Could Music Licensing Costs Kill Pandora? Last.fm's Troubles Are A Warning Sign

Maybe Tim Westergren has a point. The Pandora cofounder has been making the rounds in the last few months, arguing that the music licensing costs his company has to pay are crippling and should be changed by Congress. Music labels and many artists aren't thrilled about the proposed changes. So what's the deal? Could licensing costs actually kill Pandora? 

Probably not anytime soon. But it's certainly true that these high licensing costs make it much more difficult to do business. For evidence of that, look no further than Last.fm. Next month, the algorithm-fueled Internet music service is scaling back its most radio-like feature in several countries.

In the United States, Canada and the UK, Last.fm's radio streaming feature will still be available via Web browsers, but using it from their desktop client - just like its mobile apps - will become a subscription-only feature. The reason? You guessed it: The cost of securing rights to that music is too high for Last.fm to make the end product freely available, the company says.

In the UK, music licensing costs are even more onerous than they are in the United States, says radio futurologist James Cridland. It's exactly why Pandora isn't available there, nor is there an equivalent service. Last.fm is probably the closest thing the UK has, and it's about to see its functionality scaled back. 

"I'm not sure what the magic bullet is," says Cridland. "But at some point people need to stop and ask why there isn't a Pandora in the UK, which after all is one of the countries that produces the most music in the world." 

Cridland has done the math. Running a service like Pandora in the UK would require a company to pay out more money in licensing fees than they could conceivably earn in revenue.  

Internet Radio Is Expensive And Hard to Monetize

For Last.fm, licensing costs aren't the only part of this equation. It's also worth looking at the other end of the business model - namely, the revenue side. The fact that Last.fm is cutting its free radio service out of its desktop app suggests it's tightening up its freemium business model overall. 

It makes sense. Last.fm's desktop app collects a lot of listener data, but it doesn't appear to directly make money. I can play personalized stations from this app all day long without ever seeing or hearing an advertisement. Starting January 15, I'll have to go to the Last.fm website, where the entire layout is wrapped in display ads and before my Notorious B.I.G.-inspired station starts playing, Taylor Swift will try to sell me some perfume. 

The fact that Last.fm is pulling radio out of its desktop app all together - as opposed to augmenting it with audio ads - suggests that audio-only Internet advertising isn't quite as potent a force as once thought. Personalized, targeted radio ads seem powerful in theory, but they're far more lucrative when paired with video and display advertisements. Paying subscribers are even more valuable. Clearly, Last.fm is hoping to push users in either of those two directions as it continues to navigate a digital music marketplace that looks very different than it did when Last.fm was founded almost a decade ago. 

Last.fm isn't the big fish here - it's the canary in the coal mine. Pandora is far better-positioned than Last.fm, its chief U.S. competitor. Yet even at the head of the pack, business in the streaming music space is brutal. Music licensing costs may not kill Pandora, but Last.fm's troubles make it clear that the issue can wreak havoc on a music service's core functionality. No wonder Tim Westergren won't shut up.