Songza Soars in Challenging Online Music Field

LOS ANGELES - Songza, a new online radio service, leapfrogged Pandora as the most popular free music app for Apple devices last week. But it immediately faces a struggle to survive in a business saddled with high royalty rates for artists.

The New York-based startup aims to re-write the songbook on how an online radio service ought to run. One key difference: it has no mood-killing audio ads.

"We have playlists for getting lucky," says CEO and co-founder Elias Roman, 28. "If you're getting lucky and you're hearing a toothbrush ad in it, that's not a lifestyle enhancement. That's embarrassing for everybody."

Audio ad-free Songza, at no charge, compares with a $36 annual fee to avoid audio ads on Pandora Media Inc., or $4 a month on Slacker Inc., another online radio service. It also limits Songza Media Inc.'s revenue flow, although the company still runs display ads.

The lack of interruptions helped Songza get downloaded 1.15 million times in the 10 days since June 7, when it updated its iPhone app and offered an iPad-optimized version.

The company now enters a race to become the biggest, or at least among the biggest, online radio services, before an inevitable shake-out decimates those unable to turn a profit.

Even Pandora, by far the market leader in online radio, tripled its losses in the first quarter through April to $20.2 million, mainly because listening hours jumped 92 percent from a year ago to 3.1 billion in the quarter. Royalties amount to a fraction of a penny per song play, and rapid growth has outstripped Pandora's ability to sell ads.

"You can't build a business with these per-track rates," says Pandora co-founder Tim Westergren. He says that an eventual slowdown in growth will allow ad sales to catch up. He's pinned hopes for cutting costs on a government royalty-setting process that starts in 2014.

He says Songza might not survive the rigors of the free music business, like Imeem before it. "People were excited about them for a while. They hit the reality of the business ultimately."

The uneven economics of the online radio business were highlighted by a deal announced two weeks ago between traditional radio station giant Clear Channel and Taylor Swift's record label, Big Machine.

The deal gave Swift and other artists an unprecedented slice of royalties based on traditional radio station airplay. In exchange, they agreed to cap their share of revenue made on Internet-delivered radio songs from Clear Channel's iHeart Radio service. The deal "creates a structure that makes sense," Clear Channel CEO Bob Pittman said in a statement. The existing structure clearly didn't.

Slacker Inc., which launched in 2007, uses its free online radio service as a loss-leader to draw in potential customers. It convinces about 10 to 15 percent of them to pay up to $10 a month to choose songs and artists instead of hearing them more or less at random.

"There's no question it's a difficult business," says Jonathan Sasse, Slacker's senior vice president of marketing. The cost of marketing means the company is losing money, but that won't stop it from advertising to try to get bigger. "We'll continue to do that to invest in the growth of the company."

Songza is hoping that it can make money by learning what people say they're doing at certain moments of the day. Songza's "Music Concierge" service offers up playlists around themes like "unwinding after a long day," `'working out," and "eating dinner." Those lifestyle clues could appeal to advertisers.

CEO Roman didn't specify how Songza will use the information to create a business. "It's the type of thing you can do if you package your product as a lifestyle enhancer," he said.

Songza clearly needs to attract more users. According to comScore Inc., Pandora's website alone racked up 1.2 billion listener hours in May, compared to 2 million for Songza.

"Scale solves a lot of problems," says Tim Komada, founder of the Menlo Park, California-based venture capital firm, Deep Fork Capital, which is an early Songza investor. "Our No. 1 priority now is scale - gaining and retaining users."