Change has come to Pandora.com, the popular free music site that lets
listeners craft radio stations to fit their tastes.

The site added 15-second
commercial breaks to its streaming music service Tuesday as it continues to experiment with new ways to generate revenue.

But its founder promised the site will never carry as many audio ads as broadcast radio, despite the fact it pays substantially higher royalty fees to the recording industry.

“The fears people have about it overtaking the listening
experience are unfounded,” said Pandora founder and CEO Tim Westergren in a phone interview Tuesday. “It’s going to be a fraction of what you hear on broadcast radio.”

The changes effect both the 21 million users of its Web site and the 3 million people who use its iPhone application, which was the most-downloaded app of 2008, Westergren said.

Pandora blogged about a similiar experiment on its Web site in January 2007.

In Pandora’s latest ad experiment, a brief plug for the Fox TV show “Lie To Me” interrupted the music stream
of some listeners for 15 seconds after ten songs had initially played – the same commercial interupted again about 20 songs later.

“We’re trying different things out right now,” Westergren said “It’s certainly going to be part of our future.”

On average, people will hear a 15-second commercial about every two hours, Westergren said, adding that it is a targeted ad campaign and not everyone is hearing the commercials.

Fox Broadcasting is the only advertiser in the current campaign, which also features a plug for American Idol, Westergren said.

These changes were not unexpected, as online music
providers face royalty fees substantially higher than other music providers
such as satellite and broadcast radio.

In fact, rate hikes nearly sank Pandora and other online music services two years ago. Under the gradually increasing rates set forth by the
Copyright Royalty Board in March 2007, Pandora.com would not be able to operate
profitably, and would have to fold, said its founder Tim Westergren at the time.

Broadcast radio only pays publishing fees, and not the much higher performance fees that online services also have to pay.

For instance, The Krush radio station in Sonoma County, Calif.
paid about $5,000 in publishing fees in 2007 to the recording industry to reach about
30,000 listeners a week on its FM signal. But under the federally mandated CRB
ruling, it was required to pay more than double that — about $11,000 a year –
to stream its radio broadcast online to just 100 listeners a day. And that was just
for 2007. The royalty fees were set to increase through 2010, when The Krush was required to pay about $20,000 a year. And if the number of people listening
online doubled, then so would its fees.

Since then, the recording industry has agreed to hold off on
immediate implementation of the CRB rates, which online broadcasters credit with their continued existence.

Westergren said Tuesday that the two sides would announce an agreement on lower rates soon.

“We’re just wrapping it up now. It’s already kind of gone through the hairy part,” Westergren said.

An exact announcement date, or details about the new royalty rates, could not be provided Tuesday because the deal still needed be finalized, Westergren said.

“There has to be a move towards parity. (The recording industry) can’t go on with this absurd inequity,” he said.

The new rates are expected to be significantly more favorable, and that is vital to Pandora establishing a sustainable business
model, Westergren said.

Most of Pandora’s $25 million in revenue in 2008 resulted from display ads, and Westergren said he was not sure how big a slice audio ads will play in future revenue. Pandora users can pay $36 a year to get the service without advertising.

It remains to be seen how listeners will react. Some might
gravitate away from Pandora and listen to other options that don’t have
interruptions, such as iTunes or a friend’s music stream.

One listener used Twitter to voice displeasure on Tuesday, “Even though I understand and I knew it was inevitable… booooo
for hearing my first Pandora
advertisement.“

Another said, “Pandora just threw a radio ad at me,
and that’s the end of that. I will never use Pandora again. Sorry, but that’s why I don’t do radio.“

Still, other listeners are likely to take the changes in
stride considering broadcast radio stations, which have substantially lower
royalty fees, also inject commercials. Plus, the popular online video site
Hulu.com is rapidly attracting users despite commercial breaks inserted into the TV
shows and movies its streams.

“Like any business we have costs, and we have to figure out a way to make it work,” Westergren said.