AOL Had Tools, Not Synergy

Is the dream of convergence dead?

In January 2000, America Online and Time Warner announced they would marry, culminating a long and closely watched flirtation between Hollywood and Silicon Valley. The idea was to combine Internet technology with entertainment content, sell it online and create a blockbuster new industry for the 21st century.

Today, the dream of convergence is being shaken awake. AOL Time Warner Inc., which bet its future on convergence, is unraveling. Chief Executive Richard D. Parsons has ordered divisions, ranging from movie studios to a cable operator, to focus on being the best in their class and worry less about partnering up. Robert W. Pittman, the company’s chief operating officer and master of synergy, is out.

Meanwhile, rivals who resisted the urge to merge are prospering. NBC is the top-rated television network even though it is not part of a giant media conglomerate. Yahoo Inc., once derided for failing to merge with a major content provider, has a market value of $8 billion, while the larger America Online is valued by investors at virtually nothing.

“If AOL Time Warner couldn’t pull this off, who can?” said Bill Whyman, president of Precursor Group, a technology analyst in Washington. “Convergence may not be dead, but it’s still just a vision.”

Whyman says he is particularly disappointed by the company’s failure to deliver on its promise to package music, movies and other Time Warner entertainment and sell it online to existing customers.

“They’ve got the content. They’ve got the software. They’ve got the cable. And they’ve got the existing customer relationships,” Whyman said. “In fairness to AOL, no one else has been able to do it either. But it worries me that this whole vision about selling subscriptions to interactive content is going to happen much later than people thought.”

The Net hasn’t turned out to be the next great distribution pipeline for the entertainment industry, and as advertisers lost interest in the Web, AOL wasn’t alone in seeing its convergence initiatives founder.

Walt Disney Co. abandoned its Internet portal, Go.com, and NBC pulled the plug on its version, NBCi. Investors have lost so much faith in Vivendi Universal’s attempt to build a converged conglomerate that the company dumped its chief executive and is widely expected to carve itself apart.

Some believe AOL Time Warner’s problem is that it simply is too large.

“There comes a time when size is a disadvantage,” said Brian Seth Hurst, head of Opportunity Management, a marketing and branding consultant. “You can’t move quickly enough. In a large organization, everyone acts in their own self-interest.”

In the rush to maximize synergies, AOL Time Warner may have made a classic mistake: losing sight of what customers really want.

“Convergence is a slow process,” said Frank Catalano, president of Catalano Consulting, an Internet marketing firm. “It shouldn’t be a top-down effort. You start by taking small steps.”

The restructuring announced Thursday, which will divide the company’s divisions into two, marks a retreat from the company’s previous emphasis on cross-selling and synergies.

For the struggling Internet unit, that probably means a return to basics and improvements in features.

With Microsoft’s rival online service MSN taking direct aim at AOL customers, pressure is building for AOL to unveil more eye-catching changes.

“AOL still has a lot of brand power and a strong cash flow,” said Jessica Reif Cohen, an analyst at Merrill Lynch Global Securities, referring to the Internet unit. “It’s still a decent business.”

Some analysts remain optimistic about the potential for marrying entertainment and technology, but they say AOL Time Warner fell victim to a combination of market forces and its own mistakes.

For two years, AOL Time Warner executives boasted that the merger was succeeding without a hitch and synergies were improving the bottom line.

But in recent months it has become clear that bringing together such diverse corporate cultures was not so easy and resentments between the two companies were much deeper than AOL Time Warner executives revealed.

“At AOL,” Catalano said, “the business models ran into each other and then bounced off.”

The New York-based company has enjoyed several successes in integrating its film, music, publishing and Internet divisions.

The Internet unit promptly became a major source of new subscriptions to Time Inc. magazines. Heavy AOL promotions of movies including “Harry Potter and the Sorcerer’s Stone” and “The Lord of the Rings” helped turn those films into big moneymakers.

But those early successes proved hard to follow.

AOLTV, once considered the symbol of the combination of technology and entertainment, has been a failure. The product, which attempts to integrate the AOL service into consumers’ TVs, has been panned by critics and users.

The company won’t release subscription numbers, but analysts said sales have been slow.

AOL has been unable to sell AOLTV’s software to any cable operator--even its own Time Warner Cable. Although it’s still trying, another unit within the company is developing an “everything on demand” service more likely to appeal to cable operators.

In addition, America Online, with 30 million subscribers, has made few inroads in selling high-speed Internet service across Time Warner cable lines. Though most Time Warner customers can receive AOL broadband service, fewer than 100,000 are opting to buy it, according to estimates.

Another problem for the corporation is that AOL’s high-speed service is taking customers away from another member of the Time Warner family, RoadRunner, the cable division’s high-speed service.

“It’s a very curious, very uncomfortable mix for a lot of people, including internally,” said Gary Arlen, an independent media and consumer electronics analyst.

But Michael Harris, president of Kinetic Strategies, says AOL’s ownership of the rival services gives the company a laboratory to show that the cable industry could offer consumers a choice of high-speed providers--a key step in AOL gaining access to other cable operators’ customers.

“The technical argument about it not being feasible has evaporated,” he said.

Even the promise of cross- company ad sales, which AOL Time Warner has been promoting heavily, is falling victim to a sluggish ad market and declining interest in the Internet.

“Some companies are trying to get out of those deals now because they’re not getting the business,” Catalano said. “The effectiveness of Internet advertising is still experimental.”

There are, however, recent signs that the AOL Time Warner merger is paying dividends.

Some of the best examples of the corporation’s siblings playing nice come in the field of music. Warner Music’s labels built on their long-standing relationships with America Online and other members of the corporate family to boost sales of several new artists.

Jeremy Welt, head of new media at Warner’s Maverick label, cited Michelle Branch, whose debut album sold more than 1 million copies after receiving important boosts from the WB Network and AOL.

But the relationship between Warner Music and AOL has not been monogamous. They routinely have looked to other partners to satisfy individual needs, as with Maverick’s first experiment with selling MP3 files, done with a subsidiary of Vivendi Universal.

Nor has the cooperation led to any extensive new services, such as music by subscription, despite the enormous demand from consumers for songs delivered online.

Still, Paul Vidich, executive vice president of Warner Music Group, said: “We work with AOL Music because it makes sense. AOL Music is a strong marketing partner that delivers a significant online audience.”

And, as Warner moves forward with its first downloadable music sales through AOL, he said, the online service “will become a strong commercial partner as well.”

Sanders reported from Washington, Healey from Los Angeles.