Pandora rises out of the streaming music rubble

NEW YORK (CNNMoney.com) -- In an online world saturated by struggling streaming music services, Internet radio site Pandora appears to be making all the right moves.

Last year, the 10-year old company recorded its first profitable quarter, doubled its subscription base to more than 40 million users and took in $50 million of revenue. The company also announced several new partnerships that allow users to take Pandora with them in the car and on the TV.

Pandora certainly seems to have found its sweet spot, making it a standout among other streaming services that have not been able to make it on their own. Social music site iMeem was scooped up by MySpace in December for just $1 million, and Apple (AAPL, Fortune 500) bought cloud-based music service Lala for not much more. Analysts say even mighty MySpace Music may be unable to sustain itself for much longer.

The company attributed its ability to rise through the rubble to its substantial user growth over the past year. With a rapidly increasing number of subscribers, Pandora has been able to attract better advertisers and demand higher ad prices.

But growth is a double-edged sword. As more users listen to Pandora, the company has found itself doling out more in royalties. Company founder Tim Westergren said Pandora has finally managed to strike just the right balance.

"We've been able to grow our audience to attract advertisers and do so without going bankrupt," Westergren told CNNMoney.com. "We've gone out of business many times, so it definitely wasn't a smooth path, but we're starting to realize the benefits of scale."

Pandora had been hindered by the high royalty fees it has to pay artists to stream their songs, but the company finally succeeded last summer in its long fight to lower those fees. After two years of back and forth, Pandora finalized a deal with SoundExchange, the organization that collects royalties on behalf of the artists and recording industry.

Westergren said the royalty fees had been an "albatross," since the company's costs literally rise every hour as the site gains popularity. Of the $50 million that Pandora took home in sales last year, $30 million was spent on royalty payments.

"Pandora now has a sustainable business model," said Sonal Gandhi, music media analyst at Forrester Research. "It was quite a struggle at the beginning when royalties were very high and when they were reluctant to place ads on their site. They realized they had to do more to make money, and now they're getting the hang of it."

The site has also benefited from a loyal user base. Despite more ads appearing on the site and audio ads occasionally playing between songs, Forrester Research has found that Pandora customers have not left for other sites.

"[Pandora] figured out how to balance the two," said Gandhi. "They're making a profit without diluting their product."

Although competing Internet radio sites like Slacker are performing well, on-demand services are struggling. Royalty fees for sites that let you play a particular song are much higher than for Internet radio companies like Pandora that don't give you as much control over your playlist.

MySpace Music is the only remaining on-demand streaming Web site of note. It has a huge audience, so it is able to work with big advertising agencies, but Forrester Research says the company is still having trouble making money.

The streaming on-demand business model for the recording industry is equally dubious, since the industry largely believes that those services are reducing music sales. Warner Music (WMG) last week announced that it would stop licensing its music for on-demand Web sites. Warner Music CEO Edgar Bronfman Jr. told the BBC that streaming on demand was "clearly not net positive for the industry."

But the recording industry has grown to embrace sites like Pandora.

"The silver lining of our battle over royalties is that [the music industry] came to know our business, and they're getting to understand that we're good for them," Westergren said. "Like terrestrial radio, we're fundamentally a promotional device for music ... but we're an enormous, targeted promotional machine."

Westergren also pointed out that the music industry has used terrestrial radio as an advertising platform for decades, and those radio stations don't even have to pay royalty fees.

Whether the recording industry likes it or not, Pandora is growing and becoming increasingly mobile. After it essentially laid waste to on-demand streaming services, the company is placing itself in a space where it will increasingly compete with terrestrial and satellite radio.

The company has unveiled partnerships that put its service on Samsung Blu-Ray devices, a dozen table-top radios, Roku TV players and several home theater systems. It even recently announced a partnership with Ford (F, Fortune 500) to put Pandora in new vehicles through the automaker's new bluetooth stereo system.

Pandora's most successful mobile endeavor has been its iPhone application: The company is adding 35,000 iPhone subscribers every day. On Christmas Day last year, Pandora said it added 250,000 new mobile subscribers, which Westergren said was probably due to a large number of people receiving iPhones as gifts.

"The iPhone app triggered all of this, since it represented an enormous shift to our strategy," said Westergren. "Now we want to be everywhere you can listen to terrestrial radio. Access is our holy grail."