Pandora CFO: We do Internet Radio 'better than anyone' (Q&A)

Pandora, the Internet's biggest radio service, is the company the recorded music industry loves to hate. Some artists have loudly vilified it, accusing it ofpaying piddling rates to play their work. Labels' acrimony over the service stoked its efforts to paralyze a bill that would have lowered the royalty rate Webcasters pay, and music publishers have singled out Pandora in an effort to withhold their catalogs. The Recording Industry Association of America has outright lied, Pandora claims, about how its payments work.

Amid the vitriol comes iTunes Radio, which, unlike Pandora, struck direct deals with the labels that will let it expand across the globe. In its first five days after launching with the rollout of iOS 7, iTunes Radio notched more than 11 million unique listeners. Pandora, meanwhile, had 72.7 million active users last month.

I spoke with Pandora CFO Mike Herring, who joined the company from Adobe Systems in February, about how Pandora is navigating these challenges. The following is an edited Q&A.

Q: What makes you believe a competitor like Apple isn't a threat to Pandora?
Mike Herring: It's not that it isn't a threat to Pandora. Don't get us wrong, we take them very seriously and do see them as a credible threat. Keep in mind there have been lots of credible threats over the years, from startups to Microsoft to Google, to Apple and Twitter this year. We absolutely see iTunes as a competitive option out there, but we think we are a great service that does this better than anybody else. The most recent entrants have all been large, well-funded companies that have agendas outside a really awesome music experience. They have other reasons, selling cell phones or downloads. We sell downloads, but the priority isn't to sell as many downloads as possible. It's emblematic of the difference.

Pandora pays lower rates to the music labels than Apple because you chose not to do direct deals and instead pay according to government statute. You're also fighting to get them even lower -- what's the latest?
Herring: It's not about lowering rates -- that's about creating fair rates across lots of distribution channels. We've put offers on the table where we commit to paying no less than we pay now in absolute dollars, and with increases on an annual basis. That hasn't gone anywhere because of a lack of trust. It has created a situation where meaningful conversations for positive outcomes are going to be hard-fought wins. It's going to take a long time to get there.

One of the arguments against Pandora is that we're trying to pay artists less money. We'd like to see artists get paid more. We also understand the mistrust comes from a pretty tough decade-plus in the music industry. First you had the piracy issues, which are still rampant, mostly internationally but also domestically. And you had the download platforms, specifically iTunes, that disintermediated the entire CD business, which was detrimental. There's difficulty for people who have experienced these negative things to listen to reason.

Right, artists have criticized Pandora.
Herring: We write a big royalty check every year to performers; last year we wrote one for $250 million in performance royalties. That's one fourth of all royalties paid to performers globally by radio. But we have only about 7 percent of the US radio market. The point we like to make, we are paying a pretty large amount to performers, even though it gets pitched often that we're underpaying or not paying our fair share.

Talk more about fair rates to the rights' holders. What would be fair?
Herring: We [Internet radio] are the only ones who pay on a per-track basis versus a percentage of revenue for satellite or zero in broadcast. I'm not asking for the zero rate of broadcast. I'm asking for everyone to pay a similarly calculated rate. The problem with the per-track rate is Pandora is really the only one who can be successful at that at any scale because the costs are so high. We have 70-plus percent Internet radio market share in part because we have a great product, and in part because it is incredibly, brutally hard to compete in this market where the costs are so high.

It took someone, frankly, with a lot of cash in the bank and a big income statement like Apple to finally launch a competing service.

What has posed the biggest challenge on your learning curve at Pandora?
Herring: All the complexities around the licensing side of the business. Very few people on the planet actually get it -- certainly the artists don't understand all the details and certainly the public doesn't. It's messy, but when there's that much disconnect, there's also a huge opportunity. I've had fantastic conversations with musicians, with labels, with managers -- with attorneys unfortunately. I think one of Pandora's opportunities is to tie those perspectives together over the next few years in a way where everyone wins. The right compensation goes to the artist, the right opportunity is there for businesses like Pandora, and the right access to music is given to listeners and the public.

What inning would you say you're in toward that ideal?

Herring: We're in the second inning, but we're down 10-nothing. That's the bad news. It's early, but we've gotten off on the wrong foot. Piracy originally laid a really negative backdrop to connected music. Nothing that Pandora does facilitates piracy in any way, but the fact that the government has had to be involved in setting rates because of historical bad actions, it has created this contentious situation where lawyers set policy and make the arguments instead of business people and artists talking directly. One of the opportunities in the next few innings is to hopefully rise above the legal wrangling and make it a business conversation around fair compensation.

With Brian McAndrews taking over as Pandora's new CEO, what's the mantle he's picking up and what direction has he given Pandora since joining?
Herring: Joe [Kennedy, Pandora's former CEO] over the nine years at Pandora's helm built something that really had all the odds against it. In the hallways of Pandora, employees here are very excited. There's a lot of affection for Joe, but there's excitement about what Brian brings to the company. Brian is a very highly regarded executive in the tech world; his career has been built on bringing media, technology, and advertising together in a way that is highly valuable to each constituent. The other exciting thing about Brian's expertise is he built aQuantive [the digital marketing company acquired by Microsoft for $6 billion in 2007] by pivoting that business multiple times, moving into new markets.

Speaking of new markets, Pandora's lack of direct deals with the labels makes international expansion tough. What's the likelihood of expanding beyond here, New Zealand, and Australia?
Herring: The short answer is there is nothing short-term for an international opportunity. That said, that could change literally next week. What we're trying to do in Australia and New Zealand is not just open up a market that has a lot of potential, but prove to the world that Pandora's entrance into the market with the right rates structures is incredibly positive for the music industry in that region. If we can prove that in the laboratory that is Australia and New Zealand, I think we have a great case study to take to other locations.

People who have direct deals that are operating internationally are not doing well. Go pull Spotify's financials from last year. It's not pretty.

Your desert island, top five musicians that you couldn't live without. Go.
Herring: Wow. So, Eddie Vedder, slam dunk. Keb' Mo'. Frank Sinatra. Can they be dead?

Absolutely.
Herring: I'd probably have the Grateful Dead in there, takes me back to my childhood. And Elvis.