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Volume 13, July 2012
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Evolving Media Consumption Driving New Monetization Models (Part II)

In mid-July we addressed changing consumption and business model trends in TV (see Evolving Media Consumption Driving New Monetization Models – Part I). In Part II of this note, we address changing trends in radio.

The catalyst for writing these notes are the recent announcements by two major media companies, DISH Networks and Clear Channel, which highlight how shifts in consumer media consumption are changing traditional economic models supporting content creation and delivery.

On May 10, 2012, Dish Networks, announced that subscribers to its satellite TV service would now receive the ability to skip commercials, an outgrowth of new consumer viewing habits. In a recent WSJ article, Dish’s CEO Charlie Ergen stated that "Ultimately, broadcasters and advertisers…run the risk of linear TV becoming obsolete." Mr. Ergen further elaborated that "…there is a risk of inaction as opposed to no risk of inaction."

On June 5, 2012, Clear Channel Communications entered into an historical agreement with Big Machine Records, in which Clear Channel agreed to pay Big Machine royalties to compensate the artists and performers for songs Clear Channel plays on the radio. Radio companies have never paid artists and performers for music played over the airwaves, only songwriters and publishers, as radio was always seen as providing promotional value for artists and performers. Like DISH, Clear Channel seemed to see risk in taking no action (presumably due to changing listening habits), and saw the need to provide its new internet radio business, iHeartRadio, with a more profitable business model by finding a creative way to reduce online programming costs (i.e., internet royalty rates). We believe Clear Channel agreed to pay Big Machine a performance royalty on terrestrial radio in exchange for paying a negotiated royalty rate online, rather than the Copyright Royalty Board’s statutory rate.

Radio and the Mobile Consumer

Like television, media consumption patterns are also occurring in radio, and the broad trends are somewhat similar to TV trends. Just as TV viewing is evolving with new technology adoption and greater choice, radio listening is shifting as the internet facilitates competition.

Like television, terrestrial radio’s reach dwarfs online radio’s reach. In the U.S., terrestrial radio reaches roughly 93% of adult listeners each week, or roughly 241 million adults. This compares to online radio where 29% of the 12+ population (or 76 million) listened to online radio last week. Terrestrial radio remains the dominant form of audio listening on a daily basis. Terrestrial radio garners 69% share of daily audio listening, significantly more than iPods/MP3s (11%), satellite radio (9%), CD players (6%) and internet streaming (5%).

Terrestrial radio’s reach has remained relatively flat over the years. For example, in 2001 radio reached 95% of the U.S. 12+ population, and today it reaches 93%. However, over the same time frame the U.S. population has grown, and as a result, so too has radio’s weekly reach, as we show in the chart below. Arbitron recently estimated that radio reaches 241 million Americans over the age of 12 each week, and based on our estimates, we believe that reflects approximately 16 million incremental listeners relative to 2001, when we estimate the industry reached 225 million weekly listeners.

In our recent note on TV viewing trends, we observed that the broadcast networks typically experienced ratings declines in the mid-to high single digit range, but had made up for that through pricing increases. In the chart below, we look at time spent listening to terrestrial radio and note that in the first half of the last decade, time spent listening declines were very modest, roughly 1.2%-1.3% per year.

There was a large revision to this trend in 2007/2008 when the industry began transitioning to the portable-people-meter (PPM) from the diary method (denoted by the dotted line). This explains why we saw large declines in 2007 (when the first markets transitioned to PPM) and 2008 (when more markets transitioned), and again in 2010 (when another 15 markets converted to PPM). The PPM data shows that radio is reaching more consumers each week, but they are listening for shorter periods of time: weekly time spent listening is 30% lower today (14 hours and 19 minutes according to PPM data) today than in 2001 (20 hours and 30 minutes; according to diary data).

In a separate study conducted by Arbitron, between 1970 and 2009, time spent listening decreased from 148 minutes to 132 minutes, which equates to an 11% drop over a 40 period. However, as Arbitron’s data migrated from a diary method to the portable people meter (PPM), historical comparisons are difficult to make. Another Arbitron study of 17 PPM markets in 2011 showed that TSL decreased by 10 minutes, from 12 hours and 4 minutes in 2009 to 11 hours and 54 minutes in 2011, reflecting a 1.4% decline over the period (and suggesting that diary markets continue to report higher TSL than PPM markets).

Radio Listening Gradually Becoming More Mobile

Radio listening continues to migrate to away-from-home listening. Away-from-home listening has grown to 64% of all listening, up from 59% ten years ago. Arbitron stopped reporting the breakout of in-car and at-work listening when measurement migrated to PPM. Nevertheless, as the chart below demonstrates, a greater share of listening was taking place in the car than ever before. As we will see shortly, audio listening has become increasingly “mobile”.

Internet Radio Growth – Powered by Pandora

In contrast to terrestrial radio’s modest time spent listening declines, pure-play online radio operator Pandora is demonstrating phenomenal growth in reach and time-spent listening. Over the last three years, Pandora’s active user base has increased from 9 million to 50 million, while listening hours have increased from 400 million hours per quarter to 3.1 billion hours per quarter, as shown in the chart below.

Looking at more recent trends, we see that Pandora’s listening hours increased by 79% 1.08 billion in June 2012 from 0.6 billion in June 2011. According to Triton Webcast Metrics, Pandora’s listening in June 2012 accounted for approximately 5.98% of all radio listening, up from 3.37% of listening in June 2011. These trends also suggest that, despite the launch of Spotify in the U.S. one year ago (July 2011), this new on-demand service seems to have had very little impact on Pandora’s listening.

As shown in the chart below, listening to internet radio grew by 72% over the last year (May 2012 vs. May 2011), or to nearly 2.1 million average active sessions in May 2012 from 1.2 million average active session in May 2011. Of the incremental 870k active sessions, Pandora captured 743k or 85% of the incremental listening between May 2011 and May 2012. In fact, since September 2010 in any given month Pandora has captured between 78%-95% of the incremental internet listening. The sharp uptick in in August 2011 reflects the inclusion of Pandora’s mobile audience for the first time.

Drilling down a little deeper, we see that nearly all of pure-play internet radio companies posted strong audience growth in May 2012 vs. May 2011, including Pandora (+109%), Slacker (+61%), and Digitally Imported (+36%), with the only exception being AccuRadio (-17%, which could be explained by the fact that AccuRadio does not yet pay to have its mobile audience measured). Online streaming of terrestrial radio stations were more mixed, with 8 of 14 companies posting listening gains.

Mobile Listening Takes Off

Out in the woods, or in the city,
It's all the same to me,
When I'm drivin' free, the world's my home
When I'm mobile
-- The Who – “Going Mobile” (lyrics by Pete Townsend)

What we find most interesting about Pandora’s listening is that its audience has become increasingly mobile. In the fall of 2009, 86% of listening to Pandora took place online at desktop computers. At the end of last year, mobile listening had reached nearly 70% of all listening. In two years’ time, Pandora’s mobile listening hours per quarter increased by 1,585% to over 1 billion listener hours from just 60 million listener hours in the fourth quarter of 2009. Over the same period, desktop listening increased by 21%, but only represented approximately 30% of listening (see chart below).

It would appear that internet radio, like that of terrestrial radio, is increasingly “going mobile”, with terrestrial radio increasingly taking place in cars and internet radio increasingly taking place on smart phones and tablets.

Internet Radio’s Challenge: Profitability

Pandora’s revenue trends have followed its listening trends. Pandora’s LTM revenue in October 2010 was $113.9M, and in April 2012, LTM revenues had nearly tripled to $304M. However, despite very impressive listening growth and revenue growth, Pandora has not yet reached profitability. In order to secure rights to stream music content over the internet, Pandora, like all other music service providers, must pay royalties to copyright owners of both sound recordings and musical compositions. Pandora opted out of the CRB rate, and in 2009 reached an agreement with SoundExchange to pay a lower “pure-play non-subscription rate”.

As shown in the chart below, even with this lower rate Pandora’s royalty rates (a.k.a. content acquisition costs) as a percent of advertising revenues actually increased last year, which we attribute to the fact that it is more difficult for Pandora to monetize mobile listening than it is to monetize desktop listening.

We believe this lack of profitability is a major reason why terrestrial radio operators have not been more aggressive in marketing and promoting their online streams. Pandora was fortunate to have investors that were willing to incur operating losses while Pandora staked out the leading position in the internet radio sector. Most terrestrial radio companies, many of whom have public shareholders, were not in a position to incur Pandora’s $82 million in operating losses over the last six years.

Despite how difficult it is proven to be to create profitable digital music businesses (whether they be subscription or advertising based internet radio or e-commerce companies), venture capital firms continued to invest in internet radio or digital music opportunities in the last year. As shown in the chart below, nearly a half a billion dollars were spent on digital music related VC investments in 2011.

Terrestrial Radio’s Difficulty In Monetizing Online Listening

Terrestrial radio stations have not been very successful so far in monetizing their online streams. Little hard data is available as not one of the 14 publicly traded radio companies report their online revenues. We estimate that terrestrial radio companies currently garner approximately 2%-4% of total revenues from online services, which consist of banner ads, online/mobile audio ads, and e-commerce. We estimate that online audio ads account for approximately 20%-25% of digital revenues for most terrestrial radio companies, and that given the costs of streaming and streaming royalty rates, most terrestrial radio companies have not found a way to stream audio content profitably.

We see two main reasons that terrestrial radio doesn’t lend itself well to streaming:

  1. Content: Most terrestrial radio companies simply re-purpose over-the-air content online, resulting in 8-12 minutes of commercial time in a terrestrial radio stream vs. approximately 1 minute of commercial time in a pure-play radio stream (i.e., Pandora, Slacker, etc.). Considering that internet radio is more of a one-to-one listening experience, often with on-demand or near on-demand capabilities, terrestrial radio’s one-to-many streaming approach has not caught on with listeners.

  2. Lack of Scale: Most terrestrial radio streams lack scale, particularly in smaller markets. The internet is an effective advertising medium, but most local stations do not attract sizeable online audiences. This becomes particularly problematic when target-ability is introduced. The power to target more effectively online is one of the most powerful attributes of online advertising. Unfortunately, for many small market radio operators, introducing geographic or behavioral targeting only serves to further reduce the size of the total audience.

True Mobility – FM Chips in Mobile Phones

Terrestrial radio also faces monetization challenges as their online listening migrates to mobile phones. However, terrestrial radio’s mobile listening would receive a huge lift if the FM chip that resides in many mobile phones is turned on by wireless carriers. The benefit to consumers is clear: they would be listening to an over the air feed and avoiding higher data usage rates associated with listening to a radio stream on a smartphone.

A TNS Global Mobile Life study showed that nearly 70 percent of people outside of the U.S. have an FM/AM radio feature on their phone, and nearly 43 percent use them. In the U.S. 21% of AT&T, 21% of T-Mobile and 7% of Verizon’s phones offer broadcast radio as an available feature, but none of them are promoted by wireless carriers. The carriers would rather reap the revenue of data-intensive, fee-based streaming apps rather than offers consumers a free audio solution.

Strength in Numbers – The iHeartRadio Platform Begins to Scale

Clear Channel re-launched iHeartRadio to much fanfare in September 2011. Since that time, Clear Channel’s average active sessions have more than doubled (see the dark blue line in the chart below), to 253k session starts from 122k session starts in August of 2011, the month prior to re-launch. As shown in the chart at the bottom of p. 5, when comparing Clear Channel (the purple line) to all terrestrial broadcasters online listening (the blue line), Clear Channel and iHeartRadio’s incremental listening is more than all the online listening to terrestrial radio streams. Stated differently, excluding Clear Channel, listening to terrestrial radio’s online streams has actually declined in the past year. Much of this decline is due to CBS no longer carrying the streams of Yahoo’s Launchcast and AOL Radio (now operated by Slacker). Nevertheless, listening levels to terrestrial radio’s online streams was 10% in May 2012 than May 2011. These trends are captured more clearly in the chart below.

Other terrestrial radio companies appear to see the benefit of partnering with iHeartRadio. In recent weeks and months, radio station groups such as Univision, Greater Media, Cox Radio, Emmis, Salem and Cumulus Media have all provided local content to iHeartRadio. iHeartRadio now boasts 10 million registered users, and offers more than 1,000 broadcast and online-only radio stations and user-created custom stations.

Clear Channel Gives Up Something to Get Something

Perhaps encouraged by Pandora’s 50+ million active listeners, Clear Channel has become significantly more aggressive in promoting iHeartRadio. Clear Channel also has encouraged increased listening on the iHeartRadio platform by running the programming in a commercial free environment. We view Clear Channel’s agreement with Big Machine records as a clever way for the company to experiment with the revenue and profit potential of its new internet radio platform. By using its terrestrial stations as a promotional and negotiating lever, Clear Channel can directly influence the royalty rate structure that has impeded the path to profitability for most interest radio operators. By combining its promotional prowess with a more satisfactory online royalty rate, Clear Channel should be able to reduce operating losses while increasing the speed at which iHeartRadio reaches profitability.

The Battle for the Dashboard

We believe one of the benefits of partnering with iHeartRadio is that it provides iHeart with enough station affiliations and local content for the product to become a must-have for auto makers as they contemplate in-dashboard music services for the cars of the future. No radio station group on its own is likely to be able to compete with Pandora when it comes to being in dashboard on future car models. By working together through services such as iHeartRadio, TuneIn Radio, and HD Radio, radio companies can ensure they have a compelling service to compete with newer in-car/in-dashboard services such as XM Satellite and Pandora.

IHeartRadio and TuneIn have some catching up to do. HD Radio is now available on 28 automotive brands, with the technology available in 140+ models by year-end, with more than 60 brands featuring HD Radio receivers as standard equipment. Pandora is also well on its way to becoming a standard in-vehicle experience: it has partnerships with 19 automotive brands and 7 aftermarket manufacturers, and more than 50 car models with Pandora ready car radios are now at dealerships with more expected by year-end. However, Pandora’s in-car experience typically requires a smartphone. TuneIn just announced it will be available on the new Tesla Model S, which connects directly to the web, without any need for a smartphone.

Final Thoughts

Both the television and radio business continue to evolve to changing consumer viewing and listening habits. Given its status as a primary advertising medium, it is not surprising to us that TV advertising seems to holding up well despite long-term network TV viewing declines, while radio, as a secondary or tertiary medium has had to work harder to grow revenues in the face of its more moderate listening declines. More than TV, we believe radio needs to find a way to maintain its dominance, particularly in mobile listening, whether in the car dashboard on or mobile phones. One silver lining is that given more viewing and listening choice, consumers are choosing to consume more video or listen to more audio.

Sincerely,

Chris Ensley
(212) 901-4160
chrise@coadydiemar.com

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