Friday, September 01, 2006

An SSG Reader Response to Sirius Business

September 1, 2006

Sometimes SSG articles generate responses. We got this response from an SSG reader who took exception to one aspect of the article.

The SSG reader Wrote:

This one's funny:============
"Why do we term it a “healthy supply”? The answer is rather simple. If you grow the family plan subscribers to quickly, and the pool becomes too large, your ARPU will decline. As of last quarter Sirius had about 12% of their subscriber base in the family plan. We here at SSG have watched as the family plan subscribers at Sirius have grown at a rate between 1 to 2 points per quarter. We here at SSG feel that this category may jump to 15% or 16% for the end of Q3, because Sirius has become more aggressive at marketing the plan. We feel he likely comfort zone for family plan as a percentage of the base is between 20% and 25%

The author of this tidbit is totally overlooking the most fundamental concepts of managerial accounting and microeconomics. If it generates a "marginal profit" to add a family plan subscriber, you want to do it. Period, end of story. You don't care what it does to ARPU. You care only about whether the addition of a family plan subscriber generates marginal profit. Why would you limit it to 15, 20, or 25%? Get all you can get. But the author is concerned about the effect on ARPU. Why? Microeconomics 101 -- you will maximize profits by operating where MC == MR.In particular, when the fixed costs (like satellite infrastructure) are not subject to a "step-cost" function, you have nothing to lose in adding family plan subscribers whenever you can, so long as they can be added with a marginal profit.This isn't a physican's office, where you want to avoid too many low-margin Medicare patients, or a fast food joint where you want to avoid low-margin customers. If one family plan subscriber can generate $2 of marginal profit, then 1,000,000 can generate $2,000,000.

What we have here is a specific section of the article taken out of context. Of course, any profit is a good thing. That would appear to be a very basic premise in business. The issue here of course is that the satellite radio companies are not yet making a profit. The issue is how long will it take for that added subscriber to bring a profit.

Should ARPU be thrown out the window in the effort to make a small profit? Of course not. ARPU guides investors to understand how much profit potential there is. You would much rather have a HIGHER ARPU than a LOWER ARPU. At this point there is a lot more that goes into getting a subscriber than the fixed operating costs of sirius or XM.

Because these companies are not yet making a profit, it is important for them to maintain the highest revenue stream possible. If a small profit was all we were looking for, then these services could just lower the price to $6.99 across the board.

There is a balance that needs to happen as these companies grow. Overload the family plan as this reader suggests will carry a noticable impact on ARPU, and the street will quickly take notice.

The other point we would like to make is that the article was about balance, not specifically the family plan. The point was that higer revenue generating subscribers give these companies leveredge to expand their faimily plan efforts with less impact to ARPU (something investors in these equities are aware of).

In Q3 and Q4 of 2005, and Q1 of 2006, XM Satellite Radio used family plan prices to aggressively grow their subscriber base with numbers that we would not term as healthy (40% to 50% of the quarters net subvscriber additions). Their SAC went up, thier losses went up, class action suits were filed, and it was not a pretty picture. In Q2, the family plan percentage for XM remained flat relative to the subscriber base. Thankfully it appears that XM is now better pacing the additions of family plan subscribers.

It needs to be about SMART GROWTH.

Get a profit no matter what? Sure, but I would rather see HIGHER profit. I think most investors would feel the same way.

Thank You for your responses, and keep them coming.

9/01/2006 02:25:00 PM

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