A dose of reality (good) on AOL: -
Free Web Service Is Seen
As Little Threat to AOL
By NICK WINGFIELD
Staff Reporter of THE WALL STREET JOURNAL
America Online Inc.'s Bob Pittman says he has a "little dark secret" about
the $21.95 monthly fee that most of its 18 million users pay for online
access.
Despite AOL's strong growth in advertising and marketing revenue, "if we
didn't have those fees, AOL would lose money," says Mr. Pittman, the
company's president and chief operating officer.
Investors are concerned. Shares of the Dulles, Va., company have tumbled
nearly 50% since April, in part because of anxiety that a wave of free and
cut-rate Internet services might crimp AOL's subscription fees. Those fees
made up about 70% of the company's revenue in its last fiscal year.
Like other giveaways on the Net, such as Microsoft Corp.'s Hotmail
e-mail service, free Internet service providers have caught on in a big way
with many users and with the venture capitalists backing the services. The
largest free provider, NetZero Inc., has more than 1.7 million registered
users. CMGI Inc.'s AltaVista, Freei Networks Inc. and others have begun
offering no-cost Net access as well. Then there is Microsoft, which has
broadly hinted at its willingness to slash access fees in order to build a
larger audience for its MSN service.
But how much does AOL really have to fear from free Internet-access
services?
For the foreseeable future, not much,
according to many analysts and AOL
executives. They argue that the business model
of free ISPs is questionable. These companies face the same or possibly
heavier costs to support their telecommunications networks than does
AOL. At the same time, free ISPs have no monthly subscription revenue to
cover those costs. Instead, they hope to one day make a profit from selling
ads to companies eager to reach Web surfers.
"The great lie is, 'I'll make it up in advertising,' " says AOL's Mr. Pittman.
Clearly, there are believers that free ISPs can succeed. In fact, the first
initial public offering from a free ISP, NetZero, is expected to make its
debut Friday. NetZero, Westlake Village, Calif., which is one of the
companies that requires users to look at ads on their computer screens as
they surf the Web, has attracted funding from high-profile investors such as
idealab! Capital Partners and Compaq Computer Corp. The company,
which also plans to make money through electronic commerce, hopes to
raise $110 million from the public offering being led by Goldman Sachs
Group Inc.
But some analysts who have examined NetZero's
financial filings to securities regulators are highly
skeptical that such companies will ever be able to
cover their costs. "I've never seen a worse
business model in my life," says Brian Oakes, an
Internet analyst at Lehman Brothers. A company
spokesman declined to comment because of
regulatory restrictions surrounding the IPO.
By contrast, Mr. Oakes is more bullish on the
AOL model. By his analysis, AOL pays roughly
40 cents an hour per user in telecommunications
costs. Since the average AOL user stays online 27
hours a month, AOL spends about $10.80 a
month to keep each user online. AOL says it generates about $4.50 a
month per user in advertising, commerce and other non-subscription-fee
revenue; that would lead to a loss of $6.30 a month for every user if AOL
didn't charge them monthly access fees. And that doesn't count the money
AOL spends on customer support, marketing and other items.
Controlling Costs
Free ISPs say that by carefully controlling communications costs they will
be able to serve customers at less expense than AOL. However, most
won't reveal exactly how much they are spending. Free ISPs also believe
they can generate higher ad revenue than AOL, saying that their users are
generally willing to accept more on-screen ads since they are getting their
service without cost.
"I believe the model can work here," says Mark Grote, director of
marketing at Freei Networks. "But I think there is a fine line between
success and failure."
AOL, for its part, argues it can negotiate better deals with phone
companies because of its huge subscriber numbers -- more than 18 million.
"Does McDonald's get the cheapest beef in America?" Mr. Pittman asks.
"That's the way it works."
In spite of questions about their prospects, it is still possible that free ISPs
could reach huge audiences before running out of investors' money. This
could force AOL to cut its prices. Many analysts believe access fees will
fall, even if they don't believe free ISPs can sustain themselves long term.
While AOL maintains that subscribers to its main service aren't
price-sensitive, the company has stepped up its promotion of other
discounted online services to counter the free ISP threat. In the U.S., it has
retooled its CompuServe service as its "value brand," christening it
CompuServe 2000 and charging $9.95 a month for 20 hours of access.
British Competition
In the United Kingdom, AOL faces competition from free ISPs such as
Freeserve PLC. There, however, these services aren't totally without cost
to the customer: rather than pay their Internet provider, users fork over
per-minute access charges to their telephone company, which are then
shared with the ISP. Earlier this year, AOL launched its own free ISP in
the U.K., using its Netscape brand.
So far, free and discounted ISPs haven't visibly dented AOL's growth in
the U.S. Earlier this week, the company said that in its current quarter its
main AOL service will outpace subscriber gains made a year earlier, and
that CompuServe is also showing improved subscriber growth.
"They are nipping at their heels," says Patrick Keane, an analyst at the
market-research firm Jupiter Communications LLC, referring to the free
ISPs. "But AOL continues to meet every quarter's expectations. I don't
see free access becoming an issue just yet."
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