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Revelations from Pandora's music box

Tim Westergren, founder and chief strategy officer of Pandora, is looking to change royalty rates, the musician class system and how companies interact with their customers.

What will it take to create the middle-class musician?

It's an idea Pandora founder Tim Westergren thinks about a lot.

Between 100 town hall meetings and several sessions for seniors at this year's AARP conference, Westergen has been campaigning for more Internet radio listeners for both Pandora and musicians in general.

Pandora uses the Music Genome Project, a tool that compares musical genetic codes of songs, to create personalized radio stations. You tell it what you like; Pandora plays those artists and others that have songs with similar musical qualities. With music from both big record labels and independent artists, listeners get more selection and increased knowledge about music.

Despite a much-publicized standoff with organizations like the Recording Industry Association of America over royalty rates, Westergren (also Pandora's chief strategy officer) says Internet radio will actually bridge the gap between the pop superstar and the working-poor musician. He says it may even create a new consultant and services business model for record labels.

The new champion of Internet radio sat down with CNET to give the latest scoop behind the royalty rate negotiations and the music industry's crumbling three-legged stool.

Q: You had an unusual launch with Pandora. Explain that.
Westergren: We started off by just making it available to friends and families to just give it a trial run. Not long after, these "friends and family" wound up spiraling to around 5,000 or so within a few weeks. That was a first sign that we had something people were interested in.

We wound up launching it in October, but as a paid service for three bucks a month...We were able to get people to sign for 10 hours of the intro Pandora for free, but few people were actually registering.

The vast majority of musicians exist in that they are the working poor...They're basically starving.

People would use 10 hours for free and then delete the cookies?
Westergren: Exactly. After 10 hours they would log off, delete the cookies and then log back on and refresh their profiles so we don't recognize them. We made a dent and people were using it a lot, but they didn't want to pay for it...So we went free in November '05...I think we had 250,000 people come to Pandora.

In one week?
Westergren: In one day. The day after we launched I think probably we had that many. In the first week we were adding I think 50,000 or 60,000 new listeners a day. That lasted for a few weeks and then it went down a little bit and then a steady rise ever since.

You used to compose music for movies. Explain how that process has trickled into Pandora.
Westergren: When you're a composer your job is to figure out someone else's musical taste, to pick up the director's musical taste. I call it a musical Meyers-Briggs test...You kind of home in on what they like and you're trying to translate their feedback into musicological information you can use to create a new composition. So the genome was really born of that process.

Originally you were called Savage Beast and sold the Music Genome Project engine as a service?
Westergren: We would license access to our tool, so people could use it to make recommendations on their respective Web sites. You know, 'If you like this song, you will like this.' Then we very, very briefly thought about being an online musical retail site, but we never raised enough money to make that mistake.

Is it true you made 348 pitches before you got $1.5 million in initial funding?
Westergren: Yes, in March of 2000. Then in March 2004 we got $8 million...$12 million in '05...and we did another round the following year, but haven't disclosed that figure yet.

But you're still not making money from Pandora?
Westergren: We're losing an armful of money every month right now. But that's not a surprise to us.

You're probably the only executive I know of who travels cross-country holding town meetings about your product. Explain how this practice got started.
Westergren: My original plan was to just go looking for music. I was going to get into a van and really just drive a lot.

Literally a van?
Westergren: Yeah. I actually had a van. I was going to get a trunk in the back and fill it with CDs as I went. Just literally collect them and then actually mail them back to Pandora. That's how I started...That was 2006, I think it was March, for South by Southwest, the music conference in Austin, Texas.

How did that go?
Westergren: I spent about two weeks on the road in my first stint. I originally thought I was going to go longer, but...I'd have these long days of meetings and then get back to my hotel room and have like 400 e-mails so...I go now in four-day stints generally.

The first one just two people came, but I just kept doing them and they grew. I wanted some kind of a forum where people could actually talk, if they'd come to talk to me, and so we developed this town meeting format.

Music is something that really is such a sort of personal and important thing that people are willing to do something, you know? They want to come, they have something to say about it and they are welcoming the opportunity to tell the company founder what they really think.

You talk about wanting to create the "middle-class musician." I haven't heard of that concept since taking a semester of medieval literature. In those days, people paid local town musicians to entertain them. How would that work today?
Westergren: The vast majority of musicians exist in that they are the working poor. They spend a lot of time playing around the clubs...spend whatever little money they earn on their music equipment and they're basically starving, you know? They're all trying to get the attention of a big record label, because that's traditionally the only means for them to get exposure to enough people to make a career out of it.

Is it true that Pandora gets only about 6,000 new CDs per year from the record labels to add to the Music Genome Project?
Westergren: That's the total production from all the majors and their subsidiaries per year. 6,000. Yeah.

Historically, musicians are feast or famine. They either get picked or they don't. It's a very, very tiny number of artists who are able to do it without label backing. They just manage to do it because they gig like mad and they develop these real followings.

Dave Matthews is a good example of that. Those guys were making a living by touring and they eventually got picked up by labels...their grassroots following was big enough.

The reason there's a two-tiered system but nothing in between is because there is no means of promoting yourself as a musician. You can't get on the radio.

The toughest (piece) to crack is the promotion phase. It's not enough just to be on iTunes.

You talk about there being a "three-legged stool" in the music industry, that Pandora can bring something to the third leg?
Westergren: Us and other people, too. The three legs are production, distribution and promotion. Traditionally the deal with the label is you borrow a bunch of money from them, and they take care of all three of those things: money to record a CD...getting it into the stores and getting you on the radio or an opening spot with one of their successful acts as a promotion piece.

Well, digital recording software, which is now basically free, has allowed musicians to create world-class-sounding CDs for nothing. And now with a nominal annual fee you can get your music distributed globally through online Web sites. There are a bunch of companies--CD Baby is probably the leader on the Net--where you can join and for $35 they will warehouse a dozen physical CDs, create a little album art icon, some 30 second samples of your music, a little biography if you want to write it and make it available on every sort of online retailer.

And the third piece?
Westergren: The third piece, which is the toughest one to crack, is the promotion phase. It's not enough just to be on iTunes. I think that's where Pandora comes in. You can be completely unknown, but because we know what you sound like and do some music analysis on you we can make sure you are heard by people who are likely to enjoy your music. And when we get big enough, we can do it to a large enough audience with the prospect that they can essentially support you. For most bands it's a lot if they can get a 100,000 people to like their music. We can probably find 100,000.

What would it take for a musician to make about $40,000 a year? How many albums or songs sold? How many fans?
Westergren: That's a good question, actually. There are a lot of pieces...People buying the albums or the songs...going to hear them play live, which I think is going to be an increasingly important revenue stream for musicians...getting a royalty every time they get played on an Internet radio station and then if their band has a T-shirt...all ways in which fans are going to drive revenue to the artist.

I don't know the answer to your question about how big that audience needs to be. If I was a betting man I'd say...50,000 fans and would describe a fan as somebody who'll do some of the above.

Explain to readers the royalty rate issue very briefly.
Westergren: There are two licensing fees, a publishing fee which goes to the composers and collected by the likes of ASCAP (the American Society of Composers, Authors and Publishers) and BMI. It's the same rate for all three forms of radio--Webcasters, satellite and terrestrial (AM/FM).

The second licensing fee, the one being contested now, is the performance fee. The older rate for that for the large Webcasters was 0.0761 cents per song (based on an estimated number of listeners).

And the new rate?
Westergren: The new rate over the next couple of years would become 0.19 cents per song. The new rate is per song, which means if you skip a song or you play part of a song, we pay full royalty on that song. You take that all into account and it's basically a tripling of the rate. But the old law distinguished between small and large Webcasters.

This new royalty rule that came down wiped out the distinction between small and large, so the smaller casters no longer have a percent of revenue option. They all have to pay a per-song fee. For them this fee change in some cases represents a 10-times increase than what they were paying.

(Small Webcasters) are all officially bankrupt. But they're continuing because they believe that there's going to be a resolution.

Who would you call a small Webcaster?
Westergren: ...Every college radio station that streams online.

In July, you organized a last-minute grassroots campaign against this rate change that brought the fax, e-mail and phone systems of many Washington lawmakers to a halt. Exactly how many faxes did you get people to send?
Westergren: I would estimate about 1.3 million or 1.4 million, a combination of faxes and phone calls. Shortly after this verdict came out (a decision earlier by the U.S. Copyright Royalty Board to drastically raise fees) we got together as Webcasters to figure out how we were going to fight it and realized pretty quickly that our only avenue for opposing it was going to be some kind of large-scale public pressure because we don't have longstanding groups in D.C.

One of the things that made Pandora particularly good at it is that we do have a relationship with our listeners, we have their e-mail addresses and we know their ZIP codes. So we could not only ask them to call, but give them the phone number of their local representative. I'm going to estimate that of the 1.3 million to 1.4 million people, close to 1 million were from Pandora.

Then what happened?
Westergren: Because there was such an enormous public opposition, Congress was forced to respond. And it takes a lot to get Congress to actually intervene in a process.

One of the funny things is that a huge proportion of the Congressional staffers use Pandora and that's a great way to get the attention of their bosses. Ed Markey, this Massachusetts representative, summoned everybody together: head of the RIAA, head of the National Association of Broadcasters (the AM/FM folks), head of DiMA (an umbrella organization for Webcasters) and a bunch of Congress people.

He basically got up and said something's gone wrong here in this process. It's plainly clear to us that we never ever before had this kind of public uproar and my colleagues and I are tired of having our fax machines broken. So you guys need to get together. I'm not quoting him verbatim here.

Right. What's happening now?
Westergren: We have now met once. We're meeting again actually as we speak (September 7).

And you're hoping to hammer out rates?
Westergren: No. This is sort of like a round two...more information sharing, more discussion. Markey said that if there's not been a lot of progress by Labor Day they would be unhappy. So, we're already now into the stage where it's going slow by the standards of what they expected. We'll see what the next weeks are. The first meeting was cordial; it was in the right spirit. But we haven't tackled the biggest issue, which is the rates.

It's very hard to say what the outcome is going to be, but we certainly take some comfort in knowing that Congress is watching and their constituents are watching them. But it's not inconceivable that they would take a really hard line and we'd have to go back to Congress all over again.

In the mean time, this new rate is in effect. What are you doing about that?
Westergren: We're paying it, but we're only paying it because we have some faith that it's not going to last very long. We can afford to pay this little bit, but not everybody can.

What are the small Webcasters doing right now?
Westergren: They're all officially bankrupt. But they're continuing because they believe that there's going to be a resolution.