Microsoft’s Entry In Music Could Threaten Pandora’s Future

The U.S. online music industry is about to get more crowded with the entry of the software giant Microsoft (NASDAQ:MSFT). The company is going to launch its new music service that will allow its users to both stream and download the music of their choice. ^[1] Given the distribution channels available to Microsoft, its spending capability and its customer base, the company’s entry is going to make things difficult for the existing players such as Pandora (NYSE:P).

Even though Pandora brings unique proposition of exploring new music and personalization, the listener hours of Pandora’s users are going to get shared with Microsoft’s service. Additionally, the music composers and the copyright owners of sound recordings will get leverage with Microsoft’s entry, which could break Pandora’s hopes of bringing its content costs down.

See our complete analysis for Pandora

Microsoft’s Giant Presence Will Weigh On Industry

Microsoft has a large customer base and several established distribution channels that will allow it to distribute its new service to millions of customers globally in an instant. The company’s presence in the gaming industry via Xbox, its dominance in the PC market through its Windows operating system and the upcoming Windows-based smartphones give it an excellent ecosystem for marketing its music service.

The integration of Windows 8 across multiple device forms is likely to be an aiding factor. Clearly, the move can not be taken lightly by Pandora or other online music players. Microsoft is offering an online music catalog of 30 million songs globally, significantly higher than what Pandora is capable of. In fact in this sense, Microsoft has already beaten Pandora in terms of international expansion.

Content Cost Issue May Persist

Given the entry of Microsoft, the music copyright owners will get more bargaining power while negotiating royalty rates. A company like Microsoft will not mind paying high royalties if the music service becomes essential to its Windows 8 ecosystem and helps it compete better in PC, smartphone and tablet markets. This will be a problem for Pandora’s efforts to bring royalty rates down. Reducing content costs is one of the key strategies that Pandora will employ to become profitable as it has the potential to double its stock from where it stands currently in the market (see Pandora’s Value Could Double If The Internet Radio Fairness Act Passes).

Even Though Pandora Has A Unique Service, Growth Will Slow

Even though Pandora differentiates itself with its personalized radio service, there is going to be a competitive pressure even from simple on-demand music streaming companies.

Radio and music stores have existed peacefully in the past, but that does not take into account the fact that typically radio is listened to in the car and via in-car radio systems while music stores sell on-demand music (traditionally cassettes and CDs) that historically spanned from cars to home stereo systems and smartphones. In the past, at least there was a distinction in terms of which devices were preferred for what service.

With the proliferation of mobile devices, services such as iTunes, Microsoft’s new music service, Pandora and Spotify share common devices such as smartphones, tablets and PCs. In essence, the total potential listening hours for anyone are limited and are likely to split across Pandora and other music services that are coming into the market as all try to compete on the same devices.

Our price estimate for Pandora stands at $10, roughly in-line with the market price.

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1. Microsoft Takes On Pandora, Spotify With New Music Service, Business Insider, Oct 15 2012 [↩]