Saturday, April 21, 2007

Churn - A Clear Cut Arguement For The Merger

April 21, 2007

Some subjects simply rarely get discussed. At this point, no one else has brought this subject up, so we here at SSG decided to put together a frank analysys of churn, and how it demonstrates substitutionalty in the audio entertainment arena.

The subject of substitutionality often comes up when the merger between Sirius and XM is discussed. Those that oppose the merger argue that there is no medium that acts as a substitute for satellite radio. They develop theoretical exercises to illustrate their point, and go into a long and drawn out explanation as to why they are correct.

There is a much more simple way to address this. CHURN

Churn in this sector clearly illustrates that, for many consumers, there is indeed a substitute for satellite radio. Even if the metric that cuases the churn is financial, it is clear that there are many in this country who choose another medium for their audio entertainment. In fact, about 2.5% of the subscriber base in satellite radio discontinues the service every month. This is clearly substantiated with quarters upon quarters of data.

How does churn show substitutionality?

Actually, it is quite simple and a little common sense goes a long way.

In 2007, satellite radio will have over 2,000,000 deactivations. Now, realistically speaking, do you feel that these 2,000,000 people are giving up audio and informational content altogether? Or is it more realistic that they are simply using some other medium to satisfy their listening habits? Common sense dictates that most of these deactivations find suitable content from another medium. It is that plain and that simple. There is not an analyst or statistician on the planet that can argue otherwise.

In addition to the churn, we have the take rate on OEM installations at roughly 50%. Do you think that once the trial period ends that that area of the dashboard remains silent for the next few years? Or is it more realistic that these people are using AM, FM, CD, HD, I-pods, or cell based systems to satisfy their content desires?

Yes, there is likely a bit of “cross-over” subscribers who leave one service for the other, but realistically speaking this situation is more likely the exception rather than the rule. Certain events may transpire that have the cross-over effect spike from time to time. Events like Howard Stern coming to Sirius, the switch of NHL to XM from Sirius, the switch of Nascar to Sirius from XM, the addition of Oprah to XM, and a few others, but even these spikes do not outnumber the simple deactivations in my opinion.

In basic terms, audio content boils down to wants, needs, and dollars. For some, the trade-off of dollars for entertainment has a set limit. Perhaps the $12.95 per month is too high for them. They find a substitute in another medium that is less expensive.

The point is that there exists plenty of data to suggest that consumers do indeed find substitutes for satellite radio. Each month 2.5% of the subscriber base drops off of satellite radio. At 13,000,000 subscribers, that is 325,000 people per month that find another way to get their audio content.

Now, this subject will ire some who would rather not speak of the negative side of things (and churn is a negative subject). I submit that people who feel that way are being short-sighted. Better to look at this sector in a realistic manner…..especially if you want to have realistic results.

Not only does churn illustrate that there are indeed substitutes for satellite radio. It also is a decent predictor of price point. If prices were to increase, churn would also increase. If churn begins to overtake net additions, the prices will decrease in order to lower the churn rate.

For these companies there exists a control that is dictated by the consumer reaction to pricing. There are some who feel that a lower price of $9.95 would increase the take rate and lower the churn rate. While this would be a logical stance, there is a company aspect to this as well. Will the benefit of the company bottom line be improved if such an event were to happen? In other words, do net additions improve by a number great enough to make a price drop a profitable proposition for the company? It is a delicate balance, but it is a control nonetheless.

So, while churn may seem an ugly subject, it does cut right to the heart of the matter when people want to debate substitutionality. Yes, churn is bad, but it is also a fact of life. Better to face all of these issues head on than to ignore them……especially when they actually help prove your point for a merger. This may be one of the few times that speaking about churn can actually be a positive discussion.

4/21/2007 08:49:00 PM

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  • Using your argument, if the bottled water providers were to combine into a monopoly, that would be okay, because one could always substitute tap water. I would argue that tap water would not necessarily provide the same health, quality, convenience, and taste benefits of bottled water and is therefore not a good substitute. The same goes for terrestrial radio; it couldn’t provide the same quality and selection and convenience nor could it provide nationwide coverage. If a merged satellite radio company raises prices, I can always substitute terrestrial radio, but it would not be a parallel choice. I would be forced into making an economic choice, not preferential or parallel choice. It’s the same with all monopolies. There is always a choice, but not always a convenient choice. If there were an automobile monopoly, I could always choose to ride a bicycle or walk or take a cab everywhere. I would argue that the only comparable choice for Sirius is XM, or visa versa.

    It is not so much about substitutability but parallel substitutability.

    By Anonymous Anonymous, at April 22, 2007 9:12 AM  

  • Using you water arguement, I would submit that you can buy a brita filter and get the same benefits that bottled water brings. Further, I would submit that bottled water is not always as healthy as tap water, nor as convienient.

    The fact of the matter is that Terrestrial Radio, Cell Phones with content, I-Pods, Slacker, and many other mediums provide realistic and parallell substitutes.

    In you argument you split hairs and therin is the weakness. By example, if terrestrial radio offers only one Jazz channel in your area, and they change formats what are you as a consumer to do? You will substitute somenthing else for jazz....either by listening to other music, getting satellite, using CD's, or an I-Pod.

    your "nation-wide" coverage aspect of your argument also has a major flaw. How much time does the average consumer spend in their own area or locality. In the vast majority of cases, people tend to be within 50 miles of their home virtually all the time. Nation wide coverage is not a major deciding factor for most people. I live in the northeast. I could care less what is playing in California.

    All of these mediums employ differing business plans and differing methods of delivering content. Some involve a fee, others charge by taking the time of the consumer via advertising, some require time to download material.

    Is a DVD a viable substitute for Blue Ray Disc? Yes, it is. Is standard television a viable substitute for HD television? Yes it is.

    If you wanted the best musical experience, would you rather go to a concert and see the performer live? Of Course, but realistically, what is the liklihood of U@ jamming live in your car whaile you commute? Thus, you find another way to hear U@. Via satellite, I-Pod, cell phone, AM, FM, or HD.

    Some people prefer Starbucks....other Dunkin Donuts.....others brew their cofee at home.

    By Blogger SSG, at April 22, 2007 10:00 AM  

  • I think that you are trivializing the argument, rather than debating it head on, but whatever.

    One could also say that coke, pepsi, red bull, coffee, tea, etc are parallel substitutes for bottled water, but this would be incorrect. Sometimes they can be, but more often if someone wants bottled water, these will not satisfy. Whether or not there are real health benefits by drinking bottled water over tap water or any of the above is irrelevant. It is the perception. In any case, many feel that bottled water is worth paying for. The same is true for satellite radio. There is something that makes it worth paying for when they could have the terrestrial without any cost to them. One cannot say that it is a parallel substitute. The iPod is to satellite radio what coke is to bottled water. It's not really a competitor.

    By Anonymous Anonymous, at April 24, 2007 6:21 PM  

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