File sharing, MP3 players and online stores transformed the way we listen to music. Now the cloud is bringing even bigger changes. Pandora is the rock star of cloud-based music services, with a clear lead in streaming audio. But - true to music-industry form - a crowd of younger, hungrier rivals is pounding on the stage door.

Stairway to Heaven

Pandora struts like Mick Jagger in its latest financial report. The company's audio streams accounted for 6% of the total U.S. radio market and 72% of the top 20 Internet radio services in the most recent quarter. The number of active users on the site grew 53% year on year to 52 million, and total listening hours grew 92% to 3.1 billion hours.

That mix of rapid growth and high market share has given Pandora an early lead in streaming audio. Pandora's service is largely ad-supported, giving it an edge over rivals that charge a monthly fee. (The company offers an ad-free subscription service, but it accounts for only an eighth of total revenue.) Spotify, MOG and Rdio offer better on-demand streaming options, but they charge $9.99 a month for streaming to mobile devices.

Free is a big draw for Pandora on mobile. Listeners don't seem to mind the ads or the limits to skipping songs that come with free listening. Most of them seem so weary of commercial radio that they have turned to Pandora instead. And so mobile is big for Pandora: It delivers 70% of its streams to mobile devices.

An Arbitron survey found that 6% of drivers listened to Pandora on the road in 2011, compared with 8% for Sirius XM. Among drivers between 18 and 24, 19% listen to Pandora. And yet the old AM/FM radio remains the most popular source of music on the road. This presents an opening for online radio to displace a medium that annoys many of its listeners. Pandora, with its large share of the online-music market, is in a great position to seize the opportunity.

Highway to Hell

So why is Pandora's stock price slipping down the charts? The stock went public one year ago, and it has lost a third of its initial value since then. The Nasdaq Composite Index is up 9% during the same period.

Two things have kept investors out of the ticket line. One is the money the company has spent to entice its 52 million active users. The company brought in $304 million in revenue during the past year, but it still came up with a $26 million loss. The deficit, mostly due to royalties and marketing costs, has mounted in recent quarters.

That kind of spending would make sense if Pandora were cementing its early lead in a market that has high barriers to entry. Alas, the barriers to entry are low. And that brings us to the second of Pandora's problems: Competitors are coming fast and hard, and Pandora may simply be paving the way for them.

New Kids on the Block

Thanks to its duet with Facebook, Spotify – which finally launched in the U.S. in July 2011 – has acquired between 10 million and 20 million active users. (Facebook claims the latter figure, Spotify the former.) Audiophiles who took to Pandora early on are deciding that it's worth paying a monthly fee for on-demand mobile music through Spotify or established music services such as Rdio and MOG.

Meanwhile, other rivals are laying down fresh riffs. Songza, a free mobile app, plays hand-picked playlists rather than algorithm-selected tunes. It has displaced Pandora as the top-selling music app for iPhones and iPads. And this week, Amazon launched its Cloud Player app that lets users stream to mobile devices music they've bought or stored.

Anthony DiClemente, an analyst at Barclays Capital, issued a report this week noting Pandora's new competitors. He pointed out that Songza's ad-free, curated playlists offer an attractive alternative and that Amazon's established customer base and ability to give users more freedom in listening to songs could lure Pandora users.

Too Old to Rock and Roll, Too Young to Die

Pandora has done a great job of blasting a sclerotic music industry into the wings with free, streaming music. And the $81 million it holds in cash and short-term securities gives it the wattage to invest in innovation that could preserve its sizable market share.

But Pandora is losing money to grow in an increasingly crowded and aggressive market. The online music industry is still in its infancy, and Pandora's early lead is no guarantee it will continue to call the tune.