Research Proposal on "Sirius Xm Competitive Landscape"

Research Proposal 8 pages (2650 words) Sources: 8 Style: MLA

[EXCERPT] . . . .

Sirius XM

Shift from Dynamic Oligopoly to Monopoly

Sirius XM was formed through the merger of Sirius and XM Satellite Radio in the summer of 2008. The merger process was lengthy, drawn out by regulators who were concerned about competition in the industry (AFP, 2008). At the core of the regulators' concern was that the merger would create a monopoly in the industry. The companies, however, argued that the merger would allow the combined entity to turn the industry's first profits. Moreover, they argued, the first competes in a broader industry with terrestrial radio, Internet radio and other music providers. Satellite radio held less than 10% of the total home and car market (Ibid).

If the satellite radio industry is taken as a standalone entity, the merger brought the industry from a state of dynamic oligopoly to a state of monopoly. This represents a significant shift in the competitive dynamic. During the oligopolistic phase, the satellite radio industry was nascent and subject to significant change. Demand, for example, was dynamic rather than static, as evidenced by the strong gains made in subscriber numbers over the course of the 2000s by both of the industry's major firms. In 2007, the year the merger discussions began, Sirius saw its subscriber base increase 38% and XM saw its increase 18% (Holmes, 2008).

The two firms had relatively equal market power, as measured by their subscriber bases. Sirius had 8.32 million subscribers and XM had 9.02 million (Ibid). One of the most important bases for competition between the two companies was with respect to content, one of the key industry inputs. Prior to the merger, the two firms routinely entered into bidding wars to attract top talent capable of driving demand. Sirius, for example, offered Howard Stern a deal with $80 million per year, plus stock incentives if subscriber growth targets were met (Moritz, 2008). These deals were considered essential to grow the fledgling business. The two firms in the industry approached competition as a race to win control of the market and were willing to spend lavishly to attain that market share, while simultaneously growing the market. This illustrates that not only were the two firms competing against one another, they were competing with terrestrial and Internet radio as well. Stern, for example, was previously on terrestrial radio. The simultaneous objectives of building the satellite radio industry and building market share within the industry created an environment where both major firms became price takers with respect to content.

The propensity of the two firms to spend on-air talent demonstrated that the industry viewed itself as in competition with other forms of radio. With the willingness to run deficits, the two firms were able to exercise significant buyer power vis-a-vis conventional radio. However, this advantage was temporary because the spending levels were not sustainable.

Two firms operating in a dynamic oligopoly would, under normal conditions, be expected to find equilibrium, given relatively equivalent quality levels and market positions. As of 2005, both XM and Sirius charged around $75 to start and had subscription prices of $12.95 per month (Guttenberg & Moskovciak, 2005). In that year, XM raised its prices from $9.95 per month to match the price of Sirius. This is evidence that the two firms operated as a collusive industry in terms of their pricing strategy. The hallmarks of a collusive industry are that the firms offer a higher quality product but at higher prices. Price wars can occur, if one competitor appears close to exit (Fershtman & Pakes, 2000). At that stage in the industry's growth, however, the firms were forced into a collusive situation by their spending on-air talent. With a strong economy and an exciting new technology, consumers showed low price elasticity of demand.

When the merger was approved, the industry shifted to an arguable monopoly. Competition between the two competitors effectively ceased, although the spending on talent was inevitably going to cease anyway because of its unsustainable nature. The prices paid for talent during satellite radio's growth period were not reflective of true market conditions, but were instead the result of the competing market interests of the two firms -- growing satellite radio vs. terrestrial radio while simultaneously competing against each other for market share. By removing the second dynamic, the combined Sirius XM should theoretically strengthen its market position vs. terrestrial radio. The firms, no longer concerned with competing with each, would be able to focus on substitute products rather than direct competitors. In theory they would continue to bid on top on-air talent because that activity supports its industry growth strategy.

However, in practice the bidding wars have ceased. This would appear to support a conclusion that the bidding wars were driven more by competition between Sirius and XM than by competition between satellite radio and terrestrial radio. However, the financial situation of the combined entity was so poor that it nearly declared bankruptcy (Sorkin & Kouwe, 2009). The cash crunch, spawned by the bidding wars between the two companies during the period of dynamic oligopoly, kept the combined entity from leveraging what should have been an increase in market power.

With respect to pricing, the long process of attaining approval for the merger contributed more to current pricing than the economic forces of the shift to a monopoly environment. During the merger proceedings, Sirius XM agreed to freeze pricing at $12.95 per month and to offer a wider variety of program packages (Sidak & Singer, 2008). This pre-emptive move removed the influence of market forces from the combined entity's ability to extract monopoly rents post-merger. Under normal market conditions, the firm would have been able to increase its pricing in order to support its premium positioning in the radio industry. However, the Antitrust Modernization Commission (AMC) ruled that there was insufficient evidence of buyer substitution in response to a relative change in prices between satellite radio and terrestrial radio. That ruling narrowed the definition of Sirius and XM's industry to satellite radio, forcing the companies to freeze prices in order to demonstrate that they are not going to be able to raise prices profitably under monopolistic conditions (Ibid).

II Post-Merger Competition

There were several reasons why Sirius XM nearly went bankrupt post-merger. The company's balance sheet was atrocious. The bidding wars and high startup costs that characterized the oligopoly left the combined entity with $3.25 billion in debt. However, the downturn in the economy was another factor. New subscription growth began to falter, in part because of the industry's policy of piggybacking their products into new cars. As new car sales plummeted, so too did satellite radio subscriptions. There are other market problems as well, such as a net loss of subscribers during 2009 Q1. Faced with these challenges, liquidity became a problem and in light of the credit crunch the firm avoided bankruptcy only with an angel loan from Liberty Media (Kang, 2009).

The firm still faces intense competition. Although the AMC found no evidence of price-based substitution between satellite radio and terrestrial radio, there is considerable evidence of competition between the two. Both offer similar content, and deliver it through new cars and portable radio sets. New car buyers, for example, receive a free trial for satellite radio and must choose between paying for that service and simply using the free radio already provided. This indicates not only direct competition, but price-quality-based competition as well. Sirius XM has a differentiated strategy in the radio business. The terrestrial radio business has been in a period of consolidation for over a decade. The result is an industry that has become concentrated. That concentration, however, has not resulted in strength. Industry leader Clearchannel is in the midst of a major cost-cutting initiative in the face of declining revenues. The industry is expected to earn $8.7 billion this year versus $9.9 billion in 2009. Content is being cut and the company is expected by some industry observers to be preparing for bankruptcy. This would shift the competitive dynamic significantly. As the quality gap between satellite radio and terrestrial radio grows larger, Sirius XM's frozen rates give them a steadily-improving utility for the radio listener.

There are other forms of distributing music and audio content as well. MP3 players and cell phones equipped with MP3 are strong competitors. Apple is dominant in this market, with its iPod range holding a 70% market share. Newer products such as the iPhone have also captured some of this market, although there is evidence of cannibalization. These devices have higher costs and more customization than satellite radio. They also have greater market penetration, the iPod Touch and iPhone alone having moved 45 million units.

The company moves over 10 million iPods per quarter (Marsal, 2009). These devices can be viewed as complementary rather than competitive to satellite radio, however, in part because of satellite radio's non-music programming and its strong penetration in cars. Sirius XM has recently developed iPhone applications, which it hopes will allow it to utilize these technologies to drive new… READ MORE

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