Free ISP's have prospered in the UK and Europe because local phone calls are metered rather than flat-rate. ISP's get a cut of the local phone charge, which produces a reliable revenue stream. And the local phone charge greatly limits the amount of time that users spend online, greatly reducing the cost, per user, of maintaining an ISP.
In the US, local phone calls are flat rate so users can (and often do) stay on around the clock with no penalty and ISP's get nothing for the call. Companies offering free ISP services, such as NetZero, therefore have only one option for revenues: advertising.
In the case of NetZero, advertising is in the form of a 468 by 60 pixel window that is no part of the browser and can be moved, but never closed. The sales pitch to advertisers is that they can target users directly instead of targeting websites. NetZero knows the demographics of each user, and it tracks the users behavior (no price = no privacy), allowing for real-time updating of the user's profile.
How NetZero has fared depends on how you measure success on the Internet. Between its October 1998 launch and June 30, 1999...NetZero claims to have signed up 1.17 million users and is now a top 10 ISP. That is certainlyimpressive, as is the roster of firms underwriting its IPO: Goldman Sachs, DLJ, and H&Q.
Ultimately, though, NetZero's success has to be measured in its ability to make money, and on that score, this business model remains questionable. As with most Internet companies going public, NetZero is running large losses. What sets it apart, however, is that NetZero also has negative gross margins---rather large negative margins, in fact. For the quarter ended March 31, the company reported revenues of $781,000 and cost of goods sold of $3.979 million. Though cost of goods sold will not rise commensurate with users, they are not fixed, and the magnitude of the current negative gross margins should make you wonder just what subscriber level and advertising rates will be needed to produce profitability.
In making the transition from a company which succeeds in signing up subscribers to one which makes money, NetZero faces three challenges, all of which will be faced by ANY free ISP in the US.
First, the is the challenge of selling targeted advertising. Thus far, NetZero has sold the typical banner ads that are sold on all sites, but its prospectus notes that "our revenue has been generated primarily from non-targeted banner advertising." To pay for the cost of the free services it provides, NetZero will need to sell higher-priced targeted banner ads. It has yet to do so.
Second, NetZero must prove that users will use its service. Of its 1.17 mln subscribers, just over half -- 613,000 -- used the service in June. There are several factors which might inspire a subscriber not to use the service:
- The ads -- users are always subjected to the 468X60 ad box on screen
- Lack of privacy -- NetZero will track the websites that a user visits
- Poor service -- busy signals, slow speeds, or poor customer service are possible if the company does not keep up with demand
- Secondary service -- even NetZero admits that many users who sign up for the service pay for another ISP; it could be that users sign up only to use the service while out of range of their local ISP, or perhaps just to compare the service to their current ISP.
Whatever the reasons, the 52% usage rate in June suggests that NetZero has not been particularly successful at retaining users. The company may have benefitted from a curiosity factor among technophiles, but it has yet to tap into the mass market that has fuelled AOL's growth. The turnover problem could be a factor for all free ISP's.
Finally, NetZero and other free ISP's face a tremendously daunting challenge in the long term: broadband access. As cable, dsl, and wireless offerings become more prevalent, the attractiveness of free dial-up access will diminish. Though NetZero claims that its strategy of buying Internet access from wholesalers positions it to transition to broadband technologies, it is far from clear that the price will be the same. In other words, the company might be able to offer broadband access, but not at a price that holds out any hope of profitability. |
