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After a difficult and expensive 17-month struggle to gain the Federal Communications Commission’s approval of their July 29 merger, satellite radio companies Sirius and XM — and their hard-charging CEO Mel Karmazin — now must take on even bigger challenges: Integrate the two companies, stanch the flow of red ink and compete against traditional radio as well as Apple’s iPod and other entertainment choices.
The FCC took its time approving the Sirius-XM merger partially because the deal created a monopoly in satellite radio. Sirius and Karmazin argued successfully that the acquisition of XM should be approved because the companies compete in a larger market for audio entertainment that is ruled by the iPod and traditional radio stations. To get approval, Sirius agreed to pay $19.7 million in fines for violating FCC rules for locating signal towers in un-approved areas and making radios that exceeded power limits, cap prices for three years at the current $12.95 per month subscription rate, offer a la carte programming with tiered pricing and create new radios that can receive both Sirius and XM satellite signals.
However, Karmazin may not have that much time to prove the merits of the merger, given J.P. Morgan’s estimate that Sirius XM’s debt of $3.4 billion will have to be partially refinanced in early 2009. Meanwhile, Sirius XM faces competition from the iPod, Internet radio and other emerging music services such as Pandora and Slacker, which are interactive and deliver personalized service online. “Subscription radio models are a great way to go but it may be too late,” says Wharton marketing professor Peter Fader, referring to the steep challenges Sirius XM faces. “They may have one more shot at a Hail Mary pass.”
In many respects, Sirius XM is a paradox, say experts at Wharton. On one hand, Sirius and XM argued that the merger should be approved because the combined company would be a small player in a big audio entertainment market. But the same argument that won FCC approval for Sirius XM also illustrates what a tough battle the company faces.
Gerald Faulhaber, a business and public policy professor at Wharton, says he was surprised that the FCC approved the deal due to its monopoly status. However, Faulhaber also noted that investors aren’t giving Sirius XM much credit for dominating the satellite radio niche. In other words, Wall Street believes that Sirius XM has shaky prospects even though it’s a monopoly. According to Faulhaber, Sirius XM is in a “make or break” moment where it has to deliver on merger synergies, cut costs and attract new customers while keeping current ones. “Sirius XM has proven that it is quite successful at attracting an audience, but it has to be fairly aggressive about cutting costs. Yet it also can’t be ‘Mac the knife.’ By acquiring XM, Sirius will have opportunities for cost savings, but it has to be sensible.”
Experts at Wharton agree that the first mission for the newly constituted Sirius XM will be to integrate the companies as quickly as possible, save money and be creative yet frugal with programming, new content deals and marketing. “[Satellite radio] is a fascinating area,” says Wharton management professor David Hsu. “Sirius XM will have to pick its battles smartly given its limited resources. The problem of this company is adoption — it has 18.5 million subscribers but is still short of break even.”
There are also technical issues, including the fact that Sirius XM can’t integrate its programming and technology right away. Karmazin says the two services — Sirius and XM — will operate separately for years and the company’s satellites aren’t interoperable. Nevertheless, Wharton marketing professor Jagmohan S. Raju suggests that Sirius XM has multiple strengths it can leverage. For instance, it doesn’t have to be tethered to a computer to receive music. “At the end of the day what Sirius XM has is a product that works well in a mobile setting with good content and is relatively easy to use,” explains Raju. “Sirius XM has a lot of live content that the iPod can’t beat.”
Karmazin acknowledges the challenges facing Sirius XM, but is also upbeat on the company’s prospects. On Sirius’s second quarter conference call — the last earnings report as a standalone entity — Karmazin addressed concerns head on, including auto sales, merger synergies and marketing.
First, Karmazin told Wall Street analysts on Aug. 7 that the combined company will realize savings of $400 million, or about 15% of Sirius XM’s $2.5 billion in operating costs, in the first year. “That’s a very reasonable figure for synergy from combining two identical businesses,” said Karmazin on the conference call. “Let’s be specific; we have already started realizing synergies and we expect to realize synergies from each major line item on the income statement — advertising, subscriber acquisition costs, sales and marketing, general and administrative, and research and development.”
He will need all the synergies he can muster. Bloomberg News reported last month that Sirius XM faces more than $1 billion in debt repayments in 2009. Some of that will “be dealt with sooner rather than later, just to get that issue behind us,’ Karmazin told the news service. One Wall Street analyst described Sirius XM as a niche market company operating with a mass market cost structure. Karmazin acknowledged to Bloomberg that he agreed to an “ugly” debt structure in order to close the merger quickly, before traditional radio competitors could mount a counter attack after the FCC’s approval. “I hated it, but we did it,” he said.
Karmazin’s strategy has been to emphasize the Sirius XM growth story — the CEO has noted that the company is second to Comcast in total subscribers and has a large “footprint” in which it can reach new customers. “The long-term growth potential for satellite radio remains very strong, with over 200 million cars on the road, over 100 million households, and a large market opportunity for wearable products,” says Karmazin. He also noted that 90 percent of homes pay for television service, but less than 20% of households pay for satellite radio. “Even though there is a lot of competition for audio entertainment, satellite radio is still one of the most important,” says Karmazin.
His confidence comes from his long history as a consummate salesman — he started selling radio ads in New York City at age 17, then worked his way up through the ranks after graduating from Pace University. “Mel is the singular best salesman I have ever met in my life,” Joel Hollander, the chief executive of CBS Radio, told The New York Times in a 2007 interview. “He’s very aggressive, to say the least.”
Yet Wharton marketing professor Eric Bradlow says that the market for satellite radio may not be as large as Karmazin hopes. Bradlow argues that the company is still too dependent on automobile sales for subscribers in an economy where consumers are buying fewer cars and cutting back on discretionary spending. And the competition for audio entertainment is fierce.
“I believe that Sirius XM can compete [because] there will be demand for satellite radio programming. However, the market will be smaller than initially forecast due to the changing way people receive communications through phones, personal digital assistants (PDAs) and laptops,” says Bradlow. “The key for Sirius XM will be to find its target segment.”
Fader agrees that the company needs a marketing makeover. Although Karmazin says the company plans to make it clear what the company is about in retail outlets, Fader doubts Sirius XM will dramatically change its pitch. Fader advocates a potential name change and a marketing message that defines Sirius XM as a music service, plus an interactive content and entertainment provider. He says Sirius XM should also distance itself from being so closely affiliated with automakers.
“Sirius XM is too dependent on the car. The company is implicitly telling people that this is the only place you can use it. The company should explicitly disassociate itself from its car strategy. Come up with a proposition that can compete with the iPod,” says Fader. “I’m calling for a marketing makeover. Dump both names (Sirius XM) because both are tightly linked to satellite radio. The company should be saying, ‘Here’s a music and entertainment service that’s available on every platform every place. And it’s commercial free.'”
Some doubt that Sirius XM would make such a radical move. Faulhaber says the company has to be careful not to alienate existing customers and its first goal needs to be delivering cost savings.
Karmazin also has argued that distributing Sirius XM via car sales is still a growth engine. On the conference call, Karmazin took a hypothetical situation where only 12 million cars were sold in North America — a figure that was “the lowest number that we’ve seen anybody forecast.” Assuming that Sirius XM was installed in half of those cars — six million — and only half of those were converted to paying subscribers, the company would garner about $350 million in new revenue.
As for Fader’s marketing makeover idea, Karmazin says that Sirius XM hasn’t formalized its marketing strategy and has instead been focused on determining what content would be in a “best-of” Sirius XM package. For instance, XM subscribers could get access to Howard Stern from Sirius and the two services could swap sports packages (XM has Major League Baseball and Sirius has the National Football League). This best of both services package would be $16.95 a month.
Karmazin’s big marketing goal currently is to clarify the marketing message. “We want to make sure that when somebody goes into Best Buy or Circuit City that they are not going to be confused at all,” he said.
Hsu adds that Sirius XM should also consider more sales channels for its service. Today Sirius XM is delivered through retail sales at chains like Best Buy and as a feature in some new cars. Sirius XM could also deliver service on airplanes for a small fee on a cross country flight, pipe music into corporate settings, become integrated with other device makers such as Apple and Samsung and cut deals with wireless service providers like Verizon and AT&T. “Sirius XM’s message should be ‘let me give you product that minimizes hassle, doesn’t have ads and doesn’t need to synch with a computer,” says Hsu.
Reinventing Sirius XM
Wharton experts agree that Sirius XM may have to be reinvented to effectively compete with the iPod and other music services, but they note that there’s a market to be addressed. For instance, Fader says that the iPod lacks the surprise factor that radio can provide. Meanwhile, Internet radio services offer interactive features, but for the most part aren’t portable. One exception is Slacker. Sirius XM, which can be always connected via satellite or Wi-Fi, could offer interactive services, the serendipity of discovering new music and new user interfaces. If Sirius XM can make its service more interactive — artist information, customized playlists and recommendations based on other songs a consumer listened to — the company could be a major player, says Fader.
“I do believe a middle ground (between the iPod and radio) exists. A device could store MP3s, get updates with new songs by satellite and Wi-Fi for listening when you’re not connected,” suggests Fader. “No one cares about the technology behind the service. It’s all about the consumer experience.” To enhance that experience, Sirius XM announced in August that it hired sports talk personality Chris “Mad Dog” Russo, the former star of the Mike and the Mad Dog show, to a five-year contract. Russo will oversee a sports talk channel that will run on Sirius and XM.
Indeed, questions will remain even after Sirius digests XM. Should Sirius XM continue to be involved with portable devices? Should it enter the video market? Could Sirius detach itself from the high costs of operating a satellite network and deliver its music via the web? Will satellite radio as a technology become irrelevant? Should it deliver its services on phones like Apple’s iPhone and cut deals with wireless carriers?
“Sirius XM will have to open up innovation on hardware side,” says Hsu, noting that satellite radio would benefit from offering a must-have device like the iPod to go with it. “Sirius XM will have to address convergence and different types of media going forward.”
Wharton experts agree that Sirius XM’s future should be focused on being a content company. They have differing views about whether the company needs to focus on hardware to deliver its service. Hsu says a Sirius XM-specific device is important to broader adoption. Fader says that in the long term it makes little sense for Sirius XM to have satellite radio-specific devices, but in the short run a hit consumer gadget could spur demand. Bradlow argues that satellite radio needs to be built into other devices and Sirius XM doesn’t have a future selling music players. “I don’t think satellite radio as a portable device has much of a future,” says Bradlow. “If satellite radio could be built into the iPod it would be beneficial. People don’t want to carry another device.”
In a research note Aug. 14, Citi analyst Tony Wible speculated that a Sirius-Apple collaboration may not be that far off. Wible wrote that Sirius XM’s future is as a content provider and that satellite radio and the iPod can coexist. “Reports of a new Internet streaming application that would allow Sirius XM users to get content on their iPhones and other portable devices are now emerging and highlight that (the company’s) value lies in its content and not its hardware or infrastructure,” says Wible, adding that a Sirius XM collaboration with Apple could allow the satellite radio company to cut costs while adding subscribers. For its part, Sirius XM could generate demand for music sales on Apple’s iTunes.
While such a move is far from a sure bet, it would make one of Faulhaber’s recommendations a reality. Faulhaber suggests that Sirius XM back away from creating its own portable device and “outsource development to [Apple CEO] Steve Jobs.”
Raju says that ideally, satellite radio will ultimately become just another channel on an integrated multimedia device. “XM was originally going to be just another band like AM and FM, and that still makes sense,” says Raju. “What’s needed is a seamless device that can cover everything. That way, Sirius and XM can simply rely on subscription revenue.”
Before then, however, Sirius XM will have its hands full squeezing inefficiencies out of its business.