We do expect to see additional competition from Excite@@Home for the set-top and PC
venues. The Excite brand offers ATHM a unique ability to reach into the marketplace
and build brand, services and customer loyalty in advance of cable-based access
being available. Further, in the category of the enemy of my enemy is my friend'
we can expect to see further alliances between ATHM and MSFT to the extent where
ATHM is not a threat to MSFT and both can benefit by weakening AOL's position
publicly, politically.
It is, we believe, too soon to suggest how MSFT could (or will) reach into the
consumer market with an anywhere strategy. Beyond the PC platform (which the
company already controls via the operating system) and the browser market (where
MSFT and AOL also compete following AOL's acquisition of Netscape earlier this year)
the next battle is in TV-land a market that is clearly neo-natal today.
Accordingly, for MSFT to have any impact to AOL's "Anywhere" strategy we believe
that Microsoft would have to deploy products at nearly every venue and level where
AOL now has a presence. Funding such an effort, though considerable, is we expect
well within Microsoft's ability and running at a loss is a non-issue with MSFT as
has been demonstrated in the past with the efforts behind Windows, Win.95/98, NT,
Back Office, the office suites and other now market leading tools and services.
In the dial-up arena, the question facing investors is how MSFT can capture and
retain a user's attention and loyalty. Increasingly, we believe that the
consumer cares less about how they reach their online content (news, sports, e-mail,
chat, etc.) and cares, instead, far more about the quality, consistency and
ease-of-use factors that influence a user's decision to remain with a system or
service.
Yes, we believe that MSFT is exceptionally well positioned to simply give-away
access in the form of dial-up services. Yes, we believe that such actions could
generate tremendous attention and short-term demand for services yielding
subscribers for MSFT that could (and likely will) fuel additional press-fodder.
However, we note that the real battle is not for the access path but for the
commerce contribution on a daily, weekly, monthly and quarterly basis. As noted
below, we expect that near term traffic on the MSFT networks may not accurately
reflect longer term consumers.
As with any new system or product there is natural curiosity. With curiosity comes
lots of try' type users but the market has yet to see sustained conversion rates of
valuable' (multi-revenue stream producing) clients / subscribers. For MSFT to
have a meaningfully negative impact to AOL revenues and or subscriber levels, they
would have to reach out and capture the core AOL user a move we view as difficult
under the best circumstances. We expect MSFT could enjoy success reaching to the
top-end and bottom-end markets (where users are self-directed, and price sensitive)
but the core of AOL revenues come from the mid-portions of the consumer bell-curve
a space we believe to be heavily fortified and difficult to break open.
Reaching To the Subscriber Base: Perhaps one of the most important issues
challenging Microsoft's potential threat to AOL is how MSFT intends to reach the
clients. AOL is bundled on nearly every computer shipped to retail (and many
commercial) channels. The software is pre-loaded, and, AOL has made their now
infamous CDs available everywhere from cereal boxes to coffee stores, book stores.
The CDs are now even co-resident on leading compact-disk (CD) offerings such as the
recent Ricky Martin smash hit "Ricky Martin" (featuring the track Livin' La Vida
Loca."), which has sold over 4 million copies to date. Consumers are being
inundated with the AOL brand and exceptionally strong affiliations to content and
services that consumers demonstrate an active interest in.
Microsoft, like may of the free-services providers including Juno Online, must first
reach the customers, second incent them to switch, and third, create compelling
vehicles to retain their interest and attention. While the use of an E-Mail
identity has long-been considered the sacred-cow of customer retention,
increasingly, the E-Mail id is not enough. Users want content, entertainment,
information and a definition of "their space." We understand that the term for
creating such patterns and actions is called "habituation" and, like AOL,
Microsoft will have to spend tens, if not hundreds of millions of dollars to reach
and retain audiences.
Doing so will, we expect, require the company, which has recently divested one of
their core content assets "SideWalk" to TicketMaster-City Search will, at a minimum,
have to create a compelling set of services for their consumers. Of course, making
such an effort financially viable on a stand-alone basis (the same basis on which
AOL, Excite@@Home, and others are measured) will be important and one we would be
surprised to see Microsoft reach quickly. While MSFT has ample resources to fund
and promote the development of an "AOL Killer" we note that the ability to effect
success in the market will prove challenging.
MSN the Microsoft Network has yet to enjoy success despite its pre-load on every
Windows 95/98 system shipped (we note that unlike the AOL and other icons, users can
not easily remove the MSN icon from their desktop environments). Accordingly, we
believe that the market will have to be presented with very compelling content and
services before any early window-shoppers become customers and threaten AOL's
flagship products or current, or expected future installed subscriber base.
Looking at the "FREE" buyer / Subscriber: Turning attention, for the moment to the
free' buyer / subscriber it is important to note that this market segment often
has the weakest demographics and highest churn rates. It is possible that MSFT
could help, rather than hinder, AOL's net profitability by drawing off the problem'
users. Such a circumstance could offer AOL the opportunity to strengthen
advertising rates (CPM volumes and fees) as well. We also expect that the average
yield' for subscribers (amount of money spent with the AOL service, in total on a
monthly or quarterly basis) could also be expanded as the churn' and low-yield'
clients fade from the AOL roles.
Vendors such as Juno Online and Dixon's FreeServe (in the U.K.) base their business
models on limited access time, low customer acquisition costs and the ability to
generate offsetting advertising and direct-marketing revenues through profiling and
reserved real estate (banner / sponsor advertising space). We note that as the
market turns to more advanced content services, such as streaming video and audio
content which are now emerging and are expected to enjoy significant growth
following the wide-scale release (and availability) of broadband services via
telephone systems using digital subscriber line [DSL] technologies and/or
cable-based access) that the cost of providing free' services increases
dramatically.
While we note that the free' market offers will likely be limited to the
narrow-band (dial-up) access with speeds up to 56 K/bps AOL, we expect, will
increasingly add users via the broadband channel. In this context the $9.95 in
revenue expected for AOL (as a portion of the $39.95 total access cost to the
consumer) will yield greater online time, lower operating costs for AOL, and the
potential for significant increases in E-Commerce and advertising revenues. In
effect, AOL will, we expect, capture better consumers for lower costs while many
competitors fight for the lower tier of customers.
We do expect that the free-serve model will remain in the marketplace as there is
always a segment that will select services using price as the only discriminator,
however we expect that AOL will be able to contain the impact of these users within
their operating model.
What is more important, we believe, is the ability for AOL and others to capture
users to their web-based services. AOL, unlike Microsoft, has a strong cadre of
content sources including AOL.COM, the Netscape portal, and following the
acquisition of Spinner an expected plethora of multimedia content tools and
services. While we fully expect Microsoft to match and even exceed AOL in
acquiring similar types of properties (or making access to them available via
partnerships and licensing agreements) building such products and services which
we fully expect MSFT to achieve will take time.
Prudential Securities Incorporated makes a primary over-the-counter market shares of
Excite@@Home, RCN Corp., and Microsoft.
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