By Catherine Yang Last year, the revival that lifted the rest of the online industry left America Online in the dust. Even as a rebound in ads sent 2003 profits at rival Yahoo! (YHOO) spiking 123%, AOL's subscribers jumped ship in droves for low-cost dial-up competitors or broadband providers. Ad revenue sank 40%, to $787 million, and federal investigators continued to probe AOL's past ad deals for accounting irregularities. As operating earnings before depreciation and amortization fell 2%, to $1.5 billion, Wall Street started betting that Time Warner (TWX) would ditch AOL the first chance it got.
But AOL's date with the dump has been postponed, if not canceled. On June 24, Time Warner paid $435 million in cash to buy Advertising.com, a leading online-ad-placement company that should help boost AOL's ad revenue. "Our emphasis is on building up the AOL business," says Time Warner CEO Richard D. Parsons.
PROFITS, NOT REVENUE GROWTH. Chalk up one for AOL CEO Jonathan F. Miller. After struggling to regain focus after its rocky 2001 merger with Time Warner, AOL is finding its footing again with Miller's new strategy: providing a menu of online services ranging from full-blown broadband service to á là carte online music subscriptions to cheap, no-frills dial-up access. "We'd gotten behind in the market," he says. "We're putting in a business model appropriate to where the world is going."
Miller hasn't yet proven that the world will order from his menu, but a rebound in AOL's advertising and global businesses will buy him time. Combined with cost cuts, that should produce the double-digit profit growth this year that Time Warner expects, says Richard Greenfield, media analyst at Fulcrum Global Partners.
Still, the heart of Miller's strategy -- persuading customers who have signed up with another broadband provider to also buy AOL's broadband services -- is a gamble. "They haven't turned the battleship around yet," says David Card, online-media analyst at Jupiter Research.
In the new world, Miller is counting on profit gains, not revenue growth, to float AOL's boat. The company's old $23.90-a-month dial-up service made for fat revenues but slimmer profits, thanks to the cost of providing network connections. New, lower-priced broadband services will produce less revenue but higher margins since AOL won't have to pay network access fees. It expects earnings from ads, broadband and premium services, and global sales to rise 30% to 50% annually over the next few years.
NOT JUST EYEBALLS. An ad revival is starting to help. For the first time since 2001, ad revenue should rise 11% in 2004, to $873 million, says Deutsche Bank. Advertising.com should send them up even more. It specializes in a new results-driven approach: charging advertisers for the number of online transactions generated by ads, not just the number of eyeballs reached.
Meanwhile, Miller is stanching the bleeding from AOL's dwindling dial-up base. To preserve margins, AOL is renegotiating contracts with network providers such as MCI (MCIA). As dial-up members leave, AOL can cut network costs associated with them.
That leaves Miller freer to pursue his "superstore on the Web" strategy. To match low-cost rivals, there's a new $9.95-a-month dial-up Netscape Communications service. For members considering a move to broadband rivals, there's a $14.95-a-month AOL for Broadband service.
BITE-SIZE LURES. How will he persuade consumers to buy AOL's package of content and services if they use someone else's pipe to get online? By offering bite-size premium services such as $8.95-a-month online music subscriptions. And AOL is offering free samples of content from Time Warner's video-on-demand and Road Runner broadband units. The plan shows signs of working. In the first quarter, 600,000 people signed up for the broadband services, for a total of 3.5 million.
AOL remains a long way from a sustained revival. But with healthier ad sales, slimmer costs, and a rosier global outlook, Miller -- and Time Warner -- can afford to throw the dice for now. With Tom Lowry in New York and Ben Elgin in San Mateo, Calif.
Yang is a BusinessWeek correspondent in Washington, D.C.