AOL Seeks Payoff With Free Services

Times Staff Writers

In a move that marks a watershed moment for the Internet, AOL, which made millions of dollars connecting consumers to the information superhighway, will soon be free.

The service, which lured millions of people to the Internet for the first time and was the driver behind history’s biggest media merger, will drop access fees for anyone with a high-speed connection beginning in September, AOL’s parent company, Time Warner Inc., announced Wednesday.

The change in strategy at AOL, which is still the leading Internet service provider with a 20% market share, signals the rapid transformation of a business it helped create.

But the change will come at a cost: AOL will probably lose hundreds of millions of dollars of high-profit-margin revenue as dial-up subscribers migrate to broadband. The hope, fueled in part by the success of rivals Google Inc. and Yahoo Inc., is that such losses will be offset by an increase in advertising as AOL becomes more popular on broadband.


The strategy is not without risks, said analyst Laura Martin of Soleil/Media Metrics. “I think Wall Street will remain skeptical until it is proven that [AOL] can compete with the Yahoos and Googles of the world,” she said.

Even before the change kicks in, AOL, formerly known as America Online, is experiencing healthier ad sales, according to quarterly earnings results released Wednesday. Time Warner reported a bigger-than-expected $1-billion quarterly profit, led by strong cable TV performance and a surprising 40% jump in online ad revenue at AOL.

The news of the robust earnings -- a rebound from a $409-million loss in the year-earlier second quarter -- propelled Time Warner’s stock to its biggest daily gain since April and helped lead a modest market rally. The shares rose 42 cents, or 2.6%, to $16.67.

Yet the stock is down more than 4% this year and has been stuck in neutral for several years. It has not returned to the peak of $94 reached in December 1999, shortly before AOL announced the $99-billion acquisition.


Frustrated investors, led by financier Carl C. Icahn, last year called for the ouster of management and spinning off AOL. But that effort failed to win shareholder support and Icahn retreated, although not without a promise from the company that it would boost value by repurchasing shares and cutting costs.

It may seem strange for AOL to find itself playing catch-up with such relative upstarts as Google and Yahoo.

But what initially made AOL so attractive -- the “walled garden” that sealed its members within an environment that seemed simpler and safer than the chaotic wider Web -- eventually hurt the service. As sites such as EBay and Google became popular, the walls became an annoyance to some users. Once broadband connections became widely available, AOL members rankled at the extra costs for services such as e-mail that other sites provided for free.

And the repercussions from the collapse of Time Warner’s stock after the merger roiled the company for years, distracting executives from their focus on AOL’s competitive landscape.

The new strategy speeds up the demolition of the walled garden -- although some skeptics say Time Warner’s response came several years too late. Web surfers who connect via cable or DSL will no longer pay about $15 a month for an AOL e-mail address or security software.

“This will remove the biggest barrier for our members staying with AOL as they migrate to broadband,” Time Warner President and Chief Operating Officer Jeffrey L. Bewkes said in a conference call Wednesday. “We’re going to stop sending our members to our competitors.”

AOL reported 17.7 million U.S. subscribers in the second quarter, down sharply from a peak of 26.7 million in September 2002.

The Internet service will bet its future on winning more of the fast-growing market for online advertisements, which is expected to reach nearly $17 billion this year. AOL’s 40% second-quarter ad growth was faster than the estimated 30% growth of online advertising overall, and the company said it expected to continue outpacing the market.


Richard D. Parsons, Time Warner’s chief executive, took analysts and the press to task for speculation before Wednesday’s announcement that lower revenue from access fees would slash AOL’s profit by as much as $1 billion this year. “We don’t see any material step down in AOL’s earnings for this year,” Parsons said on the conference call.

That’s partly because AOL, while servicing existing dial-up subscribers and not turning away new customers, will no longer market the service, which had become a money-losing proposition. That means no more free AOL CDs in the mail, a longtime hallmark. AOL said it intends to cut annual operating costs by $150 million to $200 million in 2006, and by $1 billion by the end of 2007 -- a timetable that Standard & Poor’s analyst Tuna N. Amobi called “aggressive.” He’d been expecting cost cuts of $800 million over that period, he said in an interview.

As a lure to get its once-paying members to try the new service, AOL said it would offer back the old e-mail addresses to the millions who canceled their service in the last two years. AOL had saved them as an incentive.

The surge in second-quarter online ad revenue -- to $449 million from $320 million a year earlier -- only confirmed Bewkes’ conviction that AOL belongs in Time Warner rather than being spun off or sold.

“We wouldn’t want to part with a growing asset like that,” Bewkes said. He noted that AOL now trails only Google and Yahoo in online ad sales.

Wall Street, however, is not as optimistic. “We’ve seen a number of strategic redirections to try to fix AOL,” said Martin, the analyst. “Today’s is the latest. If this one doesn’t work, we think they spin off all or part or sell it off.”

She said that Bewkes and AOL Chief Executive Jonathan Miller could lose their jobs if AOL doesn’t turn around within 18 months.

AOL has long attracted nonmembers to its stable of sites, including MapQuest, Moviefone and Netscape, and to its AOL Instant Messenger service.


AOL said an average of 113 million people a month visited its websites in the second quarter. All Time Warner sites attracted 121 million visitors in June, ranking behind only Yahoo.

But AOL executives risked faster subscriber defections by pushing AOL Travel, AOL Shopping and other properties onto the general Web in search of advertising revenue.

“It’s not only a good step for them to take, it’s the only step for them to take,” said Jon Gibs, director of media analytics for Nielsen/NetRatings.

To draw a bigger audience and more blue-chip advertisers, AOL has struck a host of deals to create original content. It has development agreements with reality-TV impresario Mark Burnett and actor Ashton Kutcher’s production company.

It has created new sites through joint ventures, such as, which focuses on celebrities and broke the news about Mel Gibson’s arrest, and In2TV, a repository for TV classics such as “Welcome Back, Kotter.” On Friday, it will launch a video portal with cable TV shows available for streaming and paid download, AOL originals and amateur video. The site will include a video search engine.

“AOL is never again going to be what it was 10 years ago,” Gibs said. “There are too many powerful players. AOL’s goal now should be to be part of that conversation, not to lead the conversation.”



Q & A

Question: What is becoming free with this strategy shift?

Answer: Immediately, AOL is making e-mail accounts free, along with its proprietary software for accessing AOL features and its safety and security center that offers basic protection from viruses, spyware and other threats. By September, AOL will make parental controls free as well.

Q: I have broadband, but I pay extra to AOL for e-mail and parental control. What do the changes mean for me?

A: Nothing will happen unless you call AOL to cancel. Those who occasionally need dial-up, as when traveling, can buy a $9.95 monthly plan with 10 hours of access.

Q: What if I am a dial-up user?

A: AOL will still charge $25.90 a month for an unlimited dial-up plan, although it will add 50 gigabytes of online storage and security features. Customers can choose a $9.95 monthly plan without those added features.

Source: Associated Press

Los Angeles Times