Seeking Alpha
Growth, value, special situations, momentum
Profile| Send Message|
( followers)  

In business it is always a big plus to have a great product or service. It makes getting the company to a profitable state much easier. There are times when even great ideas simply do not work because the costs in cash, energy, and time of making the business viable are so extreme that being profitable almost stretches the imagination too far.

For many years, Sirius XM (NASDAQ:SIRI) was in the category of a great idea that was simply way to expensive to be realistically viable in the eyes of many. The product was phenomenal, but launching satellites, garnering OEM partners, and acquiring content were battles that would exact more than a pound of flesh. Even though the prospect of profits seemed remote, there were many who believed in the idea. Over a decade ago I bought shares in satellite radio and have never looked back. I saw the run-up, I saw the retracement, I saw the merger, and I saw the company on the brink of bankruptcy. I was fortunate that I bought into Sirius XM very early (actually, I had shares in Sirius and XM). That said, the road has been far from easy.

The very existence of Sirius XM changed the landscape of audio entertainment. Now that it is a profitable company, it could change the landscape yet again.

Sirius XM's trade secrets are not very secret at all. In fact, I have written about them several times in the past. Sirius XM has been adept at developing a business model that allows the company, and by extension its investors, to prosper. So what actually drives that success? In this series I will cover several business secrets of the Sirius XM model that investors will want to keep an eye on. If nothing else, hopefully some readers will walk away with a bit more insight than they previously had.

Trade Secret No. 1 -- Selective Marketing and Penetration

Sirius XM has been very selective in its approach to marketing and advertising. The company has also been quite selective in where it deploys its product. Satellite radio chipsets cost money. Every chipset Sirius XM buys offers a potential of never offering a return on the investment put into it. There are folks out there who want to see satellite radio in 100% of new cars sold. Sounds like a great idea, but will it make money? The fact of the matter is that, over the course of years, Sirius XM has figured out that it should only be installing satellite radios into about 65% of the cars. The company realizes that satellite radio is not for everyone. Let's assume for a moment that after three or four years at about two-thirds penetration the company decides to bump it up to 70%. Will that mean more profit, or more cost? Let's take a look at that question and apply some assumptions.

Current Penetration Model

One hundred cars will have 65 installations at a cost of $54 each, and 45% will keep the service. We will assume that all of these people stay on for one year.

This means that when all is said and done, the company will get 30 subscribers at a cost of $3,510. If we apply $12 revenue per month to each person (the company average), then these 30 subscribers will generate $4,320. That is a profit of about $790, or a 24% return on investment (ROI) after one year. These are good numbers and a good model.

70% Penetration Model

Now let's assume that the conversion rate drops to 35% when the company moves above the two-thirds mark.

These five additional cars with satellite radio will cost $270 and will generate two additional subscribers. Those two subscribers will deliver $288 over the next year. That represents an ROI of 6.8%. Not as impressive as the other ROI, especially considering that in both models I rounded the subscriber number up.

What we learn from this exercise is that while on its face it may seem like Sirius XM should grow installation rates into new cars, there are very real, time-tested reasons why the company is careful about exactly how many chipsets they invest in. While many investors may not see it, the company is actually being very intelligent and making investors more money by being prudent with installations. Certainly, the company will continue to monitor and explore differing penetration rates, and if the marketplace justifies a change, it will happen.

Marketing

We have all been frustrated at times with Sirius XM's marketing. We want to see the name out there. We want to see branding, and we want to see television ads extolling the virtues of satellite radio. It all sounds great. I am guilty of wanting this myself.

However, what most of us fail to realize is that the biggest chunk of Sirius XM marketing comes from the very fact that it's installed in new cars. When someone buys a new car, they will get satellite radio. The company does not have to spend scads of money to tell a consumer this. They already know because it is on the widow sticker or has been talked about by the salesperson. It is the cheapest marketing in the world. Think about it: If 45 % of those exposed to satellite radio keep the service after buying a new car, how much more would a TV ad really deliver? Yes, the company could do better by having a sales team sent out to dealerships to explain the highlights to the car salespeople, but that may come in time and when appropriate.

Sometimes investors get frustrated with the fact that Pandora (NYSE:P) is everywhere. It is in DVD players, televisions, cable boxes, smartphones, and just about any gadget you can think of. It is actually quite impressive. However, that is an app and not a chipset. Pandora actually enjoys the benefit of a low-cost (or even no cost) entry into these devices. How successful are these "installations"? They are value-added propositions. It creates a better chance of people being exposed to Pandora, but does it really drive the business?

Sirius XM is exploring this world in a measured way. Satellite Radio 2.0 is launching and the Sirius XM streaming service is finding its way. Remember, streaming royalties cost the company more money than satellite streaming. Yes, it can appear to be frustratingly slow, but we need to remember that the company is looking for a good ROI in a very competitive landscape. New types of Sirius XM marketing will be developing over the next year.

In Part 2 of "Trade Secrets Of Sirius XM," we will explore a business model concept that has a huge impact on the company's bottom line.

Source: Trade Secrets Of Sirius XM That Make It A Success - Part 1