The Cutting Edge: FOCUS ON TECHNOLOGY : 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.
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.”
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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.
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Mid-and-large-sized ISPs will combine to deliver high-speed access and other Web services to businesses.
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A new class of “vanity ISPs” ill allow affinity groups, such as college alumni associations,to share an identity in cyberspace.
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Thousands of small Internet access providers will serve secondary and rural markets, with fewer than 10,000 customers apiece.
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Internet Service Providers (in North America)
April, 1999: 5,078
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Internal Revenue (in billions)
1998: $8.4 million
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PCs Using the Internet (in millions)
1998: 84 million
Sources: Boardwatch magazine’s directory of Internet service providers; Dataquest
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Times staff writer Karen Kaplan can be reached at karen.kaplan @latimes.com.
