Radio's Stern Challenge
The shock jock is leaving AM/FM. Will the industry be shocked out of its torpor?

(FORTUNE Magazine) – The defection of Howard Stern, radio's biggest star, from Infinity Broadcasting to Sirius Satellite Radio may be remembered as the moment when a new medium crawled out of its chrysalis. It is also a singular event for the business he's leaving behind. More than 200 million people still tune in to AM/FM radio at least once a week--compared with a mere 3.2 million who currently subscribe to satellite--but terrestrial radio's listenership is eroding, its advertising is flat, and its main growth category seems to be FCC fines.

The King of All FCC Fines (career total: $2.5 million) says he switched media to escape that agency's regulation. Well, there's the money too--Stern, as has been widely noted, is getting $500 million over five years. Sirius believes it will get more than its money's worth when Stern comes aboard in January 2006, by driving its subscriber growth from incremental to exponential. "The question is no longer whether satellite radio is going to take off," says Joseph Clayton, CEO of Sirius. "It's a question of how fast it ramps up."

Stern's own grand vision for satellite radio would give him the power to engage in a sort of Star Wars assault on his terrestrial radio enemies, particularly industry leader Clear Channel Communications. The FCC, at the height of its post-- Janet Jackson indecency crackdown, proposed fining Clear Channel $495,000 for an offensive Stern show aired on six of its stations. Clear Channel not only didn't fight the charges--as Infinity's lawyers long had on Stern's behalf--but kicked him off the six stations. "I just want to bury Clear Channel. I want to make every one of their radio stations worth 3 cents," he told listeners. "You son-of-a-bitches, I will bury you."

For the record, Darth Vader has a reply. "It makes me laugh," says John Hogan, CEO of Clear Channel Radio, who purports to admire Stern's skill in honing his image as an FCC martyr and parlaying it into a huge contract with Sirius. "Howard took the money and ran. I don't blame him at all. My hope is that he has most of it in escrow, because I'm pretty sure that satellite technology is going to be outpaced by other [new technologies]."

It's true that both media have much to fear in an age when people can get their music on everything from iPods to Internet audio streaming to who-knows-what next year. But it's the aging medium of Marconi that has the most to lose. You wouldn't know it to read the FCC complaints, but AM/FM radio has left itself vulnerable to satellite and other media not because it has too much out-of-control talent like Stern, but because it has too little on-air talent. Programming has been mostly an afterthought ever since the 1996 Telecommunications Act unleashed an M&A frenzy in the industry. That law ended old restrictions on station ownership and allowed the creation of behemoths like Clear Channel, which grew 30-fold to its current 1,200 stations.

The theory was that consolidation would let companies cut costs and build profits. The new radio empires could run multiple stations with thin staffs--for instance, by spreading around their DJs via voice tracking, a technology in which their patter is recorded in a studio, transferred by computer to a station, then plugged in between songs by technicians. For a while it worked, because those savings dropped to the bottom line while the dot-com boom drove advertising prices up, swelling the top line. But the new paradigm hasn't worked so well in the new millennium. When the dot-coms went away, radio stations tried to sustain revenues by giving advertisers more airtime for a given price. The result was rampant clutter--sometimes 20 minutes of ads per hour, vs. the old norm of 12 minutes. Listeners didn't have to sit still for radio's commercial cacophony when they could share files on the Internet or listen to broadband radio services.

Younger listeners in particular--the sort who used to have transistor radios glued to their ears--have begun to tune out. While 94% of Americans over age 12 listen to the radio at least once a week, according to Arbitron, the next generation is listening less. Compared with five years ago, teens (ages 12 to 17) spend 11% less time listening to radio, and 18- to 24-year-olds spend 13% less time. Across all age groups, weekly listening has fallen 8%.

Perhaps they just hit the OFF button after hearing the eighth straight ad spot, a pretty typical run of commercials. Advertisers seem to have figured that out. The industry enjoyed double-digit gains in ad revenue in the late '90s but has never again reached its peak of $19.8 billion in 2000, according to the Radio Advertising Bureau. Virtually every communications medium suffered a post-bubble ad crash, of course. The difference with radio is that it's barely recovering. Total industry ad revenue rose just 1% in 2003, to $19.6 billion, and is up a tepid 2% this year through August.

Credit Clear Channel with being first to publicly face up to the "spot load" problem. It has announced a "less is more" initiative, which will roll back commercials to 12 minutes an hour, effective Jan. 1, 2005. While Clear Channel reduces the quantity of ads, it's also trying to improve their quality, forming a "creative resource group" to work with stations on developing punchier spots.

Credit, too, the industry's No. 2 player, Infinity Broadcasting, for acknowledging and working on programming deficiencies. Its biggest programming problem is replacing Stern, of course, whose show generates an estimated $80 million to $90 million of revenue each year. But Viacom co-president Leslie Moonves, who oversees Infinity, has asserted that stations were "starved" for investment in recent years under his predecessor Mel Karmazin. Infinity president Joel Hollander has been making the rounds of key stations to develop new programming and marketing initiatives.

Yet an odd sense of denial still afflicts the industry. Perhaps that's because, even with tepid growth, terrestrial radio is a high-margin, high-cash-flow business. At any rate, there seemed to be a lot less agonizing self-appraisal than annoyance at the recent National Association of Broadcasters radio convention, held the week of the Stern-Sirius announcement. At one session, according to trade-press reports, Entercom CEO David Field called satellite radio's threat "exaggerated." He urged the industry to fight back by refusing to take ads from Sirius and XM, and vowed to continue running ads on Entercom stations emphasizing satellite radio's negatives.

Clear Channel's Hogan denies that the industry is back on its heels and sitting on its cash. He notes that his company has been steadily developing new formats --gospel, hip-hop, and Hispanic stations, most recently--and is converting 1,000 stations to digital over the next several years to improve sound quality. "I am not so arrogant as to say we don't look at satellite [as a competitor]," he says, "but we have a delivery system that reaches 94% of the population, that's portable and customizable and free."

That price definitely is right compared with satellite radio, whose home receivers typically cost $130 and whose subscription fees can add up. For $12.95 a month, Sirius subscribers get 65 commercial-free channels of music and 55 channels of news, sports, and talk, which do have ads. For $9.95 a month, XM subscribers get 68 commercial-free music channels and more than 40 assorted others with advertising. Satellite radio has lots of variety and a great, unlosable signal, but the onus on XM and Sirius is to become radio versions of HBO, with gotta-have-it programming. "The industry can get to five million subscribers by developing the distribution channels," says one industry consultant. "But to get to 20 or 30 million, you need something dramatically more."

That's what Sirius believes it got in Howard Stern, the cultural icon who gave us Lesbian Dial-a-Date and made fart jokes an art form. According to a survey by the San Francisco market research firm Odyssey, about 30% of Stern fans said they'd "very likely" sign up for satellite radio if he moved there. Out of an estimated 12 million fans, that's a whole lot of subscribers. "That's purchase intent rather than purchase behavior," says Odyssey's president, Nick Donatiello. "Now it's [Sirius's] marketing challenge to turn intent into behavior."

The $500 million guarantee--80% cash, 20% stock--is still an audacious amount of money for a company that in the first half of 2004 reported a $137 million loss on just $13.2 million in revenue. To some in the industry it smacks of desperation. Sirius trails XM three to one in subscribers, having never recovered from being beaten to market. XM launched first, in 2001, because it was faster to develop radio chips. The Washington, D.C., company has remained a jump ahead of Sirius through succeeding generations of chips, and the technological edge has helped XM land major deals for installation in many General Motors and Honda cars. XM now gets about 50% of its business through the automakers, compared with 25% for Sirius, whose biggest tie-ins are with Ford, BMW, and DaimlerChrysler.

Because it is more dependent on retail outlets like Radio Shack, Sirius has to market harder and has higher subscriber-acquisition costs--$234 per subscriber, vs. XM's $57. It is also more pressed to make gaudy, costly programming movies, like a seven-year, $220 million deal with the NFL to put every game on satellite. It's too early to tell, but Sirius hopes this will be as clever a move as Rupert Murdoch's megabid for NFL TV rights in 1993, which put the Fox network on the map. But to some industry savants, both the NFL and Stern deals look like Hail Mary passes. XM was in talks with Stern too; however, according to people familiar with negotiations, Sirius put up three times what XM would have been willing to spend. Perhaps it's like Hollywood, where Sirius's chief talent negotiator, Scott Greenstein, used to work for Miramax Film Corp. A blockbuster hit on a gamble can be worth way more than the returns on a sensible strategy.

The two competitors' greatest vulnerability may not be the tactical strikes they launch at each other but the march of technology that could imperil both. The big thinkers in this field believe wireless broadband, in some form, could supersede satellite radio one day. That would be both a lower-cost and higher-potential device, with lots more interactive capabilities. It wouldn't necessarily be the end of Sirius and XM, but it would suggest that they should work hard and smart while their medium's star is ascendant. Robert Unmacht, a Nashville-based radio consultant, is more concerned about the terrestrial radio business. "They are a lot like Ford, GM, and Chrysler in the 1970s--fat and lazy," he says. Satellite radio and other coming technologies "will be like the Japanese to the Big Three--get them shook up and force them to focus on the product."