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Report on Business Raising its voice: Sonos’ Canadian CEO strives to boost platform in a crowded market

Inside a Sonos store in New York, Oct. 6, 2016.

DANIEL KRIEGER/The New York Times News Service

Patrick Spence knew Sonos Inc. had to find its voice.

As the former top sales executive at BlackBerry Ltd., he had a healthy paranoia about missing market shifts. So in 2015, the chief commercial officer of Sonos, the high-end wireless speaker maker based in Santa Barbara, Calif., became one of the first to buy the newly released voice-activated Echo speaker from Amazon.

Mr. Spence noticed his two daughters started using the Echo to listen to music. At his request, he asked Sonos’s data team to measure and it confirmed what he suspected: Once the Echo moved into his kitchen, the Sonos speakers in that room – with no voice function – got less use.

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The executive warned his fellow executive team members that Sonos had to adapt quickly or it could be in trouble. He met some initial resistance, but slowing growth at the speaker company eventually proved Mr. Spence right.

That sparked a three-year transformation that resulted in Mr. Spence, who is from Kitchener, Ont., becoming chief executive in early 2017 and, last Thursday, Sonos going public on the Nasdaq – a debut whose reception revealed lingering uncertainty about its place in a shifting market.

“On the [pre-IPO] roadshow we learned we have a lot more educating to do about what it is that we do and how we do it,” Mr. Spence said in an interview last week.

After setting out to sell 13.9 million shares at US$17 to $19 apiece, Sonos cut the offering price to US$15, in part because of the recent sell-off in tech stocks – but also because many investors don’t quite know what to make of it.

Sonos has partnered with tech giants Amazon, Google and Apple to offer their voice assistant platforms through its high-end speaker hardware while also competing with those companies, which all sell their own speakers. Sonos’s products are built to last for years and many sales come from customers expanding their Sonos systems, whose wireless speakers can be placed in multiple rooms in a house, playing music from any streaming service or nearby computer and controlled through smartphones. Close to 40 per cent of sales last year were to repeat buyers; 27 per cent of its customers have at least four Sonos products.

“Our model is completely different” than other consumer electronics firms that have gone public – and disappointed investors – such as Fitbit Inc. and GoPro Inc., Mr. Spence said. The Sonos prospectus noted revenue growth has been volatile and that investors should expect “short-term fluctuations and uneven product cadences.”

The stock hit US$23.60 last week and has since eased back to close at US$19.15 Tuesday, but many questions linger. “Does a great product necessarily make for a great investment?” Sanford C. Bernstein analyst Toni Sacconaghi, Jr. asked in a report on Sonos this week. “That’s a harder question to answer.”

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Without the shift to voice, however, it’s safe to assume Sonos wouldn’t have been close to ready to face an audience of public investors.

Sonos was founded in 2002 by former CEO John MacFarlane and three other dot-com-era entrepreneurs with no audio technology or hardware business experience who set out to transform the stereo system for the internet age. They believed listeners should be able to control the system and pick any song they wanted from their couches, while doing away with the tangle of wires connecting audio equipment, according to a 2014 Bloomberg Businessweek article.

The pricey devices they invented and began selling in 2005 produced quality sound and were sleek, sturdy and simple to use. Reviewers and customers loved the products, which today range in price from US$150 to US$700. One of them was Mr. Spence, who bought his Sonos system in 2010 and joined the company two years later; wireless speakers now account for about 60 per cent of the roughly US$10-billion global high-end speaker market, Mr. Sacconaghi said.

Fuelling the company’s rise was the exploding use of paid music streaming services, which reached 79 million subscriptions in 2015, up from 29 million two years earlier (the number rose to 176 million last year and is expected to hit 293 million in 2021, according to market research firm Futuresource). Sonos revenues in 2014 increased by 75 per cent over the prior year to $774.5-million, and management expected the amount to top $1-billion in 2015. “We’ve reached a watershed moment for streaming music,” Mr. MacFarlane said in a blog post on June 6, 2015.

But another mass market technology trend was about to take root. That July, Amazon shipped its first Echo and sales surged, while Sonos’s stalled: Sonos revenues in 2015 gained just 8.9 per cent over the previous year, then increased 6.8 per cent in 2016 and 10.1 per cent in 2017; they are only expected to surpass US$1-billion this year.

And while Mr. Spence pressed hard to shift Sonos into voice-activated speakers, debates dragged on internally for months about what to do.

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Finally in March, 2016, Mr. MacFarlane announced Sonos would bring voice-enabled control to its devices. “Voice is a big change for us, so we’ll invest what’s required to bring it to market in a wonderful way,” he wrote in a blog post. Three months later, Mr. Spence became president, and the following January, he took over as CEO.

"To his credit, [Mr. MacFarlane] eventually said, ‘Look, you got that one right, you could see that and I didn’t,’ ” Mr. Spence said (Mr. MacFarlane now lists his position at Sonos as “intern” and “unFounder” on LinkedIn. He was not available for an interview). “That’s part of why we made the transition. He felt … I was the right person to scale it up.”

Rather than develop its own artificial-enabled voice software – an expensive effort undertaken by Silicon Valley’s data-centric software giants – Sonos pursued the “Switzerland” strategy it had previously deployed to open its speakers to any and all streaming services.

Sonos aimed to make its speakers compatible with all voice-enabled assistants while pushing the selling point that its speakers put the listener first. Sonos struck its first deal with Amazon in 2016 for its Alexa platform; the first Alexa-compatible Sonos speaker came out last fall. Google and Apple voice assistants are being added to Sonos this year.

While Amazon and Google will likely capture the lion’s share of smart speaker sales with lower-price devices (IHS Markit forecasts Sonos will sell 2.8 million smart speakers this year, compared with 24 million for Amazon and 15 million for Google out of a total market of 50 million units), Sonos can likely maintain an edge over many of its competitors for a couple of years as “one of the very few agnostic players staking out that realm,” said Paul Erickson, senior analyst with IHS Markit.

Bernstein’s Mr. Sacconaghi said Sonos’s best bet is “riding the adoption curve” as streaming continues to take off. But he warned the emergence of voice assistants will do little to change the size of the fragmented, mature US$10-billion market for high-end audio equipment, where Sonos has been taking share from established players without growing the total size of the segment faster than GDP growth. And further gains in the high end might be limited as established rivals catch up – and as Apple pushes it own high-end, $349 HomePod. Amazon and Google also offer higher-end models.

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Mr. Sacconaghi also warned that, like most consumer hardware companies, money-losing Sonos will have a hard time improving margins “even during stages of high growth,” he wrote. Sonos products, which are made in China, will also be hit with 10-per-cent tariffs this fall.

Sonos built a name for itself by offering an updated product for the connected age in an established category. It is now betting its future on a rapidly evolving market for a new category whose future is hard to read. For Sonos to thrive, Jason Low, senior analyst with market research firm Canalys, said Mr. Spence may have to change tune again and “the company may have to evolve quickly and rethink how it positions its products, as smart assistants will soon be integrated into more devices and appliance beyond speakers."

For now, Mr. Spence is hoping that “Switzerland” is the place to be.

“What we bring uniquely to the table is a hardware and software platform that supports anything," he said. “We think we’re in a position to become that mass premium brand.”

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