Acquired - The Sonos IPO

0:00Re-cord. Alright. Where does the word record come from? We record again. Yeah, record again. That's great. Welcome to season three, episode three of Acquired, the show about technology, acquisitions and IPOs. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts.

0:34Today we are covering the IPO of a company that has devices littering my home in the most wonderful way, Sonos. So, Sonos was founded with a clear mission, and that was to fill every home with music, or so says their S1, and today we will decide based on their very recent IPO last month, you know, how to go, and we will forecast what does it look like in the future for this IPO to sort of look like an A-plus in retrospect, and, you know, what does it look like if It was a failure in retrospect and what are the things that have to evolve in the landscape of home audio and in the actions of the company in order to play out either of those scenarios. It is a unusually clear and compelling mission. May or may not have been the company's original mission. You'll just have to tune in to find out.

1:24So I want to start with some fun facts because I think they're very interesting about the company. So the first one is Sonos did not sell a speaker until seven years into the company's existence, which is a little shocking based on the company that we know today to think about, you know, two years of no product and then five years of non-speaker products really just bridges, amplifiers, ability to bring non digital music to any home in your room. Yep.

1:50And then here's another just bananas stat to tell you how loyal the customer base is and how much Sonos invests in their backwards compatibility. 93% of the speakers that it has sold over the last 13 years are still active today. Yeah, that is crazy. In all this research, that thing jumped out at me. So the iPhone is not yet 13 years old. iPhone is only 10 years old. How many 10 year old iPhones are still active? Yeah.

2:16I don't know, zero percent. I mean, it rounds to zero percent. Yeah. I believe the actual stat is that 93% of the company's products received an install done over the air update in the last 12 months, which is even more bananas that products from, you know, original products are still being supported with new firmware updates from the company. Yeah, totally nuts.

2:40Well, if you're new to the show, you can check out our Slack at acquired.fm. That's where you can find real-time discussion of the biggest tech news and chat with David and I. Tech news like the wild hour by hour news and tweets trickling out of Elon Musk and Tesla yesterday, which by the time we release this, we'll have developed two or three more news cycles and we will actually know what's going on or maybe not. But as of now, what we know is that Elon believes he has secured the funding to take the company private and has felt so confident in that that it should be announced on Twitter publicly to the world. I actually heard a rumor that Elon, you know, there's all this speculation now, did he violate any, you know, securities laws by tweeting about this. He's now considering instead of using Twitter that he's just going to use the acquired Slack channel.

3:27for future Tesla related announcements. Can neither confirm nor deny. With the density of concentration of people interested in the news, I would say not under reach perspective, but on a density of interest perspective, it's probably a pretty good platform for that. Great platform. So join us at acquired.fm. All right, listeners. Now is a great time to talk about a new partner of ours here on acquired.

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5:47Plenty of things demo well, but the question is whether a busy associate actually reaches for it during crunch time or whether a partner trusts it before going into a conversation with a major client. If your legal team wants to check it out, whether you're a law firm or you're in-house at a company, you can learn more at legora.com slash acquired and just tell them that Ben and David sent you. All right, David, you ready to take us into the history and facts? Let's do it. One note before we start on the history and facts.

6:17Sonos actually has a unusually good, I would say, though a bit biased corporate history on their website, which we will link to in the show notes. Some certainly not all of this history comes from, but they really do a nice job telling the story and like going into all sorts of detail and history throughout the various phases.

6:36much more than your average company. So kudos to Sonos for whoever their internal corporate historian is. Make sure you check it out if you want more detail straight from the horse's mouth as or. And for a company that is so incredibly driven by creating these fantastic experiences and, you know, really the best sound and the best experience of listening to sound, it really shows in things like this where they they care a lot about telling the story the right way. There's really great pictures. It's well laid out. As David you say, We're here to be the judge of sort of how it all really went down and pulling as many sources as we can, but it's a really nice piece. And I think it reflects sort of the culture of the company a lot. Well, and you know, one recurring theme on acquired is there are many versions of the truth when it comes to startup histories. So their version is particularly well told on their website, but diving into our version, the company that would become Sonos.

7:31was incorporated in August 2002. That was quite a long time ago in Santa Barbara, California. Not. Silicon Valley, for those unfamiliar with California Geography, Santa Barbara is kind of between San Francisco and LA, much closer to LA, and is a great town, great place to visit, but kind of a beach town, not like a bustling capital of industry like San Francisco or LA. But nonetheless, company was incorporated there, and it was incorporated as Rincon audio ink, which I wasn't able to confirm, but But I assume that is for Rankon Beach in Santa Barbara, which is one of the most famous surf spots in the world. Of course, another attraction to Santa Barbara. But they would change their name to the Sonos that we know and love today in May 2004, a couple years later. And a little fun aside story on that. So this was obviously immediately after the dot com crash when the company that would become Sonos was was founded. And so a lot of the

8:34kind of service providers to the technology industry were like really struggling for business. So even though these guys were brand new startup, they were able to get David Plasic, I believe it's how you pronounce his last name, who is the founder of lexicon branding, which is basically the best in the business, kind of globally branding firm, especially for tech companies to do a project with them to come up with the official name for the company. So these guys, David and Lexicon came up with the name Pentium for Intel. They came up with the swiffer. They came up with Blackberry. They came up with the power book for Apple and get this. This is the best part totally related on theme here. They came up with the zoom. Whoa. Yeah. How awesome is that? A lot of good track records until that last one.

9:25Until that last, especially because shoot, I believe I don't have this in my nose, but I think I remember reading Robbie Bach is now a board member of Sonos. Ha, small world. It all comes back to Microsoft. Anyway, because it was the dot com bust and like.

9:45no tech companies had any money. He gives them a great deal. They're able to, Lexicon gives them a great deal. They're able to land them. And apparently it was a super long process coming up with the name, the company kept rejecting everything that they came up with. Lexicon's about to just quit and fire them as a customer and then they come up with Sonos and everybody's like, that's it. And that's how the company became Sonos. It's funny how long before I've ever owned a Sonos device, I always thought the name was brilliant. Like it's one of those things where The newest branding which we should put a link in the show notes to the original Sonos branding and then interestingly the Branding that served as a bridge between the original branding and the current branding like the branding is excellent the palindromatic nature of the name is excellent You can because some of these speakers you can flip upside down and it still says Sonos. Yeah, it's just a really nice pleasing name. I haven't

10:36White been able to figure out exactly what this means, but it's also a name that if you turn it sideways, like vertically, it's still... works. It's not exactly the same because the ends and s's are flipped, but it's still very legible. There's a term for this, but I don't know if they were thinking of that initially given that their products would eventually be both vertical and horizontal, but a really, really great name. Yeah, and just while we're dwelling on their branding stuff here for a second, even though we're jumping way far ahead, which it only took us what all of five minutes in order to jump way far ahead.

11:11The 2015 refresh of their brand came with a super cool sort of burst pattern that was a bunch of tiny little lines shooting out of the center of the sonos where if you scrolled it on a digital screen and I think...

11:24this might be because of the screen refresh rate. I'm not totally sure why. It looks like sound waves. When you're just holding it still, you're kind of like, okay, that's kind of a cool pattern around sonos. They're wacky. And then you scroll it and you can kind of see these like, you know, when you look in the top right corner of your Mac at the little speaker with the three lines coming out of it, it's like those little lines sort of coming out of the logo when it's in motion. It's the harnessing sort of like the artifact of LCD or LED screens. So we'll link to that in the show notes too.

11:53You should try it, it's cool. Very, very emblematic of Sonos and their culture. But who are these Sonos guys? So there are four founders of Sonos, John McFarlane, who was the CEO from founding in 2002 until last year 2017. Craig Shelburn, Tom Cullen, and Trung Mai.

12:14How did they all come together? So McFarlane, the CEO, he had moved to Santa Barbara in 1990 to get his PhD in electrical engineering from UC Santa Barbara. He ends up dropping out and he's a pretty visionary guy. He ends up dropping out of his PhD program in 1992 and he founds an internet company with three other people.

12:36Craig, Tom, and Trung who become his co-founders of up-sonos called software.com. I guess too many names were easier to come by back then. Software.com ends up, of course, going public in the.com boom in 1999. Merges with phone.com. The synergies where, you know, you have software.com, we have phone.com. Of course, it makes sense.

13:04they rename the company OpenWave. And actually it did sort of make sense because software.com provided kind of email servers and infrastructure to email providers, and particularly early mobile email providers. So like, and I said, phone.com did, I believe a browser, like a WAP based browser for phones. So OpenWave, which is the merger of these two companies, becomes actually a pretty big company and one of the first pioneers of the mobile smart, not smart internet on phones. Blast from the past. Of course though, the .com crash happens in 2001. All of the former software.com folks leave open wave and decide they need to, they want to figure out what to do next. But they had an insight from that experience in particular as the company became open wave and focused on cell phone providers that

13:58Networks and in particular wireless and wireless networks were like a big technology wave that was coming and wireless networks were gonna be ubiquitous You could already see it in Wi-Fi networks in homes consumers were we're just starting to install even though a lot of people still had dial up Broadband penetration was still fairly low in the US, but Wi-Fi was like a big thing and they could see this coming so John is it kind of has the vision sees this trend happening and he pitches the other three guys on the idea for their next company, not a mused digital music service and hardware for the home. A wireless network for airplanes. Essentially his vision is to create go go. Hilariously, everybody else is like, that's a terrible idea. Who would do that?

14:51One recent fact that I know about GoGo, which I can't remember if I said this on the Tesla episode, is there like one of the top 20 most short hit stocks relative to their market cap. So lots of people continue to think it's a terrible idea. Well, having just taken a long flight and used not GoGo, but another one of the myriad competitors. The product is still.

15:14Terrible, but a necessity. So anyway, the other three are like, no, that's terrible idea. So they're trying to figure out what else they can do. They realize that, you know, they all love music and they all have houses. Now I presume after the IPO and then the merger with fun.com, presumably they all made, you know, quite a bit of money. Hopefully they didn't lose it all in the.com bust. They bought houses in Santa Barbara, and they're all trying to get music systems in their in their houses, multi room music systems, and it's just a total pain.

15:44So they start jamming on that. And they also see these are the days as we've talked about on other episodes of Napster and digital music and MP3s really starting to come up and become mainstream. And they think, OK, well, maybe there's an intersection between these two big trends of wireless networks becoming ubiquitous and the digitization of music and MP3s. So that leads to the clear vision that we talked about earlier of creating devices.

16:13that will enable music lovers to play any song in any room in their homes. And essentially, they want to be the drop box of a home audio, even though drop box doesn't exist yet, they want their devices to just work. That's kind of a mind-blowing concept. I mean, now we live in this world of smart speakers, and even before that, like, before Alexa and Google Home, like this, my sonos won just a... I'm not sure. So perfect.

16:41So before these people who live in our speakers came around, it's still, they call it three, four years ago, didn't seem that crazy. That, of course, it's sort of easy to have speakers playing wirelessly in your home. In 2002, this is so crazy for it. I mean, the people that were able to have a set up in their home where it was easy for them to play music in every room in their home or different music in different rooms. Like, that's a 20 to $50,000 installation at the time of building the house to create this wired system to make that work. This is brand new pioneering completely inventive technology.

17:20I mean, I remember back in these days, I was in high school, you know, 5.1 surround sound home theater systems were all the rage. And if you went to Best Buy or Circuit City or whatnot, they were hawking all this stuff. And I remember, you know, for our family room and other rooms in the house feel like, oh, we need the 5.1 and you buy these speakers and these amps and you run wires or, you know, under the carpets or maybe you drill into the wall and like, it's just a nightmare.

17:47Well, and that was just for TV setup. I mean, the notion of music in different rooms was like, you know, way, way more complicated. And in fact, so now it's even fast forward real quick to today. Like, even though they have this really great 5.1 offering, they're still at their core, not really focused on that. And it's really about this multi, multi-room audio. So that's the vision that they ultimately found the company, Rincon Audio, around in late 2002. But there's just kind of one problem while there are a couple problems, but one major problem.

18:15for all of this vision to work, you know, it's kind of based on this concept of digital audio. There are no streaming services yet, like Napster exists, MP3s exist, you know, people are ripping their CDs into MP3s and putting on their hard drives, but like exactly what I just said, they're ripping MP3s onto their hard drives on their computers. So how are you going to get around that?

18:40So they're undaunted, though. They want to figure out how to make this work. And they do have the Wi-Fi wave going for them. So many houses are especially houses that would consider doing this, you know, have Wi-Fi networks. They decide they're essentially going to build Linux PCs that connect to these existing Wi-Fi networks that consumers will have in their homes and repurpose them as connected devices. So they're not going to have hard drives and they're not going to store MP3s on the devices, but because they are full Linux PCs inside, they can join the network, they can network to your existing PCs that are your desktop or laptop. If you're really future thinking that you have on your Wi-Fi network and access your MP3s from that PC and then play them on the Sonos network throughout the house. Which is sort of mind blowing that they're able to accomplish that because just thinking about like for anyone who's had to ever

19:35allow one computer to access files on another on a home network or through a home network over the internet. The amount of strange permission checkboxes that you have to enable to the extent they made this easy for consumers, they should be applauded a hundred times because having never used the original little controller thing that would auto find the MP3 files and then list it for you and let you select it, I have no idea how they made that easy. Oh man, I mean the technical challenges of doing this were immense I mean what I just described sitting here in 2018 sounds like okay whatever but like think back to where you were in 2002 and just try and imagine that like mind blowing but they had an important architecture decision to make which was do they want to go with a sort of centralized system where they have a primary speaker or

20:29bridge or amplifier that serves as the kind of control hub for all of the replica ones that you would then add to the network. Or do they want to go with a decentralized approach where each amplifier speaker bridge could make its own decisions. You could add and subtract them from the network seamlessly. You could sync and play music in multiple rooms and all that. They ultimately decide that the latter the decentralized approach is much better from a user and consumer perspective. So they decide to go that route. Unfortunately, though, to do that, they figure out that they really need to use a technology called mesh networking. Now, today in 2018, mesh networking is all the rage. You know, all of any new Wi-Fi router you buy is going to use mesh networking. It's superior. We're recording this over mesh networking in my house right now. Indeed. Indeed. Same here. However, again, this is 2002.

21:22None of this technology exists yet. Mesh networking is this obscure thing that is only being used by the military on battlefields. It is nowhere to be found in commercialized technology. It's not productized at all. There are no standards. So Sonos has to...

21:40basically invent all of this themselves. Fortunately, they had John in a team of PhDs in electrical engineering from UC Santa Barbara, so they were equipped to do so. But it was very difficult. And as a result, it takes multiple years, as Ben alluded to at the top of the show, from the start of the company until they actually have any kind of working prototype.

22:02built. And so it wasn't until 2004 that they have just a prototype of the first product which ends up being called the zp100. the zone player 100. This was before the rebrand. They needed to re-enlist those lexicon guys to help. Yeah, I don't know. The lexicon guys were like, we're done with you. We'll give you a name and nothing else. But the ZP100 is, as we alluded to, it's a networked amplifier for existing speakers. So if you have speakers already in your house, this replaces your amp that powers them. So you still have to hook up speaker wire to the speakers. And this got rebranded as the connect amp.

22:41for anyone who's familiar with sort of what this would become in today's product line. Yeah, which is crazy. You can still buy it today. I think lots of people still do. In fact, I know someone who's building a house right now, and they have all these speakers that they want to use, and they don't want to go buy a whole bunch of new Sonos speakers, so this is the right answer. Yep. Yep. McFarland takes this.

23:03prototype. He brings it to CES in 2014. People think it's really interesting. And then later in the year, he goes to the All Things D conference, which this is before Cara Swisher and Walt Mossberg left the Wall Street Journal to start recode. This is when they were still doing All Things D within with in WSJ. And he goes to the conference and demos it there. People love it. It's the same D-Show where Steve Jobs goes on stage in a keynote. I don't know if it's a keynote or I think it was an interview with Ida Carr or Walt. And he introduces Apple's airport express Wi-Fi router, which is also going to have an audio jack plug on it in his Apple solution for a audio. Super clueless. And it's clear that Sonos is the way better experience.

23:51My personal history with this is having a set of Bose computer speakers that I used growing up that I then brought to college, that I then brought to Seattle, and I moved out here. And my solution before going with the Sonos one was like, you know, as a diehard Apple person, I think I had some Apple router that airports something, and I would airplane music from my computer through the router to the speakers, and it was terrible. Like you would have this.

24:16Three-second delay when I decided to stop or start anything, you know, fast forward to today. The newest and best Sono stuff is finally, finally actually getting AirPlay integration because Apple took forever to get AirPlay 2 out. So, we'll hold judgment on the HomePod. We'll revisit that later, but Apple has always had a little bit of a overzealous journey with wireless audio, then what actually manifested. Well, in the Airport Express, you can only control it from your PC, right, from your computer. Yeah. Well, his phones weren't worth a thing, so yeah.

24:45Yeah, it's not like they shipped a little controller for that. Yeah, there was no controller, no controller. So, funnicide here. So, as John is demoing his prototype, he uses the song he uses to demo it is the Beastie Boys, no sleep till Brooklyn, produced by Rick Rubin, a super famous producer, who ends up becoming an advisor to the company later, which is cool. But also fun, this is also on the Sonos corporate history on the website. When they were testing it, they ended up playing the band 10,000 maniacs and the song 3 a.m. by matchbox 20 over and over and over and over and over because the Sonos UI for the controller was everything was alphabetical. And those were the that was the number one band and the number one song listed. So funny. That was true for I mean that like I remember on my original iPod playing three doors down over representative of time because it was the first thing in my life.

25:42the downsides of the click wheel user interface. So they finally ship the zp100 to the public in January 2005. Great reception by the tech press. Walt Mossberg calls it quote, easily the best music streaming product I have seen and tested. So awesome.

26:02The vision has come true. They have shipped to this Apple like amazing product. And boy has the definition of music streaming changed. Yeah, but yeah. You would think people would rush to buy them. Sonos thought people would rush to buy them. People don't rush to buy them. And there are a couple reasons for this. In sales there.

26:22Okay, like the company is not gonna go under, but they're not also gonna be, you know, the next unicorn here, even though that term is won't be coined for many years. A couple of problems. The biggest one is that so this is a device intended for people who listen to music digitally, participating in the digital music revolution. Who is participating in the digital music revolution at this point? It is not older people who own and are buying houses. It's Teenagers, it's college kids, it's, you know, people who are definitely not going to buy Sonos and don't own a house. It's been in David who are rotating out what Napster songs they can fit on a hundred megabytes of storage based on whatever they like at the moment.

27:07Yeah, or I guess at this point, it's not Napster. It's because it's lime wire. Lime wire. Yeah, all that stuff. Anybody who's using Kaza and why lime wire at this point definitely is not buying. The other problem, you know, you could say, like, oh, well, but, you know, these kids, they are buying like MP3 players and stuff, but the ZP100, it costs $1,200. So like, I don't care how much of a, you know, young budding audio file you are, you're not spending $1,200 on this thing.

27:36That goes on for a few more years and, you know, they have this super niche market of older adult who own homes who also care about digital music, but they're working on developing the next generation of products. A couple of things happened. 2006, they had the ability to stream music directly from the world first.

27:55actual streaming service, Rhapsody, which was initially part of real networks up in Seattle. It's pretty awesome. Like the sonos, the ZP100, you can stream Rhapsody songs with no PC required, just directly into your home. It kind of is like the MVP of the experience we know and love today. Yeah, wildly ahead of its time. It's 2006. And doing the research, yeah, I could not believe this solution existed in 2006. Yeah, nuts. Then in 2007, Obviously, something pretty important happens.

28:27the iPhone launches, and that's going to be a mixed bag for Sonos, as we'll see in the coming years, but they do embrace it in the beginning. And immediately after the App Store opens in 2008, Sonos within months launches a free app in the App Store that completely replaces the controller, which is sort of the scroll wheel device that you have to buy separately to control the ZP100 with a free app for your iPhone. And then now you can control your Sonos system with your iPhone.

28:56pretty awesome. Android, they launched the Android app a couple years later in 2011 and then ultimately they phase out completely their own controller hardware in 2012 to go all they had on on just apps. I'll say something very funny about this. So having gone full Sonos last November, I then had to go find a company called iPort, which makes Sonos compatible hardware to buy a controller for my Sonos system because I have the 5.1 like sub and play bar and all that hooked up when I'm watching I don't want to have to take out my phone to turn up and down the volume when I'm watching a movie. That's amazing. The circle has completed itself. You're now like, you know, you are peak millennial. You know, it used to be millennials where like sitting in college dorm rooms would never use this. Now, not only are we using it, we're like going back and buying third party hardware to get back to the original experience. Yeah. So funny.

29:52And to be clear, I think Sonos has a better answer for that, which is integrating with your actual remote control for your TV, but for every reason, couldn't get that to work. That's such a good story. That's great. If only that were included in the S1 prospectus, maybe they wouldn't have priced so low. Forshadowing. All right, listeners. Now is a great time to tell you about a longtime friend of the show, Vanta.

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32:01Okay, November 2009, they finally released what they've been working towards for years and really is the Holy Grail product of the Sonus experience. At the time, they call it the Zone Player S5. Man, they really needed that rebranding. It's now the Play 5. It's an all-in-one Wi-Fi speaker. Speaker integrated.

32:25directly connects to Wi-Fi in the internet, can stream all of the, well, not Spotify yet, Spotify's still small at this point, but the music streaming services that exist, and it costs $400. And this thing is big. Like, for people that know about the Sonos 1, so the play wants today, like, this thing's a brick and behemoth. Yeah, quite large, but, you know, $400, like, you know, large, you're gonna put it in a home, but maybe you'd put this in an apartment. So this is Sonos' real first wedge into.

32:54the mainstream. On the back of that, sales really started to pick up. And in March of 2010, index ventures invest 25 million in the company. It's very hard to find out how much money they raise or well, you can find out how much money they raised, but the history of their fundraising before then, all we know is that they raised about $40 million along the way in the eight years between 2002 and 2010. It was from a venture firm called BV capital, which is now rebranded itself as e-ventures, and also angels, a bunch angels. So we can't find out who invested what, but interesting fact from the S1. There was an angel named Valderkoa, who had been an exec at software.com with all the founders.

33:37And he must have invested a ton in the company because even at IPO, he still owns 7% of the company, even despite all the delusion that is still yet to come. And interestingly, eventures was not a greater than 5% shareholder. We're going to get to that in a minute. I believe they get bought out.

33:53interesting side factoid. The person who leads them, this investment for index, Mike Fulpie, and joins the board of centers, he had previously invested in software.com when he was at Cisco. So he knew the team from that. The next year in summer 2011.

34:10two big things happen. One, they come out with their next Wi-Fi enabled speaker, the Play 3, which is still sold today. And the price point for that is $2.99. So they're getting closer and closer down into the mainstream price point. The much bigger thing is they add support for Spotify in the summer of 2011.

34:28Yeah, and it's worth pointing out a couple of things about one, these speakers and two, sort of the pre-spotify era. These speakers are really nice. They're designing them to sort of compete in the audio file market and...

34:41in saying that I know that's going to be a sensitive term for a lot of people. So it's probably not quite playing in the market of the super high-end audio hardware that you would find at a CES sort of in the private hotel suites and people that work in sound studios. But let's say they want some of that market and the next level down of people who sort of truly love music in their home and who are really obsessed with creating high quality sound in their home. And so yes, three and four hundred dollar speakers are expensive, but they're very nice speakers.

35:10The other thing is, yeah, 2011 is when they added Spotify, they already had Sirius as well, Sirius XM, or I can't remember if they had joined at that point, but that was in February of 2011. So they started with Rhapsody, then Sirius, and now adding Spotify. Spotify is not...

35:28A huge thing yet, and so it's not totally clear to them that, you know, this is a binary thing for us, but they are starting to plant the early seeds of playing the Switzerland strategy across anybody who is providing music. Yeah. Well, on the other big, big thing about Spotify, just like we talked about earlier in...

35:472005, 2006, people who are listening to digital music are, you know, Ben and David in college, Spotify in 2011, 2012, 2013. This is now where millennials are listening to music. And they're paying for it. And they're engaging with it, you know, heavily. In 2011, they hadn't come to the US yet, right? No, I'm sorry. They had. They had. That was like 2009 or 2010. Yeah. Which actually that's an important thing that I didn't have in my notes that is important to note about.

36:17Sonos, the US is only about a third of the company's sales. About two-thirds of the company's sales come from international markets. Europe being the largest, pan-Europe being the largest in Indonesia as well. So it's very much an international company. So on the back of that, they've now gotten into the 299 price point.

36:39Spotify is natively supported on the platform. They're starting to get into the mainstream. They're starting to get into the younger millennial market. In 2012, KKR, the big, enormous, huge private equity fund, they had started dabbling in tech investing and growth investing. They come in and they lead a $135 million investment in the company. Interestingly, only 45 million of that is primary is money raised on the company's balance sheet 90 million of it is secondary so they are buying shares directly from Sonos shareholders as opposed to the company itself raising more money and again it's hard to parse exactly what happens so that's 2012 a couple of years later in 2014 KKR leads another secondary round so no primary all secondary the net of all of that is that

37:32BV slash eventures pretty much completely exits the company. And as Ben mentioned, and the S1, there are nowhere to be found on the cap table. They've been in the company for a long time now. They get liquidity, they get returns. But as we'll see at a much lower evaluation, then the company ends up going public at.

37:49The other thing that happens now, I don't know if it was in conjunction with KKR investing or if this was in the works separately anyway, but Sonos hires a guy from rim who had been the head of sales at rim named Patrick Spence and Patrick comes over to Sonos and he joins as chief commercial officer essentially head of sales for the company. That's going to become important in a minute here. For anyone who's read the prospectus. For anyone who's read the IPO for a success. Yes.

38:182013, the next year, we had mentioned when we were talking earlier about the 5.1 surround sound system in the home theater market, Sonos enters the home theater market itself, not just the music market with the Playbar soundbar product. And on the streaming side, by this point, I think in 2012, they added the Amazon cloud player for folks who remember that music service. I think next year, maybe 2013, they added 10 cents QQ music.

38:42So they're really starting to build up this arsenal of wherever you get your music from, it's delivered over Sonos. So on sort of the upstream side of the business and then on the downstream getting very serious about all these different speaker offerings. Yeah. And they also add around this time, Mog, which fans of the show and of Tech History will know we have discussed. Mog gets acquired by Beats, becomes Beats Music.

39:06gets acquired by Apple becomes Apple music, but more to come on that. The other device that they introduced in 2013 is the Play 1. which is now $199.00. It is a one speaker. The play one is one speaker. The play three is three speakers. The play five is five speakers all housed in the box. They introduced the play one for $199.00. So now they are like solidly in the mainstream on the device side. And this play one is like totally company changing. They've now entered a market that isn't currently, I mean, in what, 2013?

39:39It's not served very well, you know, $200 speakers. There are people who want $200 speakers in their home. And this is before the era of smart speakers. And so streaming started to come online. It's really a key moment to have a speaker at a price point like that. Yeah. And this is like huge for the company explosive growth. They grow in that fiscal year. So the company has a September fiscal year. And so in fiscal year 14, which is from October 2013 to end of September 2014 revenue grows 75% at the company on really on the back of the play one and all the the wave of Spotify integration. So this is huge. The company seems to be super well positioned. All the investors must be thrilled. They're heading towards an IPO. Things are going great. We're now in November.

40:30of 2014. Super interesting time for the company and really interesting as we are doing research for this episode to talk to folks who sort of did business with with Sonos at these different services. People that were at the company that were involved with the company and sort of get their perspective. At this point streaming is totally taking off. By the end of 2014 there were 15 million paying subscribers on Spotify. The notion and the company is really, hey, we've got this $200 speaker that we just announced.

40:59We actually have a meaningful share of the people who have a Spotify account buying Sonos devices and really buying these $200 speakers. We can totally just ride that wave and draft off that and it's going to be awesome. And if you do the math, like if you're subscribing to Spotify, you're spending what $150 a year ish on Spotify, you're making that kind of commitment. Why wouldn't you spend $199 and get it in your home or your apartment with great sound. Absolutely. Some of us have definitely bought into that. So fast forward one year to 2015 Spotify is just blowing up.

41:40And as it turns out, the major thing contributing to that is that smartphones have mass proliferation, data plants have gotten way cheaper, people like listening to these streaming services on their phones, which isn't great for Sonos, because what Sonos was sort of drafting off of was people using streaming services in the home. And so at this point, Sonos' growth is not keeping pace. They're not keeping that large percentage of Spotify users that they previously had as Spotify continues to blow up. And so they're sort of strategic crossroads where as a company of people who are obsessed with the experience and truly audio file or near audio files themselves, what do you do to stay true to yourself?

42:22And so what Sonos does is they continued to invest in super high audio quality, but lots of people just do not care enough to buy a 199 network connected speaker in their house. Probably a lot of listeners know what we're talking about when we say audio file. But just to describe, we're not saying audio Fi, like a file of audio. It's a lover of music. PHILE, someone who really loves music and cares about sound quality.

42:49It's probably a good, good donation. Good disclaimer. So what does Sonos do with this sort of existential point in their company's existence? Well, that year they released a $500 play five, the newer, better play five. They launched True Play, which is this, I think it's called True Play. This really beautiful way to tune your Sonos setup to your room, which is kind of a fun thing to do if you have Sonos to hear this crazy sounds bouncing off the walls and tune it. Most people aren't going to spend $200 on a speaker and they're sure as heck not going to like care enough to tune it to their room. And so they're advertising that year during the walking dead, these very expensive ad spots, they are really just demonstrating this feature and showing off how crazy true play is. And David, who is the music producer that you mentioned worked with with Sonos? Rick Rubin.

43:40Yeah, Rick Rubin is in these ads. And so it's, you know, they're sort of like paying Rick Rubin. He's walking around barefoot. It seems like this sort of strange sort of hippie high end thing. So yeah, the world is shifting toward, you know, listening on mobile and they're introducing higher price point speakers. They're spending a lot of money to market the true play feature. They're not exactly moving to the lower price point and going mass market. And they're really showing that they're not willing to compromise and to double down on really showing that Spotify is launching Spotify Connect at this point, which is a really magical experience for a lot of people who use it out there today. And what that would enable is really easy native playing from Spotify directly to a Sonos without using the Sonos app and stuff like that. Sonos doesn't feel that Spotify Connect at that point provides a good enough experience for multi-room listening, which I really don't think it did. It would have been kind of a kluji solution and wouldn't have unlocked the power of all of Sonos' sort of multi-room

44:39room flexibility offering so they don't play ball with integrating with Spotify Connect at first and they sort of roll their own and I think they miss out on an opportunity to get Spotify sort of promoting them as hey this is the best way to use Spotify by doing that. There was another piece in there too where I think it would have left some of their customers behind because It required custom hardware to be able to do the thing that Spotify wanted them to do, which a lot of their speakers didn't, and I think they eventually overcame that and figured out as a company how to do it without making it for their newer speakers only, but it really shows another value of theirs, which is not discontinuing old hardware and making it so that every customer of theirs can have a really great experience. Yes, backward compatibility, you know, as evidenced by ZP100's still working out there, getting firmware updates.

45:23This is a huge strategic challenge for the company. One final point I want to make to bridge to where I know you're going is remember I was saying people aren't willing to pay $200 in mass market for a network connected speaker. Well, it turns out they may be willing to pay $200 for a smart network connected speaker. What would they pay $200 for? That's a good question. Well, it's funny. I didn't know about the walking dead spots and commercials and like how funny is that? I mean, This is going to be really mean to Sonos and I don't intended that way, because they do pull out of it. But they're advertising during this period on The Walking Dead. Who is The Walking Dead? It's Sonos for God's sakes. I mean, November 2014, as I was alluded to, a little company called Amazon, makes a big announcement out of nowhere, launches this crazy product that

46:17People have no idea that it's what it's gonna do what it's gonna work on the heels of the failed fire phone right on the heels of the failed fire phone everybody's like Jeff Bezos is not a product guy He doesn't understand anything consumer. He doesn't get consumers They come out with the echo Don't don't don't November 2014 launches introductory pricing for only for prime subscribers of $99 for You know, this thing does not sound as good as a play-five or a play-three or even a play-one, but like, it fills your room with audio. A room-filling tin can. Yes. But, you know, it's loud.

47:00And most importantly, you just talk to it. And it does stuff for you. David, that's the most millennial opinion of audio. That's a great encapsulation. But it's loud. It's like the number of people who still play on either crappy Bluetooth speakers that I heard a stat a while ago and I don't have it in front of me. But the number of people who play podcasts and even music out of their phone speakers is disproportionately large. The people just set it on a table and play. And that's why Apple added all these like better speakers and double speakers to iPhones and iPads, because a lot of people just don't care enough. And they're like, yeah, I can hear it. Walk down Market Street in San Francisco. Like there are a lot of people, especially kids these days, just walking around playing, you know, playing music or whatever out of their, out of their phones. Convenient speeds quality. Yeah, indeed, indeed. Well, turns out that Amazon and Bezos were actually onto something with,

47:57the Echo and it's included Lady A, shall we say, so we don't enrage listeners in their homes all throughout the world here. Sonos does not see this coming at all. They are totally flat-footed. You know, A, they've got the strategic challenge that Ben was just talking about of like, they're now weirdly going up market in a time where, you know, the market is moving down market in terms of audio quality and accessibility everywhere. But when it comes to smart speakers and voice assistance, they have done nothing. So the history of the company was they were actually out ahead of the technology waves in terms of wireless connected speakers, but now they are way behind. The company has always said they're about democratizing the ease of accessing music in the home, but there's a little bit of what I say is different than what I do that goes on. Because if it's really democratizing, then their execution should follow that

48:55they make speakers available to the most people and make it the easiest possible experience in order to just play music. Like sit there and yell at your speaker but it's not totally clear what created the blind spot but they really have stayed premium and they really didn't do anything with voice and it kind of shocked them and the world when Amazon started doing something with voice.

49:17And McFarlane, actually, he talks about this in an interview. This is a quote, we were late to recognize the impact of the Echo and the Echo Dot. I mean, the Echo Dot Amazon sells these things like when they go on sale for 30 bucks. Like, it's crazy. And voice overall, I think the magic Amazon did was clear that undefinable bar of usability. All the voice systems before that weren't But being able to walk into your home and say, I want to listen to KCLU or KCRW or whatever, also telling that he's talking about radio stations here, not podcasts. Come on, John. Living the 21st century here, he says, that's part of an ultimate home music experience. So we needed to get there. We pivoted the company. And that they did in a serious way, not right away, you'll notice.

50:05November of 2014 is when Alexa is first announced and the echo is made available to prime subscribers. And then it goes general availability in 2015. I believe it's summer of 2016 when Sonos sort of formally switches their strategy to...

50:22the burning platform. Yeah. To be sort of voice first and announce that they're going to have products with voice baked in and at the very least right away they're going to start integrating their existing products if you have an Alexa in your home. The product experience for that is if you bought an Echo and you have a Sonos system that, you know, let's say you have a Play 5 and a Playbar, you could say something like unnamed voice assistant.

50:50play XYZ song on play bar. And then it could play it on there. So, you know, it's a little bit of a stopgap solution before they eventually release their own Sonos ones. And now the Sonos beam, which are voice baked in, but they're perhaps a little bit too late, but switching strategy in a big way. So yeah, it takes a long time. The Sonos one, which is essentially the play one, but with microphones in it. So you can actually talk to it. And it is, you know, Lady A baked into it. And coming Google Assistant will get to that as well. That launches in October 2017. And then the beam, which is the same thing in a sound bar format for home theater systems, that launches only last month in 2018. Yeah, so we are in the middle of this right now. We're in the middle of it. Yep. Good time to go public. Well, so a couple things. I don't know what exactly it was a result of could be a lot of things, but certainly missing this.

51:48both of the strategic inflection points as Andy Grove, famous CEO of Intel, would point them, would say was not good. McFarlane announces in January 2017 that he's gonna step down as CEO. And Patrick Spence, who we mentioned earlier, who had come over from RIM when KKR invested, is gonna take over as CEO. And McFarlane, like he stays in the company as an advisor, but he leaves the board. He really hands the reins over to Spence. It's a pretty fulsome transition.

52:17And then spence, you know, from that point forward is now leading the company into this new voice era. So let's talk about that a little bit. When they launched the one in October, 2017 and announced the beam, they come out with a pretty interesting take on the voice world.

52:35They say they're going to bake Amazon's voice assistant into the products you can talk to the speakers. They will work just like Echoes do, which Amazon announced super early on in the in the product development of Alexa that they were going to make the Alexa voice service open to anyone that wanted to include it in their device. They also so knows announces at the same time that they are in the future. It's not ready yet going to support Google assistant as well. So you will be able to multi-home with your voice assistance if you go the Sonos route, which makes sense. You can see why an Alexa and why Google want to do this because their main goal is just get the most people interacting with their service. Amazon's going to sell these many different use cases of fairly inexpensive Alexa devices to get them biggest proliferation possible. And we think today they've shipped something like 40 million or more of those, but their strategy is really just get people talking to Amazon through whatever.

53:32whatever they need to be. And Google's sort of the same way. A really interesting potential, you know, argument to consumers. If you are like Ben and you're going to outfit a home with smart speaker technology, do you want to lock yourself in to the Amazon ecosystem or the Google ecosystem or anyone ecosystem? Or do you want to be able to use whatever and switch between them?

53:58First of all, this is all future-looking because we only know about what the Alexa integration actually looks like right now because it's the only thing that's shipped. But I can tell you this sort of my consumer psychology around it. I am not convinced there's any value to being able to real-time or dynamically multi-home. There probably won't be a scenario that arises where I'm like, oh, I need to talk to Google Assistant now rather than talking to Alexa.

54:19crap, sorry everyone. The psychology for me was really I don't know how this is all going to play out yet and I don't want to invest thousands of dollars into one ecosystem so the longer I can stay neutral, basically gives me option value as a consumer and preserves my option value for longer.

54:37curious, when Sonos talks about the value of having multiple voice assistants, are they really thinking about the use case where people are going to use multiple voice assistants? Or is it really sort of this like piece of mind that people should choose them because it means they don't have to make a choice? And if we know anything from watching consumers over the years, if you give them the option to not choose and continue to make no decision for longer, they will. Well, I made a decision to go...

55:04full on Amazon ecosystem. But that was mostly driven by Prime Day. This year where these things were on sale for so cheap. I was like, why not? Even if I don't like it, I'm spending a couple hundred dollars on many devices. I can just recycle them. I'm like, ain't buy something new. But I could see a world in the future where Wave runs on Google Apps. It has my calendar. It has my email. It's like, Amazon doesn't have any of that. I would like to talk to Google and have it.

55:32do things for me in the future. At the same time, I would also, I really like the Amazon ecosystem. So anyway, it's a very interesting position that they're almost like a save that they've gotten themselves into here. And you can see how this strategy evolved because I think people who are newer to Sonos look at it and go, oh, that's kind of an interesting business strategy. Like they're not building their own voice assistant and they shouldn't because it's a terribly expensive R&D cost and it requires network effects.

55:59two good ones out there. I'm going to ignore Siri for the moment. And then we'll get to Siri. Yeah. A lot of people are at least we're a little puzzled when Sonos first announced that we're going to integrate other people's voice things. But if you look at them historically and you think The company's actually just looking at these voice assistants the same way that they looked at streaming music services and that they're going to sort of be in the middle and be the bundling point for all of these other offerings. It starts to make more sense from the company psychology of why they would do that because they like Apple make money selling hardware that's differentiated by software and services.

56:36they just aren't necessarily providing all the services. The question is and then that of course is where we'll get to later in the crux of the company is how differentiated are their services and is their software really and otherwise are you just sort of competing on audio quality, which is a little bit of a tougher vector to compete on now. But as we look to the history of the company understand a lot about why they're making the decisions that they're making now. Also, I do want to touch on Siri.

57:03They've announced Siri integration. Apple obviously isn't a very different position. Amazon makes money on you when you buy stuff. Google makes money on you when you search for stuff. And Apple makes money on you when you buy their hardware. And so for Apple, they released HomePod, which had limited adoption, which I think they probably knew, but didn't go gangbusters. Siri really exists as a way to differentiate Apple hardware so that you should...

57:25buy more Apple hardware and invest more in the Apple ecosystem. It's not really in their best interest to make that available to other people. Not that Siri is itself better than any of these other services anyway, but the access to plug into Apple devices is differentiating. For example, if I were to tell Siri, and I'm going to refrain from addressing, hey, if I were to tell Siri that you should add something to my reminders list, it works really well. It's really nice. It's unfortunate that I can't bark at my Sonos 1 until it to add something to my reminder's list because I won't see it on my phone. And so you can see how like the HomePod is differentiated in that way. What they have announced is that coming with AirPlay 2, there's some limited Siri functionality. So when you look at the business models of Apple, Amazon, and Google, you can sort of see why Apple is really integrating less with Sonos than the other two companies are. It's so frustrating as a consumer with this stuff because like, at least for me, like,

58:23I love the Amazon voice assistant and like I think it's really good. I haven't really played too much with the Google one. A series is just terrible in my experience. Like I hate it, but you know, especially like I've got the cellular watch and like I go for a run. I love having the cellular watch of like I think of things when I'm running. I'm like, oh remind me, you know, Siri remind me to do this. That's great. I would love to have, you know, much better.

58:48cross-functional, cross-ecosystem accessibility here, just like we do on mobile and on the web. Maybe there's a world where Sonos becomes that, you know? I don't know. Yeah, there is definitely this trend that we saw before with Google Maps and Apple Maps, where it's sort of companies have a disagreement on whose customers they really are, and companies have a disagreement on how they're thinking about those customers strategically, and then the consumers lose because of it. It's totally frustrating. Yeah.

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1:00:55So if you're trying to turn AI ambition into real business outcomes and make it work safely, securely at scale, go check out servicenow.com slash acquired and tell them that Ben and David sent you. Well, all right, to bring the history and facts on home here in the middle of all of this.

1:01:13The company announces they're going public. Interesting timing, but I can shed a little light on the timing from talking to folks. Basically, there was a notion that, hey, maybe we'll be acquired. That could totally happen. And when Apple released the HomePod, it was really like, okay, Apple's decided to build not buy. We would sort of be the people that they would buy. Google already has a thing in market. Amazon has a thing in market. Save sort of like an Android manufacturer. There's really no one left. We can be a standalone company. So let's go be one.

1:01:43And I presume also at this point, investors, you know, certainly index invested back in 2010 and KKR invested in 2012 and they have shorter, you know, time horizons for their investments. I assume there was desire for liquidity on the investor front here. So July.

1:01:596th 2018, they filed a go public. Rumors are that they expect a kind of two and a half to three billion dollar valuation. The company did just under a billion dollars in revenue last year. They then a couple weeks later after the road show starts, they announced their pricing range of $17 to $19 a share, which is lower than that rumor. The midpoint there, $18 a share would be about one and three quarters billion valuation. They end up pricing on the eve of the IPO at $15 to share under the range so that gives it a market cap when they start trading of just under one and a half billion. They do pop on day one, they start trading on Thursday, last Thursday, August 2nd, they closed it near $20 and then yesterday they closed at $19.15, market cap of just under

1:02:50two billion, but you know, it's interesting. This was not like a hot IPO here. No. And they actually only raised $88 million in the IPO, the rest of the tender, the 130 million because it was a $208 million IPO actually came from existing shareholders. And so it's only 88 million of new cash into the company. Yeah. It was KKR. It was index. It was other investors and employees who were selling. That's also typically not a great sign into an IPO. But again, I mean, I'm sure there's huge desire for liquidity here. We'll transition into narratives here, but just a couple points to keep in mind. They want to draw out as we do talk about narratives. They did about a billion dollars in revenue in 2017, but they just haven't been growing very much. They've only had about 10% revenue growth over the last couple of years, and typically high-flying IPOs are at least 20% revenue growth year over year, but really you won in the 40% plus. I think it was a little higher. I think there were 18% revenue growth, but still half or a third of what you'd like to see.

1:03:47They also disclose their revenue by who their largest sales channels are. Interestingly, Best Buy is the largest sales channel. 17% of Sonos sales happen at Best Buy. Now, remember, only about a third of their sales happen in North America. So, like, it would be a little more than a third, but almost half of their North American sales are coming from Best Buy.

1:04:11That's troubling. And you can read two things into that. You can read an edition to be troubling. One, you can read, they're paying a lot of money to the channel because they're not retelling these things themselves from Sonos.com. They're probably spending 50% on a wholesaler and then another 50% to the retailer. This is just a huge markup when you have to go through a channel like Best Buy. The other thing you should read into that is it's interesting that it's not coming through Apple or Amazon or Google because I'd say in a advantageous light for the company, company, it reduces the reliant. You could think about those three companies as now supply chain for Sonos. They're sort of the component that Sonos builds into their smart speakers.

1:04:52It's nice to not have your supplier or one of your suppliers also be your retailer. And so they found themselves in a nice place where they sort of have their Switzerland sort of bundler there. And of course when I say Switzerland, I'm meaning sort of neutral third party, but they're a neutral third party bundler of these services. Their biggest sales channel is also a neutral third party, which is good because if it was all on Amazon, then you'd start to get a little nervous that Amazon's gonna apply pressure to sort of squeeze Google out.

1:05:21and vertically integrate it in some way. So I would say not good, not bad that it's through Best Buy. But who shops at Best Buy? Like it's not millennials, it's not Spotify listeners, you know? So it's interesting. Before switching fully into narratives, there's a couple key numbers to know. One is Sonos has 19 million products.

1:05:42in approximately 7 million households around the world. That 19 million, you can compare it to 40 million plus Alexa devices that have been sold. Again, sorry for saying the name. It's just interesting to sort of keep that in mind as you start to see the smart speaker, the low end smart speaker segment grow very quickly. It'll be interesting to see what the high end smart speaker grows at because the way that I sort of see this going is there's tons and tons and tons of $150 devices sold and it might be a tougher road for...

1:06:11I don't know, selling more expensive ones. The other thing to know is that they're right around break even on net income. The six months leading up to the IPO, they were net income positive, but only by about 13 million. They were net income negative before that. And I think they did some things, head count reduction or other things as they approached the IPO in order to be net income positive. So that may not have been in the same time frame, so don't Hold me to that, but the way you should think about this company is they're still kind of break even. If you look at like their price to earnings, it's something insane, like 70X. So you should look really at their price to sales, which is just a hair under 2X. So they did a billion dollars of revenue right now. They're valued a little under $2 billion. And what you should really look at in that number is they need to grow their profits a lot to really grow into that valuation. And they're kind of priced reasonably based on revenue.

1:07:03Growth is the question mark here. Yeah, yeah, there are company that's growing 10 to 20% per year and they're definitely priced to grow so Well, should we should we lay out each side's narrative here? Yeah, absolutely. Let's start with Sonos the company desperately wants to be seen as a software and not a hardware company They are are really trying to avoid comparisons to Fitbit or to jawbone And oh bad We could do a whole episode on that someday. Yeah, they're pounding the strum of we are not just a manufacturer of devices. We have this like unbelievable pioneering technology that is really woven the whole home together. They're really trying to spin that story and tell that message. There's another intellectual property story that they're telling that is that they have a patent portfolio of 630 issued patents and 570 applications in progress. So, you know, we're an IP machine. We sort of

1:07:57invented this category of wireless multi-room home audio and everyone else is just sort of like you know playing around in our backyard now and sure we're integrating with some of them because the voice stuff is a title wave and we need to be there but you know we're the we're the big guys here we started here we invented this way it's the it's the Steve Jobs line from the the iPhone keynote boy have we patented it yeah Yeah. Some other things Sonos is sort of espousing is that we have a non-hardware growth story so they haven't ruled out doing digital services business in the future which it's not clear what they mean by that. Probably not a full assistant but maybe a little sort of for programmers out there like subclasses of an assistant or being able to add additional

1:08:44sort of features to any given assistant just to create. It's almost like customizing Android firmware, like to create differentiation on top of the core assistant that you inherit from. It's like Xiaomi and the MIUI. Yeah. Yeah. Maybe they're thinking that's our own streaming service, not totally clear there either, but they've said they haven't ruled that out.

1:09:06Other thing that they talk about a lot is that 27% of Sonos households own four or more products and 61% of households have more than one so they're sort of retention and expand once they land is huge so the bigger base they build they don't have to re-acquire that customer in the future and they can just sort of get cost-free revenue which is nice or at least acquisition cost. The way they frame this I think is right and true is our customers, people who try us love us. You know, once you get a sonos, you use it forever and you buy more. And so that sort of justifies extremely high sales and marketing costs. And the last message that they're really pounding that I've got is this is the first time I've seen this term. I don't know if it existed before, but if it's something they coined.

1:09:55in the S1 they regularly refer to the sonic internet as the wave and that people are totally overwhelmed with screens and that voices the answer and the the quote is that they're well positioned for this as the leading home sound system for consumers content partners and developers sonic internet I love the product. I think I bought two to start and not going to disclose how many I've bought now. So that's a very real thing. Well, before I open up any questions, that's Jonas's case. You hit all of mine except the only slightly different one I had that you covered a little bit is they talk about this concept of like we're the only company in this whole space that puts the listener first. And if you look at Google, if you look at Amazon, if you look at Apple, they are

1:10:46making choices as I expressed earlier, my frustration with some of the choices that those companies are making that is not putting the listener first, that is putting their own business models first. Sonos is making the argument, we put the listener first, and so we will let any open platform play ball with us. We will work tirelessly to make all assistants work and integrate easily in our platform. That's a great point. Their incentives are aligned with the user. They're not trying to make money from them in other ways after selling them a device.

1:11:15Now, should we move to the other side? Yeah. Well, we'll just trade bullet points back and forth. So the first one that I have seen that really speaks to me is this story that they're telling around growth, a non-hardware growth story isn't really there. Wariah Bear, I would say it's difficult to see them creating software services that people will pay for on top of buying devices. Yep. Yeah, not only is that...

1:11:40Not there, but like your growth story period is not there. You know, you're growing between 10 to 20% like, okay, you know? Yeah, in a high end segment, which I'll go into the next one because I think it comes from that high end segment. Awesome. Like you should think cool. We're selling Mercedes. Like, well, we should have great margins. They do. They make really nice gross margins. They sell above 40%. I think in some of their categories at 46% in the last six months, but They're 16 years in and they're just barely breaking even on a net income basis because they pay a ton in sales and marketing costs. Both to the channel and through advertising, it's just expensive to acquire the customers they're trying to acquire. Yeah, I mean, this is a very considered decision. I mean, how many hours, days, months of research did you put into deciding how you were going to outfit here?

1:12:32Yeah, how many conversations with other smart people that I respect and, you know, want to understand their perspective and, yeah, a lot. Yeah. I have a few more. One is like, yeah, okay, like your voice story, you know, that's interesting. This is what's like, you've got a good one. But like, you were way late. And like, this whole Switzerland thing is like, you were way late to the market. And like, you know, you keep saying Google Assistant is going to ship. I don't see any Google Assistant on any Sonos devices yet.

1:13:01is this really going to be as easy as you say it is to fully integrate all these platforms? Yeah, and the fear is that they really do get commoditized to being a hardware maker when that's not where the money is and they're selling expensive hardware. So they end up looking a lot more like a Fitbit or a job on than a Spotify. And the sort of bottom line for me is can they find the segment that's not price sensitive, cares a lot about audio quality, cares about audio all over the home, and wants an agility between voice assistance. It's tough for me to see that being a big segment, especially if you're not able to make money hand over a fest on each customer. My two others are, I think the loyalty point that Sonos makes is a really good one. That's crazy. 27% of their customers have four more speakers. Ben, you are a case in point. Once you try it, you don't stop and you're hooked for life. That's great, but...

1:13:57I feel like their business model is not aligned with that. They don't have a subscription business model. Spotify's business model is aligned with that. People start using Spotify, they love it, great, they're paying Spotify every month. With Sonos, it's still dependent on them coming out with new products and adding them, and the replacement cycles are so long on this.

1:14:22Now that I have a bunch, and I'm almost embarrassed by how many I have, but it's awesome. I'm kind of done paying that company money. Yeah. They would have to come out with something amazingly new that you would replace those. You're not going to build an addition on your house just to buy more Sonos stuff. I was going to ask you this during tech themes, but it's too apt right now to not do it. They sell hardware that's differentiated by software and services which they bundle in for free with the hardware.

1:14:49Sounds a lot like Apple. That's a huge growth business. I mean, first of all, they're selling a product that has perfect product market fit that they have a high margin on and everybody wants, which is different than Sonos because Sonos only really gets the high end segment.

1:15:04But I guess let's address some of the major differences. The refresh cycle is rapid for Apple. It's every two years or so for an iPhone. Once I invest in that ecosystem, I kind of don't stop buying stuff. I mean, I'm buying an iPhone every two years and buying a computer every three. I'm buying a watch every once in a while, buying AirPods, I'm paying Apple...

1:15:22because they're cheap for eye cloud storage. I'm buying apps and they're getting a cut of that. So not only is it fast refresh cycle on the hardware, it's also that they have very real value they can offer through software and services that I'm willing to pay for. It's what Tim Cook is beating the drum on on every Apple earnings call is Apple has two business models. They have the hardware business model, which benefits from a quick refresh cycle.

1:15:46they also have the services business model, which is essentially a subscription or a pay-as-you-go fee-for-service business model. And that's generating $10 plus billion in revenue every quarter for them. As Sonos tries to convince investors, we are a software company, not just a hardware company. Does that matter if they're not monetizing the software and services? I think so. I think it matters a lot. Yeah, I mean, it seems like even if you do all that software and services, you should still be valued like a hardware company unless you're generating cash flows from those things. Right. That's my point is like your fair like your product is great. Like your services are great, but like your business model is not aligned with your product and services. That's a great point. And then the other quick one I had, I don't know how far this is. If this is more me projecting than anything else, but because I do think speakers are interesting, but like also headphones and personal devices are also

1:16:40real interesting, um, see AirPods and Apple's acquisition of Beats. Sonos doesn't do anything in that. What makes sense now that they've locked me in as a customer to offer me where I'm like, here are hundreds of more dollars. Well, um, imagine AirPods that, you know, you could use Amazon's assistant or Google's assistant or Siri or, you know, like that's compelling. Yeah. It's so funny how I talked to my phone for some things and my speakers for others. And it does feel like that should be unified.

1:17:08particularly the notification point that I mentioned earlier. Like I can't ask my phone for a flash briefing and I can't ask my speakers for adding something to my to-do list and it's super frustrating. Yeah. Alright. Those are my points. Alright. What would happen otherwise? I think we really covered this. I mean, I think they basically needed to IPO. You could have like a little...

1:17:31McFarland Elon style take public or take private or something or you know buy buy outright if you start to look around it who acquires could have been it would have been Amazon in 2013 or 14 deciding to instead of Hiring their own hardware engineers to buy Sonos instead and then base it on that and I think once they made the decision to start building that out the LADA ecosystem Themselves they they weren't gonna buy by Sonos Google probably the same thing Amazon would have had to have made that decision even earlier. They started work on the Echo in 2010, 2009, 2010. So I don't think that ever really would have been on the table. Yeah, the only other one you could sort of see is a Android phone maker. I think the most interesting one though is what if Apple had acquired Sonos instead of Beats?

1:18:19Oh, I see. I was going to make the comments of building their own for the HomePod, which they had all that expertise from the iPod Wi-Fi or iPod Hi-Fi. That's interesting, instead of Beats. I don't think they would have, though, because the real reason they bought Beats was Mag was the streaming service. They bought it for the hardware and the headphones as well, but Sonos not having their own streaming service kind of made that a non-starter, I think, for Apple.

1:18:47and the beats connections into the music industry and contracts they had signed in order to really make album music have a fighting chance against Spotify Rick Rubin is great I have tons of respect for him as an artist but he didn't have quite the same industry he wasn't involved in the business side in the same way that the beats guys were this is quick sidebar it's a revisit from a previous episode we talked about sort of how Apple music and Spotify work doing Spotify Like, really seems to be ramping. We don't need to adjust any, you know, calls we made on previous episodes, but like Spotify seems to be sort of pulling away. Well, I don't have great numbers in front of me, but I think Spotify now has like 70 million paying subscribers, and Apple Music is somewhere around 40. Wow, interesting. I remember I at least being more skeptical on Spotify and more bullish on Apple Music, but...

1:19:43I don't know if it sounded like I'm being very critical of Sonos. I am in some fronts, but I think they also are doing something really interesting and I do see the value of, you know, open platforms and Spotify is much more than on the music streaming side than Apple Music is. Well, we'll have to keep watching that battle and see what plays out. Yeah, it's fun. Like we didn't intend this this way, but like we kind of have this mini series going of music, you know, from Sound Jam and iTunes to beats to Spotify to Sonos.

1:20:13And we can give ourselves credit for sort of these like accidental cool mini-series, or we could probably look at household spend and just determine that we are gonna end up in mini-series based on transportation, food, you know, entertainment. Yep, yep, smartphones. Yeah, yeah, yeah. Waves, yeah, tech themes. Perfect, SAG into tech themes.

1:20:38And of course, my first one is technology waves, which is probably what you were going to go with, too. Yep. And I'll just sort of name them, and then we can talk about them. There was one they rode and fell off, and that was streaming services, changing the way that audio is consumed. And then there's a second one they're trying to ride, which is voice assistance disrupting home audio. Yeah. What I think was interesting, there was one even before streaming, which was just wireless networking.

1:21:02In general, and Wi-Fi and homes. Yeah, I mean, I think the big takeaway for me and like waves throughout this episode is just how important it is to time them correctly. Like, Sonos has built a great company and they've got great products, lower priced IPO than they wanted, but still like this, a multi, almost $2 billion company. It's great. This company could be so much more if they had timed the streaming wave and the smart voice assistant enabled speaker waves better.

1:21:29they could be a $20 billion, $40 billion, $50 billion company. Let's examine that. How would you have time streaming services better and what would you have changed? Because my view of it is that it's time streaming services perfectly, but ended up just without an offering in the smartphone and headphone space and really only were in the home where that's not where most the listening was.

1:21:50So you would either had to go down market or diversify on product. I would argue that they were too early on the streaming wave and that their DNA from the initial kind of wireless networking wave of wanting to be like super high end prevented them from like the correct strategic decision would have been in call it.

1:22:092012, 2013 to go all in on how do we get as many apartment living millennial folks as possible who are Spotify subscribers and their core base. How do we get them to buy a sonos product and get into the sonos ecosystem and kept a relentlessly driving down market on cost or even just starting there as a company versus like doing this weird like, oh, we're going to go back up market now. Yeah. There's no discounting premium product. Yeah. So you think the way you could have road that way better would be to sort of appeal to the fatter part of the segment. Well, like he said, there's 70 million Spotify subscribers now, right? And there are seven million homes with Sonos. Like that's one 10th penetration many years later. Like that should be like 80% penetration. And then how would they have done voice assistance better? I mean, they would have had to start building their own, I think in like 2013. Because imagine if they had a $100 product and they had their own voice assistant, I mean, then

1:23:07these things would be everywhere, but I think the R&D costs required for that. It needs to come from a fang company. And I don't know that you could really do that as a private company. So absent the resources to do that, could they be riding the voice assistant wave any better? Yeah, that's this one's harder because it's more out of their control. I don't think they could have built it themselves. I think they could have been faster to market on integrating Lady A and Google and Siri if they can.

1:23:37But that's outside of their control in a lot of ways. There's another pattern I've noticed, which is kind of interesting. So Breakthrough hardware company produces expensive device. Then component costs come down and others are able to do it, leaving them sort of only with a small segment who cares about either brand or quality, or has some sort of ecosystem lock in for some reason. And one, I'm definitely thinking of as job bone because we used to see $300 job bones who invented the portable USB speaker category. And now they're $8 dangling from the checkout at that CVS, not that we're seeing exactly the

1:24:10that in speakers, but after sort of poking around a little bit, the components have become a lot cheaper, and there has become a lot more know-how on how to build good audio systems. And so I think we're able to see people like Amazon run loss later businesses on hardware or break even or small margin businesses on the speaker hardware. And it may not be the greatest place to be to...

1:24:32be the one who invented the category and brought the cost down for everyone and then have someone sort of out-compete you strategically. And so, of course, then the only hope of combating this is really with network effects, like what sort of Fitbit was trying to do in the competitions and really building a strong brand and habit in consumers' lives. And my mom has a Fitbit, so I want to Fitbit. And the other way that you could sort of compete is with channel and supplier contracts, like what Roku is doing, where Roku has relationships with Netflix and Hulu, and then they also have relationships with all the TVs that bunch

1:25:01them in. So they're sort of making a few bucks on every TV that's sold and sort of diversifying the way that their platform is used without them having to sell all the devices themselves. We're seeing Sonos sort of try and do all these things, when you think about the channel relationships, they're definitely doing that with all the fang companies, or at least Amazon and Google, the supplier contracts. You know, Roku did that with TCL and all these TV companies. Sonos just announced they're doing that collaboration with IKEA. It's unclear if that's the right sort of brand alignment for them to be bundling a premium product into an IKEA piece of furniture. So, no, millennials. Bottom line. I guess when I take a deep breath here, how do they avoid?

1:25:44Going the the path of the job on. Yeah. Yeah. Oh, man. I originally wanted to include a lot more job bone in the history and facts is like a parallel path. I think we should just do a whole episode on job on someday. Man, that is a wild ride of a company. Fun fact, job bone and Airbnb shared an office building for several years. Talk about two divergent paths, but anyway. Yeah. And amazing people at job bone. I mean, like true missionaries, visionaries, brilliant.

1:26:14the world is better for job-owned having existed. Yep, yep. Also a wild ride. Well, minor tech theme, footnote to this story, but I just think it's an interesting thing that I've been thinking about this whole season three with Tesla and Xiaomi and now. Sonos, this idea of being the iPhone of something and what I mean by that is over-the-air updates of hardware devices and improving them, either hardware or any experience, improving a core operating system or hardware seamlessly and quickly. It's just such a powerful thing and like every company should do that. Like the fact that Sonos is upgrading adding features, adding services to devices that are 10 plus years old, would a powerful technology lever versus Chevrolet or GM or Ford that's like, oh my car that I bought in 2005, still the same car I bought in 2005.

1:27:10You know you need to align your business model so that you make money continually from your customers as you're providing them value Which Tesla doesn't? Sort of right now, but I think they are maybe getting there in the future with charging and supercharger networks Jerry's still out a little bit there When we inevitably do one or several more Tesla episodes, it's an interesting lens to use and keep revisiting of how they continue to make money off of their existing customers. And the criteria that we laid out earlier in this episode is the refresh cycle fast enough. Are there services revenue and is there enough high-value products that you can continue to sell them over time to bridge the gap until the next refresh cycle?

1:27:55Tesla could go either way right now, but I can see a path with the energy networks. I have one more. In the S1, Sono states that experts believe that half of all web searches will happen through voice within five years. I read that as well. That is nuts. Like when you think about the implications of that and sort of my favorite one that I've thought about and don't have a great answer for is when you search for something, you get results. When you ask for something from an assistant, you get an answer. And results leave one to five spots for blue links that are paid. And answers leave zero spots. And it will be fascinating to see Google's business model change if this proves to be true. It's obvious why they're in the voice assistant market. If that's where search is going,

1:28:50I just haven't come up from a product perspective with the answer of how you sell advertising or monetize voice-based, sort of high-intent search. It's a bold claim. We'll see if it becomes true or not. But if it does, also interesting, and I think explains a whole lot about what's going on in this space, who is the company that stands to gain the most from that future? It's Amazon, because I think Amazon is no, I believe they are no longer Google's biggest customer, but they're like one of their topics.

1:29:20Amazon pays so much money to Google for adwords for products. Amazon has shifted the mind share such that more than 50% of products searches start on Amazon now instead of on Google. Exactly. So anything Amazon can do to move consumer searching out of a world where they are paying any amount of paid search to Google is good for them.

1:29:44Yeah, Amazon actually has the aligned business model with voice search and Google does not because Google does not make money on the transaction whereas Amazon does Yep, by Amazon by real estate in Seattle Well, uh, one of us. Wait, sorry. I shouldn't yell by Amazon. We should, I think like we actually should disclaim, this is not a stockpicking show. We don't recommend that you buy or sell stocks based on our actions. I'm sure there's a more official way we could say this. But, um, and that was clearly a joke, too. You know, if you want, if you decide, do the work and decide you want to buy Amazon or, or Seattle real estate, or whatever, or HQ two real estate, wherever, why is that not been announced yet? Toronto. I don't know.

1:30:27Toronto or DC, but I'm still going to Toronto. Yeah. I thought it was supposed to come out last Wednesday. I thought there was some like narrow down announcement that didn't seem to happen. I don't know. What are those guys doing over there at Amazon? Guys and girls. Yeah. Yeah. All right. Grading. Should we bring this home?

1:30:45Yeah, so Listeners who may have not have caught the last couple episodes in season three We did have decided that when something happened very recently We will not just arbitrarily grade it We will paint the picture of what an A plus looks like how they could get there and then sort of paint any other cases as well, you know with historical acquisitions we have the data to be able to show that and here it's really super speculative. The way that we tend to grade these things is what will they do with the money that they raised and will and was it a good idea to IPO to raise that money? It was a good idea to IPO because they needed the liquidity and they weren't going to sell to anyone for the evaluation comparable to what they could IPO for. So yes, they should have IPOed. What will they do with the $88 million that they raised? I think largely continue to fund operations. It's not like this tranche of cash gives us a new

1:31:36They needed money to fund operations still because they're such a sort of cash flow narrow business. I can see two ways where it becomes hugely successful. One is if they figure out how to either go down market or release things outside the home like headphones and they're able to be the way that lots more people get access to multiple voice assistance. If they're able to sort of secure the contracts and relationships so that I can realize my dream of being able to talk to the same device to set a reminder and to hear a flash briefing. The other way that they could become successful is if they do figure out a real way to get services revenue off of me. And I don't know though what those are yet, but it's not unreasonable. I think this could become a, I don't know, you name it, five billion dollar market cap company just on writing the natural course of things and wave there on, which is like,

1:32:35Millennials who subscribe to Spotify are getting older and buying homes and doing what you did, you know, and so sales will naturally increase because of that, but that's not an A plus. That's like a B. So I think I agree on the A plus. You know, on the C, I think maybe it's that, but the price points just remain so high that people make a decision that I made of like, I'm moving in San Francisco and to a bigger place and Want to outfit it with smart speakers and prime day came along and I was like, hmm, well, I could spend a couple thousand dollars and do this with Sonos or I could spend a couple hundred dollars and do this with Amazon. And I went with the latter. Quite honestly, if it's just business as usual and there's no sort of strategic or material product change, it's probably in the C or D land. Again, our grading criteria is a little funky right now because it's not. We're sort of at this point now grading

1:33:29the company, rather than grading the actual event of the IPO, but my prediction is that this becomes a nice company that grows into a, it stays between the one and a half to three, three and a half billion dollar valuation and at some point deserves it. There we have it. There we have it. Carvouts. Carvouts. Let's see, I'll go first. So the one I referenced on the Tesla episode that I wanted to do then, but I pulled back because we were already so far over time. Now is a good time to do it. Brotopia by Emily Chang. I read it. You all should read it too. Everyone should read it. I thought mistakenly. I was like, well, I've read all the headlines. Like, I'm super steeped in tech. I know if, you know, everything it's good. Like, I felt like one of those books where like, yeah, I should read it. But, you know, I already know what is written in there. And I read it and I was like, no, it's worth reading the whole thing. There's...

1:34:24just so much more detail and stories and things that, you know, I didn't know. And, you know, it's not lost on us here at Acquired either that we're now in, you know, episode three of season three. And we've covered three really great interesting companies here, which, you know, we're proud of our work that we've done on them. But there are, you know, no women that we've talked about at those companies founders or otherwise. And that is definitely not lost on us. So everybody view it as your homework and opportunity. Read Britopia. Well, I now feel silly recommending a podcast with a man. Well, that's okay, too, but I am the exact same camp that you are in thinking I've read all the headlines. I've read a bunch of excerpts from the book. I'm sure I know. So homework, it is.

1:35:13My Carvoud is another podcast episode called Invest Like The Best and this particular episode has the guest Andy Rackliffe. And so Andy has a founding partner of Benchmark and the CEO of Wealthfront. There's a lot of amazing things on that episode and I'll give one anecdote but the main takeaway on Andy is when that guy talks it's like these pithy statements of correctness and it's just like an amazing action packed 40 minutes or whatever it is of great point, great point, great point, and true intellectual honesty and value alignment. So he sort of admits what he's not great at or maybe like what benchmark decided not to do and what that enabled them to do by not doing something. And I think a lot of people try and pay lip service to being great at lots of things and it deludes their message. And Andy is just so crystal clear on we are not that we are this. We put energy behind being good at this.

1:36:07And one interesting thing that he pointed out was a lesson that he learned from, I think it was judo. It was the martial art that all strengths are also weaknesses. And when you look at someone else's strength, how is that also a weakness for them that you can sort of exploit? And so when they were the scrappy upstart starting benchmark, they looked at the big guys, Kleiner Perkins, and noticed that Kleiner had a...

1:36:32big team and when you sort of went to Klaner, you sort of got the individual partner because there were so many people there that you sort of just had access to that one partner and that benchmark was really about like you get all of us. It's five of us and you get all of us. And the other point on top of that when they were analyzing Klaner was when you take investment from them, they aggressively try and create deals between a lot of their portfolio companies. And of course, this is from 1995. That's great, but you may not necessarily want that. And so benchmarks take was Sure, we'll introduce you to people if you want, but we're not forced anything, it's your company. And so by just looking at the things that make your enemies strong, you can find ways in which you can differentiate and be strong against them. And so I just thought that was...

1:37:16really cool and there's 10 other awesome tidbits like that in the episode so go listen to it. Yeah, so good. Andy was one of my professors in business school at Stanford and he's the real deal and it's such a good place. Clearly he has a disciple of Sun Siu in the art of war. Know yourself, know your enemy, know the situation. That point also has stuck with me in starting wave and how we've positioned ourselves.

1:37:42I'm sure you guys at PSL and tech companies and startups are the same deal. I mean, it's written all over this episode. You can't start something new and position yourself in the same way as the existing ecosystem. You have to be opposed. This is why bundling and unbundling is a TikTok cycle. All right, listeners. Now is a great time to talk about one of our favorite companies, Statsig. Yes, there is a reason why the best product teams rely on Statsig, whether they are iterating on their core product features or shipping AI-powered experiences at scale. Yep. In the crazy speed of today's AI world, shipping fast is just table stakes now. It's basically trivial to build and deploy your app constantly. The real advantage is how quickly you learn

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1:39:01All right, well, if you haven't subscribed and you want to hear more, you can subscribe right now from wherever you're listening to this, from your favorite podcast client or if you're on the web, acquire.fm to sign up for our email list or join the Slack. If you feel so inclined, we would love a review on Apple podcasts or any love on social media. So thank you so much for listening and we'll catch you next time. We'll catch you next time.