Sonos Must Lean on "Frenemies" as It Expands Its Speaker Lineup

With Sonos' preliminary IPO prospectus in hand, Vincent Shen and senior Motley Fool contributor Asit Sharma consider the company's risks and the significant competition it'll face in the coming years. If you're thinking of investing in this smart speaker pioneer, don't miss the video below!

A full transcript follows the video.

This video was recorded on July 10, 2018.

Vincent Shen: Asit, what does the competition look like here? We've started to mention it, at least a little bit. This is one part of the filing that really set off some actual alarm bells for me, in terms of who they're dealing with in the competitive landscape.

Asit Sharma: Me too, Vince. The company has two sets of competitors. On the one hand, you have audio component makers. Many of these have been around for decades. Again, I mentioned I'm a hi-fi guy. I grew up with these names. Harman Kardon, JBL, Hooke Audio, Bang & Olufsen. These are mostly now owned by larger companies like Samsung and Sony. They have deep-pocketed owners.

In the components market, that's just if you think about these multi-room wireless devices, most of the companies I just mentioned have already developed their own products which compete with Sonos' products. Bose is another great example. One of the biggest channels that Sonos has is through Best Buy. They list out, "These are the channels that we sell to." Bose sits right beside Sonos on the shelves, and we've seen them be a formidable competitor to many different speaker makers that have come. That's one side of the competitors.

Then, you have what I want to call not enemy competitors but frenemy competitors. We haven't mentioned yet that Sonos has a really great ecosystem of content providers. It integrates with companies like Pandora and Apple via iTunes for streaming content. It lists about 100 partners. In this business, you have to have frenemies.

Shift just a little bit over to another type of cooperation, and this is in the voice-activated speaker market. The big elephant frenemy for Sonos is, of course, Amazon.com (AMZN 1.30%). Sonos One and Sonos Beam both feature voice control. It's powered by Amazon's Alexa technology. Amazon is a competitor in that market. Amazon, of course, offers its own components.

To bring up a metaphor, I guess the best one that I can think of would be a point guard in basketball. Think of Amazon as the playmaker on a basketball team. When I was growing up, the point guard was always described as a triple threat. That means that the point guard can dribble, can pass the ball, or shoot. Amazon can, with any company it deems to hold a strategic interest, it will say, "This could be a competitor or something we could roll into our company," it pays attention to. We've seen it do this. On this show, we've talked about Ring, the home security devices. Everyone is familiar with the acquisition of Whole Foods Market by Amazon.

Amazon cooperating with Sonos, putting its technology into Sonos products, has this decision tree to make -- dribble, pass, or shoot. To me, dribble means, "Maybe we can acquire Sonos at some time. We've done that with other companies. We like their technology. We should just swallow them and extend the product line." Pass means, "Let's give them a pass. Let's let them keep going. They're not in our way just now, we like the product. It spreads Alexa's technology into the world. Let them be." Shoot, that's the most dangerous outcome. In that outcome, Amazon simply decides to undercut its frenemy. We've seen it do this repeatedly once it finds a market that it wants to dominate and underprice competitors out of the market. It doesn't have anything binding long-term with Sonos that would prevent it from doing so.

I think you hit that nail on the head, Vince, this is a red flag. I'm really curious to see what your thoughts are. Don't worry about this too much, or, we need to think about it?

Shen: I love the analogy. For me, the issue ultimately comes down to the fact that, given the emphasis that Sonos has placed on smart speakers as an important source of their future growth, their roadmap looking forward, investors do have to consider this predicament that the company is in when both a hardware competitor, with the Echo and the Dot. Then, there are also the offerings from Alphabet, as well. They have this upcoming speaker that will feature Alphabet's own voice assistant technology.

They're powering the software on these Sonos devices. Again, if they decide to pull the rug out from beneath the company, as much as Sonos might try to spend on R&D -- they talk about their strong patent portfolio and things along those lines -- it will be a huge challenge for them to build up the software services side if these frenemies that they have decide, "Hey, strategically, it doesn't make sense for us to support what is ultimately a hardware competitor anymore."