NOVEMBER 2006 :: SCIENCE & TECHNOLOGY

Is Satellite Radio a Fad?
High Cost of Chasing Subscribers and Talent Puts XM and Sirius in Trouble

By Sarah McBride
Staff Reporter of The Wall Street Journal

Last year, Nicky Baumohl bought a new Audi A4 featuring an XM Satellite radio with a free, trial subscription. But Ms. Baumohl's salesman never activated the service. So Ms. Baumohl instead listens to CDs, regular radio and her iPod as she drives around San Francisco.

The customer who got away-especially after so many inducements-is one reason why satellite radio is encountering unexpected trouble after just a couple of years of being a hot consumer item.

The problems are varied, underscoring the fast-changing nature of the consumer-electronics business. In addition to not activating pre-installed car radios, or those given as gifts, customers who actually sign up don't always stick with the service. Many people are simply having iPod adapters installed in their cars and skipping satellite altogether. In addition, bidding wars have driven up the cost of on-air talent far beyond expectations.

Coming of Age

When morning talk-show host Howard Stern moved from regular radio to satellite earlier this year, it was supposed to be a coming of age for satellite radio. Instead, the industry's two rivals, XM Satellite Radio and Sirius Satellite Radio are still reporting heavy losses. Last year, XM lost $667 million, and Sirius lost $863 million. And Sirius is facing a potential exodus of subscribers as a clutch of promotional one-year trials soon comes to an end.

XM and Sirius are taking markedly different approaches to overcoming their problems. XM is aggressively cutting spending on advertising and rebates. The company has twice lowered its subscriber targets, though it still leads Sirius by about two million customers.

Sirius, while actively cutting costs, is working hard to stimulate subscriber growth. It introduced a $100 summer rebate on one radio model and also is offering longer free-trial periods through some car partners. Sirius CEO Mel Karmazin notes that Sirius has cut XM's lead.

Hugh Panero, CEO of XM, says his company is "well-positioned to navigate through each of our near-term challenges with the same determination and focus that have enabled us to attract more than seven million subscribers."

When both companies were getting going, they seemed to be mastering their biggest challenges: lining up financing, firing satellites into the sky and attracting talent. In addition, from the beginning, both knew that getting satellite radios into cars would be a key part of their strategies, and each worked hard to set up exclusive deals with auto makers. XM landed the biggest U.S. auto maker, General Motors, in 1999. Sirius followed with Ford Motor and DaimlerChrysler.

XM won an early advantage when GM started hardwiring XM radios into more than two dozen 2003 models. By 2006, XM was in about 35% of the four million or so U.S. passenger cars sold by GM. But XM soon learned that installing radios in the dash isn't enough. GM dealers tried to sell XM subscriptions to car buyers, but few customers bit. Starting with 2003 models, GM launched a free three-month trial, and about 55% of those customers sign up for a paid subscription when the trial runs out. The free-trial model would later be widely adopted by other car makers.

To battle drivers' apathy, the radio companies started pushing free trials on consumers. DaimlerChrysler started activating radios at the factory, rather than requiring new-car buyers to call an 800-number for activation. GM and other car makers use the same technique.

A wave of the one-year trials will begin ending soon, providing some indication of how many real subscribers will emerge from the car programs. So far, well over half of Sirius's 1.4 million car-based subscribers don't pay directly for their service, according to James Dix, an analyst at Deutsche Bank. Sirius has 4.7 million subscribers in total.

Many analysts say that "churn," the percentage of subscribers who don't renew, could rise significantly at Sirius in coming months as the trials begin to expire. Until now, churn at Sirius has held steady around 1.8% monthly for the past couple of quarters. At XM, which measures that figure differently, it has hovered around the same level. Analysts expect churn to increase at both companies as their customer bases widen beyond the early adopters of new technology, who are more likely to renew.

Selling radios through retail outlets has been equally tough. Last holiday season, each company added record numbers of subscribers, but the growth was costly. Shoppers at big superstores could pick up satellite radios for $30 to $50 after rebates-well below cost. Sirius and XM absorbed the loss, leading to giant fourth-quarter losses.

"Think of how many radios might have been given as Christmas gifts that were never turned on," says Joe Damato, director of aftermarket consumer electronics at auto-parts maker Delphi, which works with both companies. Indeed, analysts estimate that about 10% of store-bought radios weren't activated, creating two big costs on each sale for XM and Sirius: subsidizing the radio and losing a subscription. Prices are back up to at least $40, improving the odds that the buyer will be committed enough to buy a subscription.

Costly Growth

On the content side of the business, satellite companies are beginning to feel the cost of acquiring on-air talent and programming. When Sirius found itself far behind XM in subscribers at the end of 2003, the company hired Hollywood executive Scott Greenstein to help glitz things up. In quick succession, he delivered deals with Eminem, the National Football League, and most importantly, Mr. Stern.

That helped Sirius narrow XM's lead, but at a high price. The NFL cost $220 million for seven years and Mr. Stern cost $500 million over five years. The deals set off a bidding war with XM that drove up everyone's expenses. XM ended up paying $650 million for 11 years of Major League Baseball. And to counter the wave of free publicity that accompanied Mr. Stern's move to Sirius, XM nearly doubled its ad and marketing spending in 2005, to $163.3 million. A crucial test for Sirius will come early next year, when many of the more than one million subscribers who bought the service because of Mr. Stern will have to decide whether to renew.