity to a strong terrestrial radio tower.

As to which is a better investment, and as it stands today, Sirius XM's business model of subscription based radio is far superior to an ad-based model when it comes to monetizing radio listening, as illustrated in the image I created below.
2011 Radio Listeners vs. Revenues

Back to the focus of these articles. Pandora actually has a choice in how much they have to pay in royalties. If Pandora can increase its revenue so that 25% of revenue becomes a larger number than the per song royalty fee total, the per song rate becomes irrelevant. Since we are three years away from the possibility of royalties being negotiated down (statutorily speaking), the best chance of profitability remains boosting Pandora's ad revenues. My biggest concern is the perception of the value of ads when placing myself in the shoes of an advertiser.

"The consumer isn't a moron; she is your wife." - David Ogilvy

Advertising In Real-Time:

I decided to spend some time today to review my ad experience while listening to Pandora on the iPhone. First I spent an hour listening and purposely interacting with each song (i.e. thumbing, skipping, changing and creating stations and revealing artist/track info pages.) I spent the second hour passively listening to Pandora in the background, never looking at or interacting with my iPhone.

I decided to choose the Pandora account that I created that uses my accurate Birth Year/Gender/Zip Code. I say this only because I also have another Pandora account where I can listen as an 18 year old girl in the only other zip code I have memorized ... 90210. Combined with a pair of high-end headphones, this is a brilliant, guilt-free way of listening to my "Gravity" by the Sara Bareilles station. Also it affords me with the plausible deniability if perhaps some day I am accused of being a sentimental softy while amongst my fellow Metal-Heads ... Diabolical.

Hour 1 Pandora App (Interaction):

I was presented with one new banner ad for every 3-4 interactions, the first style of banner ad that is served is a small 3/8" banner that is displayed precariously close to the thumbs up/down, pause and skip bar. Unintentional interaction with the ad can and will happen quite easily. A small "X" measuring 1/8" can be touched to remove the ad, which will be replaced within five seconds, most commonly by the same ad, but occasionally a new ad will appear. I would assume that by being presented with a small "X" I am being afforded the opportunity to say I'm not interested in this product, it should logically trigger a new advertiser, not the very same advertiser. Insistence is not a great relationship builder.

After skipping 2-3 songs, I was presented with what I feel is the most effective style of ad for Pandora, a 15 second video ad (I have heard 30 second versions before.) Effective, because these ads are unavoidable and cannot be minimized, it isn't accidentally triggered, it is intentional, and is always ~10dB louder than the music. I was presented with six of these over the hour. Only one was what I would consider a "local" ad. Convincing local businesses to produce this style of ad will generate higher ad dollars, it may cost the advertiser more, but ads like these are far more likely to generate valuable consumer traffic. As Pandora moves into autos, a creatively produced video ad that works with and without the visual component enabled should be a priority. Pandora has plenty of room to add many more of these ads before approaching the terrestrial radio threshold of significant ad pain. Many times, based on luck and timing, terrestrial radio ads can span an entire 20 minute journey in your car without ever hearing a single song.

As a potential advertiser, I was not happy to see what I feel was the most disturbing part of this analysis. It occurred 3 times over the hour. I was served defective and incompatibly produced banner ads as depicted below.

Hour 2 Pandora App (Passive Listening):

An uneventful hour of listening as far as ad frequency. I was served three "Audible" 15 second ads. The volume boost on these ads are attention grabbing, but a definite mood killer. I feel as though Pandora could have served three times the amount and still not approach a listening experience that could be considered annoying. With the automobile being the "Holy Grail" of radio, where up to 80% of listening occurs, Pandora should be increasing the frequency of these audible ads, especially if the mobile audience is urban and will not have long enough car rides to be served ads sufficiently.

"I notice increasing reluctance on the part of marketing executives to use judgment; they are coming to rely too much on research, and they use it as a drunkard uses a lamp post for support, rather than for illumination." - David Ogilvy

Suggestions

I don't wish to be considered a useless complainer, so I will offer what I feel should be seen as helpful suggestions. Any move in this direction may help to influence my willingness to invest in Pandora eventually. I would love to get in on the ground floor of something big, but if the IPO can be considered the ground floor on Pandora's stock price, I can actually get in on the subterranean parking levels, presently 16 floors below ground level.

1. Abandon the practice of "trickery." Move the banners up to the middle of the page so that consumers will receive a prominent impression, and advertisers will not be misled by unintentional activity. Like this...

2. Rotate longer songs into the playlists, so that the per performance royalties can be artificially reduced.

3. Ask the user "Is this ad relevant to you?" Adjust the service accordingly.

4. Add marital status, income and education to the birth year, gender and zip code portion of registration. This will help in being significantly more accurate while serving targeted ads.

5. Add an additional second between each song to reduce royalties, possibly create a station I.D. every third song (you are listening to "XYZ" channel on Pandora Radio.)

6. Play more audio ads, if the average car ride is 15 minutes, you need to increase the frequency of the Ads.

7. Get the Genome guys back to work, that 900,000 song catalog has remained constant for over a year now. There are 17 million more songs to add. Having a larger catalog could justify raising the ad-free subscription price.

Usage Disclosure: I use the free Ad-supported Pandora version and I really do like it (The music discovery and pseudo-control ... not the ads) and so does my 6 year old daughter, my 68 year old mother, my "30-something" year old wife and my 19 year old girlfriend. (Just kidding, that's not really true ... my mother is actually 69 years old.)

I marvel at the ease of use, the gentle learning curve and the simple elegance of a dovetailed combination of Pandora on the iPhone. I love knowing that actual musicians are employed to generate the Genome. I like knowing that Tim Westergren is an intellectual and a musician, I find him to be a charismatic and effective spokesperson and a technological visionary who appears to sincerely care about the opinions of Pandora users.

As such, I believe he is the most valuable person at Pandora, and if Pandora somehow survives, he would deservedly be, my logical nominee for (and the legitimate recipient of) all of my respect and congratulatory accolades. Pandora deserves to survive, I am just not convinced that it will. I'll keep my eye (and ear) on it, and so should you.

If you are considering initiating a long term position in Pandora, I would suggest remaining on the sidelines until management can clearly demonstrate evidence that Pandora's advertisers are willing to pay more for mobile ads. I don't see Pandora's share price going much lower than the $9-$10 range, so I personally would not be too quick to initiate a short position today. I may try short term trading Pandora as it approaches $10 and ride it up to $14 and trade it in time to fund my summer vacation.

Source: Pandora And Mobile Ads, A Touch Too Much: Part II