Car radios used to be simple, as listeners searched for AM broadcasts by twisting a knob until they found the right frequency. High-end radios featured buttons you could preset to your favorite stations, thought you were limited to your local radio options. The marriage of car radio and satellite technology has transformed these once simple devices, taking the listening experience to a new level and making the automobile manufacturing market a key focus of the two satellite radio operators.

Nearly 14 million Americans have embraced subscription audio services, but that figure remains a small percentage of overall radio listeners, and the rate of growth seems to be slowing. Sirius Satellite Radio and XM Satellite Radio are seeking new ways to attract and retain subscribers, and whether the future of satellite radio in the United States revolves around a single company or a pair of operators (depending on whether U.S. government regulators approved a proposed merger of the two operators) a key component of future satellite radio sales will be deals with major car makers.

Baby You Can Drive My Car

Initial offerings for both XM and Sirius were heavily skewed toward aftermarket systems, though both companies eagerly sought original equipment manufacturer (OEM) agreements with automobile manufacturers, a sector that promises to be a major battleground for the two providers (or for a single satellite radio company competing against other forms of entertainment) as they try to link with the hottest car makers and hopefully use free service trials to turn car buyers into long-term satellite radio customers.

To date, Sirius and XM have booked deals with car companies encompassing 39 different brands. Notable names on Sirius’ side of the ledger include Audi, BMW, DaimlerChrysler and Ford, while General Motors, Honda, Toyota and Nissan have aligned with XM. Consumers have shown an appetite for factory-installed satellite radios, and the subscriber base built from these car deals continues to grow for both Sirius and XM. “In 2006 in the automotive segment, we added more net new customers through our automotive partners than at retail,” XM CEO Hugh Panero said in a February conference call to discuss the company’s 2006 financial performance. “XM’s automotive or OEM performance is the cornerstone of our long-term growth strategy, the big impact of which will be in 2008 and beyond.”

More Cars, More Marketing

Both companies tout these exclusive deals with car manufacturers in an effort to differentiate themselves, but when the numbers are tallied, XM holds a significant advantage, having 60 percent of all car models in their corner. “The most significant development has been the emergence of OEM as a key growth driver for both XM and, we think, for the industry as a whole,” Nate Davis, XM’s president and COO, says. “XM has placed a strong emphasis on this segment having established strategic partnerships with automobile manufacturers.”

While Sirius holds fewer auto deals, the company added 349,000 OEM subscribers in the 2006 fourth quarter and 1.1 million OEM net additions for the year, representing 55 percent of OEM net subscriber growth in the satellite radio industry. “Our goal for 2006 was to double our OEM subscriber base and we more than accomplished that goal,” James Meyer, president, sales and operations for Sirius, said in the company’s February earnings call. “Sirius started 2006 with 823,000 OEM subscribers and ended the year with more than 1.9 million subscribers in this important channel. Factory programs continue to gain momentum. Sirius ended 2006 with 132 individual vehicle model factory programs and 149 total vehicle model programs. OEM economics will continue to improve and our penetration rates continue to increase.”

Chrysler is targeting a 40 percent overall penetration rate for the 2007 model year with Sirius factory programs, compared to 30 percent in 2006. During the fourth quarter, the Chrysler Group launched a national media campaign featuring Sirius in TV spots for Chrysler, Dodge and Jeep vehicles. “This national exposure was not only great for our brand but also had a very positive impact at the dealer level. Awareness of the Sirius option at the consumer and dealer levels has never been higher,” says Meyer.

Ford now has Sirius as a factory-installed option in 22 vehicle lines, compared to four at the beginning of 2006. Volkswagen and Audi began their 2007 model year launch of their previously announced exclusive partnership with Sirius, and the two manufacturers are targeting an 80 percent installation rate. Mercedes-Benz now installs Sirius radios in more than two-thirds of all model year 2007 vehicles.

“On the OEM side we have learned a lot,” Meyer says. “I am afraid we have not learned as much as our counterparts have, but we are working very hard at it. … We are learning more and more to be both integrated with the factory or a part of how the mother company goes to market with their merchandising and their campaign. I think we have made great progress there with both Chrysler and Ford.

“The dealer does play a very important role in retention rate,” says Meyer. “First and foremost, just making sure the consumer knows he has the service, so we are very focused on that now. We have added a group in Detroit that is fully focused on working with the dealers and working with how we communicate with the dealers to improve our retention rates.”

While Sirius is trying to close the OEM gap, XM continues to make moves as well. The satellite operator recently announced an extension of its relationship with American Honda until 2016 and projects production of 650,000 new units in 2007. “The roll-out of XM in our vehicles has been one of the fastest in the car industry and over the years XM has become an increasingly important entertainment service to our customers,” says John Mendel, senior vice president, automobile operations of American Honda Motor Co. Inc.

XM followed that deal with an extension of its agreement with Toyota to be the sole provider of factory-installed radio equipment until 2017. XM estimates that 1 million new radios will be installed in Toyota and Lexus vehicles by 2010. “XM provides exceptional entertainment programming and innovative data services like real-time traffic, recently launched on the all-new Lexus LS. Our agreement with XM will help us continue to provide these services and develop additional in-vehicle applications for future products,” says Dave Danzer, group vice president of strategy and product planning for Toyota Motor Sales U.S.A.

In 2007, GM will produce 1.8 million XM-equipped vehicles, Honda will produce 650,000 and Hyundai is moving toward factory equipping 100 percent of its vehicles with XM by late 2007, says Davis. In 2008, Nissan has projected it will turn out 500,000 factory-installed XM vehicles.

“To make the most of all of these cars and the greater availability of factory-equipped XM vehicles, we will work with our partners in ramping our marketing efforts to increase OEM conversion,” Davis says. “First, we’re going to shift a greater percentage of our promotional dollars to OEM-related initiatives that match this segment’s improved performance and importance. Our promotions will leverage our marketing money in ways that involve greater and more effective integration of our brand with the brand of our OEM partners. “

Retaining Subscribers

While the two companies are touting their additional subscribers gained via OEM deals, the real key is holding onto the listeners after any free trial periods expire.

Lucas Binder, an analyst at UBS, says that XM is the leader in the market now by virtue of their OEM agreements but noted that Sirius is quickly narrowing the gap in the number of subscribers. “Churn has plagued other subscriber industries, such as the cellular market,” Binder said. “Sirius has been successful at offering longer trial periods than XM (three to 12 months for Sirius versus three months for XM), and ultimately holding onto their subscribers for a longer period. I am not making a call on who will be the winner and looser right now. Both companies have challenges ahead of them.”

“We’re increasing our direct marketing to OEM trial subscribers and adding new targeted promotional offers to better communicate our value proposition,” says Davis. “For example, together with one of our OEM partners ,we used a five-year history of OEM factory installations to create a predictive model that allows XM to target the customers most likely to convert into paying subscribers. Throughout this year, we expect to maintain and improve on the conversion of trial subscribers.”

“… What we’re trying to do is elongate the time frame that customers have when they first get XM, but not as a promotional service, more as a paid service,” says Davis. “So instead of three months of promotional service, what I would rather do is have you sign up for a one-year plan. The way we do that, of course, is to try to get the car manufacturer to include that subscription somehow in the car, whether it is financed or it is included in the price of the car or as an option. We’re getting more and more OEM partners, whether it’s a leasing program or a car that is purchased, to include the one-year subscription or maybe even a two-year subscription of XM into the car.”

Sirius CFO David Frear also notes the major difference between Sirius’ and XM’s OEM marketing plans. “We have a big distribution partner who bundles in 12-month subscriptions,” he says. “We have another big distribution partner who uses six months. We have got guys coming online in the course of the next year or so that will be at three months. So as we look at the conversion rate, we do not have a bundled subcategory that rolls up for renewal at a predictable and consistent pace the way that our competitor has.”

XM also is trying to increase the features included in its car deals, says Davis. “We recently tapped into a new segment, the certified pre-owned market through new deals with Honda and Acura,” he says. “Our strategic partnerships with Honda, Toyota, Nissan and GM have expanded beyond just radio service. Our exclusive XM Nav Traffic real-time traffic information service will be standard on all 2007 Acura vehicles equipped with the Acura-link satellite communications system. Nav Traffic is also an option on the 2007 Infinity G35 sedan, the Lexus LS sedan and every Cadillac CTS that has navigation.
“We’re obviously pleased with our progress at OEM and thanks to our growing relationship with these automotive partners, we’re confident in our ability to increase additions from OEM,” says Davis. “We’re becoming less vulnerable to the short-term fluctuations in the retail marketplace. As our OEM partners ramp up their XM factory production in the latter half of 2007, our OEM subscriber count will continue to build with the biggest impact coming in 2008 and beyond.”

XM also is trying to develop other services such as providing drivers information on the occupancy rate of parking garages in major metropolitan areas, and both companies envision the delivery of video information to the car in the future.

No Change If They Merge

The proposed merger will not have a negative impact on the OEM deals, says Davis. “Our OEM partners and subscribers can be assured that XM will support them, their equipment and their technology platform for years to come,” he says. “This is important and I want to be clear. Any XM Radio with a paid subscription in any car will continue to work in the XM Radio network, period.”

Some of the OEM’s may even be looking forward to a merger of the two satellite radio operators, says Sirius CEO Karmazin. “We have a contract with Daimler-Chrysler. They are a very important partner,” he says. “We are an important partner to them. Certainly we touched base with them since our merger and they were very enthusiastic for us and we will just wait and see what happens with them. But you should rest assured that we have a long-term contract with them and there is some very attractive economics for that contract to go on forever because of the fact that they receive a revenue share for the life of the vehicle. If in fact we were not involved with them, they would have significant shortfalls from what they would expect to have received from us. We are working closely with them, and we are excited about their commitment to satellite radio.”