AOL Free for All

AOL announced yesterday that it would begin to offer its online services free to all Internet users. In this shift AOL anticipates that it will lose half of its 17.7 million subscribers over the next three years. However, it believes that by cutting $1 billion from its expenses and increasing advertising sales it will still come out ahead in the long run. The company intends to cut costs by eliminating employees in marketing and customer service (it has not stated how many, but the New York Times estimates it will be in the thousands) and make up for losses by offering ads on what the New York Times refers to as an “expanded line of free Web-based services.” The move has analysts on both sides of the fence, some believe that it may be too little too late and others that it might be just what the company needs. In either case the move is based on two facts, AOL is losing its subscriber base and it is seeing a larger than anticipated increase in advertising revenues.

In ever increasing numbers dial-up customers, AOL’s one time bread and butter, are jumping ship to broadband options from big cable and phone companies as well as to cheaper dial-up services from rivals such as NetZero and Earthlink. AOL lost a million subscribers in the first quarter of 2006 alone and 3 million last year. Looking ahead the company foresees losing more than 6 million more over the next year. With average monthly fees of $19.45 the total income lost to this exodus is at least $1.4 billion. In addition more will be lost as AOL introduces a low-rate unlimited dial up account for $9.95 a month.

On the other hand, AOL’s advertising wing, which currently comprises just over 20 percent of the company’s sales, grew 40 percent over last year to $449 million; during this time subscriptions dropped 11 percent. Some say this hefty increase, which beat expectations by as much as 14 percent, is due to the fact that last year under company chairman and CEO, Jonathan Miller, AOL began offering some of its once proprietary Web content for free. If this is the case it may suggest that offering more at the same price could have the same effect on a larger scale. Given this scenario, moving to an ad based model may make sense.

However, moving to an ad-based model is not without risk. According to the Financial Times, “AOL’s income from its 18 million U.S. dial-up subscribers, although declining, accounts for 80 per cent of its income, which was $2 billion in the last quarter alone.” The move is also not without critics. Gordon Hodge, an analyst with Thomas Weisel Partners said that to cut $1 billion and still increase profitability would be, “an amazing achievement.” Some also see that this may be too little too late, that the move to a free ad-based model should have happened earlier. According to the New York Times Morris Mark of Mark Asset Management, which owned nearly 612,000 Time Warner shares at the end of March, said, “It’s something they should have done two or three years ago . . . They’re going to lose these people anyway.”

AOL, however, acknowledges the fact that they will be losing subscribers, and cites this as a large reason for the shift. Arguing that subscribers are leaving anyway Time Warner president and chief operating officer Jeff Bewkes says that by offering the services free users may drop their subscription, but stay on as AOL members. “Our members don't want to leave; they want to keep using AOL . . .They tell us that the No. 1 reason that they leave AOL when they switch to broadband is price. So, now we're fixing that problem. We're going to stop sending our members to our competitors.” Retention of members that would otherwise leave to competitors is critical; AOL members represent 36 percent of unique visitors to the AOL network, but 80 percent of the page views. Not fixing the problem, forcing these members to cancel, would be dangerous to advertising revenues. Bewkes said, "If we didn't change this practice [of charging all members for e-mail and other services] ... we would be giving up 30 billion to 40 billion page views this year. Just to give all of you a sense of the magnitude of that, it's the equivalent of 10% of Yahoo. It's a third of a Google” Charging for the services was the problem, not the services themselves. Therefore, offering services free for all will, AOL hopes, keep current members, bring in new ones, and all the while increase page views and advertising dollars.

Dan Poole, who helps manage about $34 billion at Cleveland-based National City Corp., including Time Warner shares told Bloomberg, “They needed to do something with this business, it was in constant decline . . . The old model just didn't work.” Whether or not the new one will be debated until the verdict is returned.