ISP'S face a choice Evolution or Extinction
Monday, September 6, 1999
ISPs Face a Choice: Evolution or Extinction
Internet: As media and phone giants invade their turf, access providers are
reinventing themselves with new content, services or a unique niche.
By KAREN KAPLAN, Times Staff Writer
John Brown is president of IHighway.net, an
Internet service provider in Albuquerque
that caters to businesses with high-speed
connections on ISDN and T-1 lines. Even with a
mere 200 customers, Brown said, the 3-year-old
company posts profit margins that surpass 50%.
But he isn't savoring his success. Instead, like
most people who run ISPs, Brown is frantic about
finding new avenues for growth, lest he be
overtaken by bigger rivals with much deeper
pockets.
"We have to keep growing the network to be
bigger and better," he said. "That's the only way we
can afford the new technologies. It's like a
perpetual motion machine."
For years, companies such as IHighway.net
dominated the market for online access. But with
the Internet blossoming into a full-scale
communications network, media giants ranging
from AT&T and Time Warner to America Online
are using their huge war chests to muscle their way
to the head of the industry.
Their heavy spending on the latest broadband
technologies and splashy entertainment content are
putting enormous pressure on independent Internet
providers to reinvent themselves--or risk going out
of business.
It's not just small Internet service providers that are feeling the pinch.
Even large ISPs such as EarthLink Network and MindSpring
Enterprises are in danger if they don't find a way to be more than a
simple conduit from a PC to the global computer network.
"Three years ago, if you had a fast, reliable connection with no [busy
signals], you could pretty much write your ticket," said Garry Betty,
chief executive of Pasadena-based EarthLink. "Now people expect that
as a baseline. Your ability to differentiate your service means you have
to do things like good software, easy-to-use mail and high-quality tech
support."
The conventional wisdom used to be that Internet access was
destined to become a commodity, with a few companies offering service
as uniform as dial tones. Now that the industry is maturing, those early
predictions have changed. Instead, industry leaders and analysts now
predict a future in which users will have a choice of four distinct varieties
of Internet service:
* A handful of giant companies, such as America Online and AT&T,
will bundle Internet access with other telecommunications services,
ranging from local and long-distance phone service to movies on
demand.
* Other large Internet service providers--cobbled together from
mergers of today's middle-market ISPs--will focus on delivering
high-speed access and related services to businesses.
* A new class of "vanity ISPs" will emerge, allowing groups ranging
from college alumni associations to a beagle breeders' club to share their
affiliation in cyberspace.
* Thousands of small Internet service providers in secondary and
rural markets will continue to earn a healthy living with fewer than
10,000 customers each.
Gone will be the roughly $20 monthly fee for unlimited online access.
In its place will be pricing programs that charge fees based on the
connection's speed and reliability--with demanding uses such as
game-playing and videoconferencing more expensive than simple e-mail.
Some, such as Westlake Village-based NetZero, may even offer
Internet service free of charge, subsidized by revenue from advertising
and electronic commerce.
Internet service providers will also offer high-speed connections,
Internet phone capabilities and Web-based video services to entice
customers, said Greg Tally, associate editor of Boardwatch magazine, a
Golden, Colo.-based publication that covers ISPs.
With more than 5,000 Internet service providers in North America,
the possibilities for experimentation are great. The flashiest innovations
are expected to come from the top tier of about 300 ISPs that together
account for 90% of the network traffic, according to Shane Greenstein,
an associate professor of management and strategy at Northwestern
University's J.L. Kellogg Graduate School of Management.
America Online alone serves more than half of the nation's 34 million
Internet households, and Barry Schuler, president of AOL's Interactive
Services Group in Dulles, Va., thinks he knows why.
"We bundle a group of services like content channels, chat and
e-mail," Schuler said. More bundles are on the horizon, and a number of
varied offerings are likely to survive in the marketplace, he said.
AT&T is building a bundle of its own that links Internet access with
other telecom services.
"With our long-distance, wireless and cable assets, we have the
opportunity to extend our Internet service in ways that no one has done
before," said Michael Chaplo, vice president of marketing for AT&T's
WorldNet, which has more than 1.6 million subscribers.
AT&T has also made a content play. The @Home cable service it
gained control of through its acquisition of Tele-Communications Inc.
bought Web portal Excite on the theory that even high-speed
connections will be a low-profit commodity, while the real profit
potential will lie in giving subscribers a unique entertainment experience.
EarthLink and Atlanta-based MindSpring, which have 1.4 million
and 1.2 million members respectively, insist they will be able to attract
and retain subscribers simply by offering high-quality customer service,
without layering on entertainment or information content.
But analysts doubt that will be enough. The companies will need to
offer a more complete package of services to appease their customers,
whether they take the AOL route and focus on content or follow
AT&T's lead and concentrate on telecommunications. Either strategy
will be expensive and may require the companies to essentially merge
themselves out of business.
"Those two companies are at a pivotal point," said Dave Eiswert,
director of ISP research for Strategist Group, a telecommunications
consulting firm in Washington. "They're going to have to be more. The
question for them is 'How do we do these transactions?' "
Rumors swirled this summer that EarthLink was holding merger talks
with PC manufacturer Gateway. Long-distance phone service provider
Sprint--which owns 28% of EarthLink--is also seen as a possible
acquirer. Under their agreement, however, Sprint can't launch a bid for
EarthLink any sooner than the fall of 2001 unless EarthLink invites an
offer. But if another company makes a play for EarthLink, Sprint will be
free to match or top it. Either way, many analysts see an
EarthLink-Sprint merger as inevitable.
For its part, MindSpring has made vague statements about exploring
potential "business combinations."
"The number of potential combinations would be pretty vast," said
MindSpring President Mike McQuary. Generally speaking, ISPs could
marry other ISPs, telephone companies, personal computer makers,
Internet portal sites, software companies or cable firms, he said.
Merger activity is already well underway in another segment of the
market. Among ISPs that serve between 5,000 and 100,000 customers,
"there's been more [mergers and acquisitions] in the last six months than
in the previous six years," said Deb Howard, executive director emeritus
of the ISP Consortium and co-founder of 2 Cow Herd, an ISP in
Venice.
Wall Street's enthusiasm for Internet-related stocks has helped fuel
merger activity by giving publicly traded ISPs the currency to buy their
smaller brethren. New technologies, such as high-speed digital
subscriber line service, are expensive for small companies to deploy,
and that makes buyout offers more appealing. These trends have
combined to create a new breed of "roll-up ISP," such as Verio,
Voyager and OneMain.com.
"The interest in rolling up ISPs is tremendous," said Eiswert of
Strategist Group.
Walnut Creek-based Verio has bought about 50 small Internet
service providers in the last three years and now serves 254,000
business customers in 41 big cities, said Paul Montoya, Verio's vice
president of marketing. But the shopping spree has slowed.
"We're running out of sizable companies to buy," Montoya said. "The
larger ones have already been purchased or may not be the right fit for
us because they're consumer-focused." Instead, Verio has turned its
attention to companies that host corporate Web sites and has snapped
up five so far.
OneMain.com, based in Vienna, Va., has bought 22 regional ISPs in
less than two years, including companies serving Sacramento, Fresno,
Bakersfield and San Luis Obispo. The company now has more than
520,000 subscribers in small-market cities, said Steve Smith,
OneMain.com's founder and chief executive.
Unlike Verio, OneMain.com is focused on consumers. Smith plans
to build a collection of locally themed Web sites for cities his company
serves. Then OneMain.com will be able to augment its access-fee
income with revenue from e-commerce and advertising, he said.
"We don't view ourselves as an ISP per se," Smith said. "We view
ourselves as an aggregator of content."
Some are taking an easier route by becoming virtual Internet service
providers. A real ISP such as EarthLink provides the actual service, and
the partner--a company, club or other organization--provides the
customers.
"Say I'm the World Wildlife Federation and I have a pool of people
who are interested in me," said Joe Laszlo, an access and bandwidth
analyst with Jupiter Communications in New York. "I pay [EarthLink]
every month, and I get to be the dial-up ISP, even though I don't need
to own the facilities."
The arrangement is so popular that "ISPs are starting that are based
around ex-cancer patients and dog lovers," Eiswert said. "It connects a
group of people that have similar characteristics. Personalization is
becoming more and more important."
But for the foreseeable future, the majority of Internet service
providers--perhaps 75% or more--are likely to remain small. Although
they serve no more than 25 area codes, they need only about 1,000
dial-up customers to become profitable. Plus, operators in small
communities usually aren't challenged by ISPs with national aspirations.
As long as there are Net users who prefer personal service, there will
always be small ISPs, Greenstein said.
"Why don't we just have Midas doing all the muffler repairs around
the country?" he said. "Because there are local service shops where they
have an ongoing relationship with their customer. That could happen
with ISPs. Customers will want to have the local guy they can call at 2
a.m. to make a repair."
* * *
Internet Service Boom
Analysts expect the number of internet service providers to double to
10,000 in five years, and they expect four distinct kinds of ISPs to
emerge:
Giant companies will combine Internet access with other
telecommunications servicees, including delivery of digital entertainment.
* * *
Mid-and-large-sized ISPs will combine to deliver high-speed access
and other Web services to businesses.
* * *
A new class of "vanity ISPs" ill allow affinity groups, such as college
alumni associations,to share an identity in cyberspace.
* * *
Thousands of small Internet access providers will serve secondary
and rural markets, with fewer than 10,000 customers apiece.
* * *
Internet Service Providers (in North America)
April, 1999: 5,078
* * *
Internal Revenue (in billions)
1998: $8.4 million
* * *
PCs Using the Internet (in millions)
1998: 84 million
Sources: Boardwatch magazine's directory of Internet service
providers; Dataquest
* * *
Times staff writer Karen Kaplan can be reached at karen.kaplan
@latimes.com.
Copyright 1999 Los Angeles Times. All Rights Reserved
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