By David Shook Remember Bob Pittman? The former president of America Online was once considered a possible heir for the top job at the combo AOL Time Warner (AOL). Turned out that Richard Parsons replaced Gerald Levin as CEO, so since early April, Pittman, AOL Time Warner chief operating officer, has been laboring at his old office at America Online in Dulles, Va.
His mission: Reviving growth at the slumping Internet service provider. Largely due to that slowdown at America Online, AOL Time Warner stock has tumbled 66% over the past 12 months, closing at $18.70 on May 31.
ON THE MOVE. If Pittman has a grand plan, he isn't saying anything. But there have been some noticeable changes at America Online. He has shuffled execs and brought in new talent to resurrect America Online's sagging advertising sales (see BW, 6/03/02, "Good Morning, AOL"). He's also laying off dozens of employees in the lower ranks, and making each channel on the AOL service more accountable for its own profits and losses. Pittman needs to do a lot more than cut staff, curb spending on research and development, and make minor adjustments if he is to revive ad sales in today's tough market.
While Pittman and AOL Time Warner declined to comment for this story, former AOL execs and people who know the company say one critical part of Pittman's long-term strategy likely involves rolling out premium, subscription-based services that subscribers will pay for on top of their monthly fees, which now average $24 for America Online's 33 million users.
Charging for premium content on top of the monthly Internet access fees would be a big departure from the old AOL strategy, which emphasized offering AOL customers everything under the sun for one price. This focus on subscription-based extras would likely include the sort of increasingly popular content and entertainment for which Internet users have demonstrated a willingness to pay other providers. This might include à la carte music services and Internet gaming subscriptions, which would see AOL compete with Microsoft, Sega, and Sony. Other possibilities are a host of smaller, more specialized services for AOL's personal finance channel, shopping network, and other areas, say people close to the company.
PREMIUM CONTENT. Another avenue for generating extra revenue is high-speed broadband Internet access, and Pittman is already making advances on that front. According to investment bank Robertson Stephens, in the first quarter, America Online added some 820,000 broadband subscribers, who each pay about $40 a month.
Gradually, Pittman is hoping to bundle several premium services, thus raising the average revenue per user from $24 a month to $50 or more. That kind of growth would be just the ticket for attracting investors' attention. "If I were in his shoes, I'd be looking at building incremental revenues from the existing base of subscribers, the same thing Yahoo! is trying to do," says Ron Sege, CEO of Ellacoya Networks, a company developing e-commerce technology for high-speed Internet providers. "The difference is that America Online has 33 million credit-card numbers and Yahoo! doesn't."
That's a valuable asset. "People are willing to pay more for higher-quality premium services. Just look at The Wall Street Journal and Internet gaming sites such as Microsoft's XBOX, and American Greetings," says one former America Online exec. "These companies are successfully charging thousands of customers monthly or annual subscriptions because people realize that free stuff on the Internet doesn't mean high quality."
ADVERTISER DEFECTIONS. A more immediate concern is rebuilding advertising and subscription sales -- the cornerstones of America Online's business. The drop in both during the first quarter helps explain why so many investors have dumped the stock, which is down 44% since Jan. 1. With more than $2.3 billion in first-quarter sales, America Online still accounts for more revenue than any other division at AOL Time Warner, yet online advertising and e-commerce sales plummeted 31% in the first quarter, to $501 million.
Many advertisers haven't renewed multimillion-dollar promotional deals they signed with AOL during the heyday of the Web in 1998 and 1999, says James Warner, president of Avenue A/NYC, a subsidiary of an interactive ad agency whose clients often work with AOL. Warner says AOL's advertising account reps now operate more like those in a traditional media company -- with one person assigned to each major advertiser or agency. In years past, advertisers dealt with different AOL staffers on different channels of the service. "It was not well organized," says one longtime America Online advertiser, the CEO of a retailer.
Working more closely with advertisers couldn't come a minute too soon, this advertiser notes. "I like Pittman, and I expect him to succeed," he says, "but this year, we're paying for things we're not getting. Performance isn't where it should be." As an example, the CEO points out that on the days before Mother's Day, America Online's home page carried promotions for office supplies -- rather than ads for gifts, flowers, and chocolates. "That was a window of opportunity to give consumers what they wanted, when they needed it -- and to please advertisers too," he says. "Things like that can't happen."
Fixing that type of problem should be fairly simple, especially when compared to the daunting challenges posed by the subscription side. America Online's subscriber growth -- at 1.4 million new Internet members signed in the first quarter -- was down from 2 million new subscriptions in the first quarter of 2001. Subscription growth is decelerating at an alarming pace because AOL now competes in many markets against phone and cable giants selling high-speed Internet service. Then there's Microsoft, which is offering enticing rebates to AOL users who agree to switch to the MSN network.
BROADBAND'S GROWING REACH. Pittman's strategy here is more inward-looking than the rhetoric investors heard after AOL merged with Time Warner in January, 2001. Rather than a powerful content force every rival ISP would want or need to partner with, many high-speed Internet providers are launching services without AOL -- a trend that is forcing Pittman to focus more on getting Time Warner Cable subscribers to pay for high-speed Internet access through their cable connections.
The greatest challenge may be that competing cable providers have no incentive to partner with AOL. They can offer their own brand of Internet services without AOL's help. "This puts AOL in a tough bind," says Scott Cleland, CEO of the Precursor Group, a Washington outfit that advises media clients on regulatory issues. "As more and more Internet users make the transition to premium high-speed broadband connections, AOL needs to take advantage of the fact that it now owns the second-largest cable operator."
Time Warner Cable offers broadband service in 30 of its markets and is expected to offer it in the remaining nine by the end of the summer. And Time Warner Cable added 278,000 Net broadband subscribers in the first quarter, bringing the total to more than 2.2 million. In the short term, margins on cable subscriber growth aren't mouth-watering because of the costs associated with upgrading cable systems to make them broadband-ready. But in the long run, high-speed data over cable modems represents the real growth opportunity for AOL as the dial-up Internet access market matures.
WORDS AND DEEDS. To give Pittman his due, he was the miracle worker who reinvigorated a stumbling America Online in 1996, when technology glitches and disorganized content were causing network outages and leading thousands of subscribers to cancel service. Perhaps he can work another miracle. But this time around, the problems seem to run much deeper -- including the struggle to formulate a vision that will work as well as his fixes did six years ago. "Pittman is exceedingly capable," notes Cleland, "but the challenges are exceedingly large."
True, Pittman has built a reputation for confounding naysayers. But investors would love to hear Pittman himself explain how he plans to preserve and expand AOL's dominance in the Internet arena. Shook covers financial markets for BusinessWeek Online in New York