By Stephen Blum

Satellite radio is about to turn a critical corner in the United States. Estimates of the size of the early adopter, technophile market range between 300,000 to 600,000. Right now, Sirius Satellite Radio [Nasdaq: SIRI] and XM Satellite Radio [Nasdaq: XMSR] combine for just about 600,000 subscribers.

If satellite radio is just another technophile phenomenon, the sector’s growth should be peaking. But if the subscriber numbers keep climbing briskly throughout June, it would be clear that this newest satellite service has caught on with the consumer marketplace.

In the second quarter last year, XM added 61,000 subscribers. If XM and Sirius together cannot grow at least that much in the second quarter of this year, then it would be fair to conclude that satellite radio will join laser disks, quadraphonic records and 3-D movies in the aficionados-only section of the entertainment industry bazaar.

On the other hand, quarterly growth of 100,000 or more subscribers would demonstrate both year-over-year acceleration and mass market appeal. It also would position satellite radio for the critical September through December holiday selling season that will determine whether both companies meet their year-end subscriber targets.

XM expects to amass 1 million subscribers by the end of 2003, while Sirius projects 300,000. That total of 1.3-million subscribers would show that there is sufficient market demand for the companies to keep growing.

However, the 1.3-million subscriber mark falls short of previous Tellus Venture Associates’ projections that pegged the year-end 2003 subscriber base at 2.6 million. The biggest single factor in the slower than expected growth has been the comparatively glacial pace of automobile manufacturers in integrating satellite radio into their product lines.

Automobile Power

Car manufacturers are gradually coming to embrace satellite radio and should eventually drive significant growth. General Motors [NYSE: GM], a major investor in XM, is rolling out the radios as an original equipment option in dozens of models this fall. GM thus far has accounted for about 20 percent of XM’s subscribers. Chrysler is offering Sirius equipment for about $300 per installation, and Ford [NYSE: F] has committed to expand Sirius’ presence in its vehicle product line.

However, satellite radio is an option that must be requested on many cars. As a result, satellite radio will not gain traction in the factory-installed market until the 2005 model year, at the earliest. Until then, auto manufacturers aren’t expected to be able to install significant numbers of integrated radios that will have receivers built into the dashboard unit, along with AM, FM and CD players. Right now, satellite radio receivers are either a black box hidden somewhere in the car or a plug and play module. Typically, it takes three to four years for automobile manufacturers to fully embrace a new technology. Satellite radio is following that schedule.

Retail Inroads

So far, satellite radio’s growth has come primarily in the aftermarket by relying on sales from large consumer electronics chain stores and smaller mobile electronics specialty shops. Both kinds of retailers have been experiencing steadily rising sales. That trend is threatened, however, by weakening price points on the equipment.

A key mobile electronics manufacturing executive is projecting that XM and Sirius are moving toward the same subscriber acquisition model that direct broadcast satellite (DBS) and mobile phone companies adopted. Although emphasizing subscriber acquisition over hardware sales helps meet market penetration goals, it does not energize specialty audio retailers. Bigger consumer electronics stores, such as Best Buy [NYSE: BBY] or Circuit City Stores [NYSE: CC], might be able to adapt to a higher volume/lower margin environment. But if they can’t, then satellite radio companies might eventually have to open their own retail stores, just as mobile phone companies have done.

Broadening Focus

Both Sirius and XM emphasized mobility when they first launched their services. However, their focus is broadening in 2003. XM hopes to cash in on the growing frustration of data network administrators with Internet delivered streaming audio by introducing a receiver that plugs into a computer. Sirius is looking at ancillary markets, such as streaming data and health clubs. Receivers designed to be used in homes and offices also are in the pipeline, and generally should be available widely by this fall.

Looking ahead, 2004 should be the year that XM and Sirius finally put it all together. Car builders will have accepted satellite radio’s potential, and car dealers will have figured out how to sell it. Home and office use will take off with the availability of dedicated indoor units and continuing subscription price breaks for second and third units in the same household. If the two companies can hold the line in the mobile electronics aftermarket and retain mass consumer electronics distribution channels, a total market of three million subscribers becomes a real possibility.

Kozlowski’s Countdown

One reason for optimism is a market milestone identified by Stan Kozlowski, Sirius’ senior vice president of retail distribution. Kozlowski, who formerly headed sales at Thomson Consumer Electronics where he was the top field commander in the successful campaign to launch DBS in 1994 and 1995, pointed out that 1 million units is a significant milestone in the life cycle of a new product. By that point, most people know someone who has one and come to accept it as mainstream. Turning that corner will lead satellite radio out of the technophile and niche market side streets and onto the mass-market freeway.

Stephen Blum heads Tellus Venture Associates, a satellite broadcasting consulting firm in Marina, Calif. He can be reached by e-mail, [email protected], or by phone, 831/582-0700.