If you have been following Sirius XM (SIRI) for any length of time you have been witness to a roller coaster ride that many investors will not soon forget. The satellite radio provider has offered a compelling service for years, and is finally coming into its own with a business model that is proving itself out. While Sirius XM does not tout some of the aspects that have generated success, a little bit of digging can unearth some serious gems as to why this company can continue to prosper.
In Part One of this series, Trade Secrets Of Sirius XM That Make It A Success - Part 1, I noted the marketing and penetration of this company and why the company has focused on smart growth rather than growth for the sake of it.
In Trade Secrets Of Sirius XM That Make It A Success - Part 2, I noted how the implementation of a Music Royalty Fee has helped the bottom line, Earnings, Ebitda growth, and free cash flow growth.
If you have not yet had a chance to read those pieces I suggest doing so prior to continuing on.
The third trade secret of Sirius XM that makes it a success is the subscription model, the pricing of that model, and value added services. Yes, it is not a big trade secret, but some of the nuances of the Sirius XM model are only now being realized by investors and competitors.
First, There are serious challenges to any subscription based business. The moment you ask a consumer to pay for something the bar is raised on consumer expectations. You need to be able to offer a compelling product that has perceived value. If consumers do not see value, they become less likely to keep a service. Sirius XM's subscription model was not an instant success. It took a long time to get it to the point of compelling profits. Now that the company has reached that stage, the road to similar success for other companies is a bit harder. There is only one Howard Stern, for example, and Sirius XM was fortunate enough to lock up his services.
When 2012 rolled in, it came with a much publicized price increase for Sirius XM. It was the first time that the company was able to raise prices, which were frozen as a merger condition and then remained frozen for several additional months as part of a settlement of a lawsuit.
Many investors saw the $1.54 base price increase as a great potential for the stock and did a simple multiplication process of taking some 22 million subscribers and multiplying them by a $1.54 for each month. Many projected added revenues upward of an additional $300 to $400 as a result. There are many errors with this assumption, but Sirius XM knew something compelling that many investors did not consider.
You see, the price increase was also a price decrease. That is correct. Many Sirius XM subscribers actually pay less in 2012 than they did in 2011. What Sirius XM has done was reward the passionate long term subscribers with lower prices, while raising the cost of the base service. While a basic subscriber did feel the impact of a price increase, a premium subscriber actually got a discount. The effect was an ability to raise average revenue, but not to the full extent of $1.54 per month.
Prior to the new pricing, A base subscription was $12.95 per month. If you wanted Internet it was an additional $3.50, and the "Best Of" or "premium" tier was another $4.00. Essentially, absent the music royalty fee, a premium subscriber was paying about $20.45 per month. It is estimated that about 15% of the self pay subscribers were in this category.
What Sirius XM did was create what they call an "All Access Package" This package gives you the premium programming tier as well as Sirius XM Internet Radio for $16.58 per month (excluding music royalty fee). Yes, the company is giving up some revenue, but they also gain loyalty and longevity from those that are the most passionate fans.
In effect, the most reasonable and logical package Sirius XM has on the market is the one that comes in at a sweet spot of about $16.50 per month. Consumers paying a base price of $14.49 look at the value added with additional programming, and availability in a mobile environment via the Internet side of the business and are more willing to upgrade, while those that may have been begrudgingly paying over $20 per month get some reward in lower pricing.
Essentially Sirius XM is finding that magical zone that allows them to capitalize on as much as they can in a competitive audio entertainment market. This will improve as the company makes its Internet radio offering more compelling. Sirius XM currently has an average revenue of about $12 per month per subscriber. The company has disclosed in the past that about 25% of the subscriber pool is in a discounted family plan, which lowers the average, but on the flip side, they are becoming very effective with getting more and more consumers to a price point that is higher than current pricing, but does not break the bank.
We can expect average revenue to go to between $12.20 and $12.40. This is about $0.80 to $0.90 per more than the company was getting under the original pricing. This is real revenue and a good amount can hit the bottom line.
Sirius XM is also quite adept at keeping subscribers on board via retention discounting. This does carry a negative impact on average revenue, but it does help the revenue overall, which translates to better earnings, better EBITDA, and better cash flow. The secret is that they make the discount process cumbersome enough that many will not take the time to deal with the issue, and would rather simply pay a few extra bucks for the ease in re-signing.
Subscription vs. Free
With a subscription model Sirius XM is able to generate substantial amounts of revenue from the consumer rather than relying on the highly competitive world of advertising in a model like that of Pandora (P). In addition, the subscription model allows Sirius XM an easy path to collect that music royalty fee. If you can sell someone on the concept of paying $14.49 per month for radio, they are not likely to balk at the $1.48 fee that gets tacked on to help offset royalties.
Pandora's free model (they do have a subscription tier, but it is not really marketed well) presents a much bigger challenge in getting money out of consumers. While collecting a music royalty fee from some 56 million listeners would be very helpful to the Pandora model, it is cumbersome because it is difficult to get someone to take a step to paying when they do not already have their proverbial wallet out. Pandora is in a precarious position with regard to this.
Spotify on the other hand was successful in figuring out a way to get people to subscribe. If you want Spotify on a mobile device, you have to pay $10 per month. It is that simple. Millions pay Spotify and millions pay Sirius XM for subscriptions. In my opinion, Spotify would have a much easier path to adding a music royalty fee than would Pandora. Whether Spotify takes this path is unknown at this time.
Slacker has also figured out the secret to subscriptions. A subscription level with that service adds premium content, customization, on-demand music and sports, talk, etc and the ability to listen to any song you want at any time. Sirius XM is just getting into the realm of On-Demand and that value added proposition makes subscribers more sticky. Slacker, would have an easier path vs. Pandora to adding a fee as well. On the technology front Slacker is ahead of Sirius XM. On the content front Sirius XM leads. On the true on demand for music, Slacker carries the advantage. The issue for Slacker: It has not gained the mass appeal that Sirius XM has.
The subscription model, with value added consumer benefits tied to that subscription, gives Sirius XM several business advantages that simply do not exist in the free model. Slacker and Spotify figured this out, and have moved into this territory. Pandora will have a harder hill to climb.
The subscription model allows Sirius XM to keep compelling and unique content because the company is able to generate the cash needed to acquire it. The free model can work, but it is not an easy path.
Sirius XM Avoids Free - Adds Value
This section will draw some ire from many, but that is what the comment section is for. In many ways, the idea of Sirius XM lighting up all radios and offering a limited free service that is ad supported seems compelling. After all, the company invested money into radios that are not subscribing and thus not generating revenue.
Sirius XM is actually being smart in its decision to avoid free. At least at this point. Here is why:
- Ad sales do not generate what they used to. There are only so many ad dollars that companies will spend, and the inventory is massive. This means that the dollars that a company can command for ad space are severely impacted.
- Sirius XM already has ads on all talk and sports channels and has been unable to generate substantial revenue from them and even has difficulty in filling that ad space with quality advertising. Trying to sell more would dilute an already diluted pool even further.
- People unwilling to pay for a subscription are probably not the best consumers anyway and are likely satisfied with the local content already offered.
The Sirius XM strategy is to add value. The company is making the value of a subscription higher by adding content, and adding capability that allows the consumer to customize content via on-demand. Sirius XM is accomplishing this through Sirius XM Internet radio delivered over IP rather than satellite. As the company makes its IP product more capable and robust, consumers get added value. Yes, IP delivery has higher royalties, but sometimes a company needs a "loss leader" to remain compelling, current, and at the helm.
There are some 50 million cars on the road that have satellite radio. There are almost 100 million smartphones. The connected dashboard is getting closer than many imagine. Today a consumer can easily connect a smartphone to a car via an AUX input. Within a 5 years the truly connected car will be nearly 30 million cars on the road with seamless connectivity. Sirius XM will have about 100 million satellite equipped cars on the road at that point. The company sees this and sees the reason why it needs a compelling IP product that delivers capabilities satellite delivery can not.
If Sirius XM can maintain high penetration in satellite equipped cars and add value from an IP standpoint, it can be an effective competitor within the space even with the car dashboard being as capable as it will be. Sirius XM is aligned with the auto sector, and may well align with a cell company in the future to maintain its position in the market. The key is that the subscription model allows Sirius XM the revenue stream to play in the game.
Disclosure: I am long SIRI.