Spotify Has the Bad Business Model, Not Pandora

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NEW YORK ( TheStreet) -- Just to be clear, short-term I am a Pandora (P) bear. I explain why in Absolutely Horrible News For Pandora .

Long term, little has changed regarding my conviction.

I do have concern over how the royalty fight in Congress will play out; however, on the issue itself, Pandora is 100% correct. If sanity and fairness prevails, the company will see its content acquisition costs come more in line with cable and Sirius XM (SIRI) satellite radio.

It's time to demystify the royalty situation. Even people who know it inside out, explain it poorly or provide more information than necessary.

I compare Pandora and Spotify to help flesh out my argument that, contrary to popular perception, Pandora does not have the broken business model, Spotify does.

What is Pandora's General Royalty Situation?

Pandora abides by federal copyright law under the compulsory licensing provision. Pandora can play any song -- though it faces some limitations in how it serves music -- but must pay a per-song royalty set by a board.

What is Spotify's General Royalty Situation?

Spotify chooses to negotiate with record labels and artists directly. In other words, it cuts a bunch of separate deals as opposed to using an objective formula.

Both companies lose money -- and lots of it -- primarily because of the amount of money they pay for content acquisition.

Who Has the Better Deal?

It might not seem that way based on the media coverage, but Pandora does. It has a better deal, both from a business perspective and from the consumer/listener's perspective.

Pandora serves music from a much larger catalog than Spotify. Because Pandora licenses music via a standard and universal method, it can play anything. As such, it is able to play music from major artists/labels, but it has access to independent artists and labels. In fact, these relatively "unknown" acts make up the vast majority of Pandora's catalog.

If Pandora negotiated directly with labels and artists like Spotify does, its catalog would shrink exponentially. In fact, it would look a lot like traditional radio with much less variety. That's because it's literally impossible -- time- and cost-prohibitive -- to negotiate with thousands of tiny labels and artists directly. In fact, Pandora would not be able to find most of them to cut deals.

How Is Spotify Like Netflix?

Again, Spotify negotiates deals directly with labels and artists . . . directly with the content owners. That's exactly what Netflix (NFLX) does. The process comes with the same pitfalls in both situations.

It's well documented that Netflix operates at the mercy of content owners. Over the next five years, Netflix counts roughly $5 billion in off-balance sheet obligations for content. It owes roughly $2 billion of that within the next year. And that's just the debt that's off the balance sheet.