AM and FM radio owners had best start looking over their shoulders. The U.S.-dominated satellite radio industry has topped 2 million subscribers since Washington-based XM Satellite Radio’s [XMSR] “soft” rollout in two markets during September 2001.

Traditional radio stations have begun to mimic the behavior of the cable industry 10 years ago. Back then, cable TV operators almost completely missed the competitive signals from direct broadcast satellite (DBS) for at least the first couple of years. Now, satellite radio is offering superior quality digital signals nationwide, as well as vastly superior channel line-ups without ads. Meanwhile, AM and FM owners and operators across the United States are becoming similar to the owned and operated broadband TV stations that became less relevant in the face of new competition from satellite TV service providers. Yet satellite radio, too, must begin looking backwards at its potential rivals, as it grows not only to build its base, but also to maintain its lead in the global audio and radio businesses.

Radio’s Competition

Competitive dynamics are an important indicator of the prospects for satellite radio. One factor is the emergence of digital terrestrial radio, led by a new iBiquity-labeled product that will improve markedly the sound quality of existing terrestrial AM and FM radio signals. The comparison to satellite radio, however, ends there. The reason is that the more important element, i.e., programming, gives a clear edge to satellite radio. Indeed, satellite radio is in the big leagues – with 70-plus, advertising-free music and entertainment channels and 30-plus information-based channels per operator. At the same time, the less appealing, advertising-supported single channel services will be those carried by the iBiquity’s of the radio universe. Until digital terrestrial radio can offer a comparable channel line-up to that offered by satellite radio, it can do no more than simply enhance the quality of the single-channel signal. That limited response by terrestrial radio will not be enough to retain a significant number of their listeners.

Satellite radio not only improves the signal quality to a near-perfect digital level, but, more importantly, it delivers a quantum leap in enhanced programming. In the end, both quality and content are important, but the latter measure – enhanced content — is the true Holy Grail of multichannel industries.

Analog AM and FM both will become less tolerable to listeners once they have been exposed to digital quality radio. That trend will hold especially true with generation-after- generation of young people who have been reared in digital-rich school, home and other environments. Those coveted young consumers will seek and demand the quality and the choice offered by satellite radio.

Another competitive factor in the mix is every other device or service that offers information and entertainment to vehicle drivers and their passengers. This list is growing and now includes cell phones, PDAs, laptops and any other device or service that draws the attention away from listening to the radio.

Maintaining Momentum

Both XM and New York-based Sirius Satellite Radio [SIRI] are moving aggressively to present ideas for video content to vehicles. Each company is looking for the proper business model to provide content through a relatively bandwidth-lean infrastructure. Both XM and Sirius also are beginning to offer local traffic and weather services to listeners in a couple dozen or so urban centers nationwide. XM has talked about adding a special layer of traffic services that will provide information about road construction or similar obstacles along a particular route.

For Sirius, the National Football League (NFL) is an important partner. Sirius has a new alliance with the thousands of Wal-Mart [WMT] stores nationwide. In addition, there is a new joint venture with DBS provider EchoStar Communications [DISH], which will bring the Sirius service to the more than 6 million “premium service” subscribers within EchoStar’s 9-plus million subscriber base. Sirius also has initiated a relationship with 7,000 Radio Shack [RSH] stores to make its service the exclusive offering at those specialized retail outlets beginning this fall. The EchoStar and Radio Shack agreements together offer Sirius a tripling of retail outlets nationwide. Moreover, 11 new factory installation programs have been announced with original equipment manufacturer (OEM) partner Daimler-Chrysler [DCX]. That deal brings to 50 the total number of vehicle models that will offer Sirius receivers as OEM equipment. That number will rise to 80 by year-end 2004.

XM continues to develop new receiving equipment to supplement its already successful SkyFi service. The company focuses on five key metrics: strong product, substantial word of mouth, solid pent-up demand for improved radio services, its auto industry alliances (especially with General Motors [GM] and Honda), and its strong management team. Moreover, XM’s management team is finding that success is dependent upon expertise in five key businesses: automotive, radio, consumer electronics, hardware manufacturing, and subscription packaging.

And The Numbers Please…

For the close of first quarter 2004, XM and Sirius together have reported more than 2 million satellite radio customers. XM accounted for 1.7 million subscribers, while Sirius approached 400,000 subscribers and subsequently passed that mark within the past month. These numbers represent a more than 80 percent market share for XM and almost a 20 percent share for Sirius. Since the close of 2003, Sirius has increased its market share slightly. However, the overall pace of new subscriber growth industry-wide is surging. Quarterly subscriber growth within the industry has gone from approximately 200,000 net subscriber additions a couple of years ago to more than 500,000 net subscriber additions now.

Sirius is aiming to follow the second-to-market strategy that EchoStar Communications [DISH] took during the past eight years to cut into the market share advantage of satellite TV pioneer DirecTV, the satellite TV arm of The DirecTv Group [DTV]. Sirius, in effect, now is akin to the satellite industry’s “David” in a clash with the industry’s “Goliath,” rival XM. Sirius will do everything it reasonably can to narrow XM’s market share lead. The battle for U.S. satellite radio market share will be fought deeply in the trenches of the retail and Original Equipment Manufacturer (OEM) marketplaces, quarter-after-quarter, year-after-year, for many years in the future.

Since EchoStar Founder and CEO Charlie Ergen first began his race against DirecTv and other DBS rivals, the company’s mantra has been: “We will always be the low-cost leader.” Thus far, Sirius has not followed that strategy of marketing itself as the lowest-priced service. In fact, its monthly subscription fee is more than 30 percent, or about $3 a month, higher than XM’s monthly subscription price. Sirius instead appears to be trying to differentiate itself on the basis of content, especially sports programming. Sirius signed a contract with the NFL to offer nearly all the league’s games to cater to fans who live outside the home markets of their favorite teams. This fall will mark the first NFL season in which Sirius will hold that product-differentiating advantage in its battle with XM. Sirius also seems more open to ideas that some would argue might take it away from its core mission. This mission, in the words of XM CEO Hugh Panero, is to quickly add new subscribers at the lowest cost, and reach cash flow breakeven as soon as possible. XM projects hitting cash flow breakeven during the first half 2004, while Sirius plans to do so by the end of next year.

XM’s growth during the first quarter of 2004 totaled 322,000 net new subscribers, compared with 139,000 for Sirius. That is a 183,000 subscriber differential in XM’s favor. The accompanying chart, labeled “U.S. Digital Satellite Radio Subscriber Growth,” shows that Sirius and XM will push the subscriber bar to just shy of 25 million by year-end 2008 (slightly more than four-and-one-half years from today). This projection also is considered by The Carmel Group to be a conservative estimate. If Sirius and XM are particularly successful at maintaining their competitiveness against outside threats, then this growth projection could be low.

Jimmy Schaeffler researches, analyzes and writes this report. He is a subscription TV analyst at The Carmel Group, publisher of industry databooks and the monthly newsletter Satellite Radio Investor, as well as a conference-organizer and consultancy, based in Carmel-by-the-Sea, Calif. (http://www.carmelgroup.com). The company specializes in telecommunications, computers and the media. He can be reached by e-mail, [email protected], or by telephone, 831/64-2222.