Pandora's Moat Not Nearly as Strong as Analysts Believe
Margie is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
After Apple (NASDAQ: AAPL) announced iTunes Radio last week, I watched a panel of experts on Bloomberg discuss its effect on Pandora (NYSE: P), as Pandora's stock was actually up following the announcement. When asked whether Pandora would be negatively impacted by Apple's move, an analyst equated Apple going after Pandora's market to the following, "It reminds me of Yahoo and Amazon going after eBay (NASDAQ: EBAY) on the auction side, they lost that war, Pandora has first mover advantage, if Apple is going to be successful, they're going to have to do something different."
This is a fundamentally incomplete analogy that would give Pandora shareholders a false sense of security if they were to take the analyst at his word.
"Economic moat" is of course a term coined by Berkshire Hathaway's Warren Buffett, and is one his primary qualitative criteria he evaluates before he invests in any company. A moat essentially is a strong, hard to duplicate/overcome competitive advantage. There is a huge difference in the value of eBay's moat and, similarly, Facebook's (NASDAQ: FB) versus that of Pandora.
Facebook and eBay
What generates the strength of Facebook's or eBay's moat? Not just their already installed base (developed in part from first mover advantage), but the fact that their users are so intertwined with one another. One user begets another for both companies.
Google Plus might be a superior platform in many ways to Facebook, but that's like having a beautiful night club with no one in it, versus your local bar where all your friends are. You can go to the marble walled nightclub, yell for hours, and maybe hear a faint echo back, or stay on your favorite worn out bar stool and joke around with all your friends, having a good time. We can't leave Facebook for long like we can't leave the Earth's surface when we jump--gravity pulls us back. Simply put, we Facebook because all our friends Facebook.
Similarly, Yahoo was unsuccessful in taking on eBay's auction business (even with Yahoo charging no fees and generating its revenues from advertising.) Why? Because eBay had built a user base that was interacting continually and was thus interdependent. Put your stuff on Yahoo Auctions, and you wouldn't find as many bidders; go to Yahoo Auctions, and you don't find what you want. It was a catch 22, and thus even with superior pricing, Yahoo couldn't penetrate eBay's moat and has since shut down its auction site in the US and most countries.
Pandora vs. Apple
Pandora is a great service which I really enjoy using, but Pandora's moat does not have the intertwined base of users/gravity of a Facebook or eBay. Yes, Pandora has a large installed user base which it did gain from first mover advantage, but unlike Google Plus, if iTunes Radio is a better service somehow, there is nothing to keep me from moving over.
I'm not saying Pandora doesn't have a competitive advantage: it does after all use the Music Genome Project (MGP), and every time we skip, like, or dislike a song, it adds to the knowledge of Pandora's highly developed algorithm to help better predict what songs we'll want to listen to in the future. Yes, it is absolutely superior to terrestrial radio, because it matches our tastes exactly, and it's why I listen to Pandora in the car. But to say that first mover advantage alone will act as a strong moat against Apple's incursion is false, as social interaction/intertwinement is not nearly at a high enough level to keep users loyal.
Part of Apple's moat includes its near obsessive fan base who believe (maps excepted) that nobody does it better than Apple. The company has a limited supply of products, because it puts so much effort into making each one perfect. This halo effect will undoubtedly draw many Pandora users over to Apple, and Pandora's stock not even wincing at Apple's actual entry into their market (though it may have been priced already to a degree) I believe is a mistake. Pandora's moat is not as strong as certain Bloomberg analysts will have you believe. It's my belief that iTunes Radio will garner far more of Pandora's market share than people currently believe.
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For more info on this please read my Foolish collegue Sal Mattera's column about the subject.
Margie Nemcick-Cruz owns shares of Apple and Facebook. The Motley Fool recommends Apple, eBay, and Facebook. The Motley Fool owns shares of Apple, eBay, and Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!