There's No Escaping Aol

Its new plan: Get inside every information appliance

When America Online Inc. Chairman Stephen M. Case peers into the future, he sees a world where AOL's brand is an ever-present sidekick to tens of millions of people in their daily lives. You'll whip out your cell phone on the way to work and send an AOL instant message to your boss to discuss the day's schedule. While lunching at McDonald's, you'll check your AOL stock portfolio on your pocket organizer. After dinner, you'll flip on AOL TV to watch the news or use your PC to buy Christmas gifts at Shop@AOL. And if you remembered one more gift after you've climbed into bed, not to worry. You turn to a mini-Web terminal at your bedside to place the last-minute order.

The strategy is called AOL Anywhere. And, early next year, Case's vision will start to become reality--at least, if everything comes together as planned. AOL hopes to begin marketing Web devices developed with PC maker Gateway Inc. and an AOL TV set-top box made by other partners. "We want to be as pervasive as the telephone or TV, but even more valuable in people's lives," says Case.

WINDOWS BREAKER? It's a bold new attack on the biggest opportunity to come along since the Internet exploded on the scene in 1994. Call it "everywhere" computing. An endless variety of newfangled information appliances that connect you to the Internet are expected to emerge in the next half decade, from smart phones to TV set-top boxes to cute gizmos that sit on your kitchen counter. By 2002, the number of info appliances that will be sold annually is expected to hit 55.7 million, outnumbering consumer PC sales, according to researcher International Data Corp. For AOL, which made its $4.7 billion in revenues last year on dial-up Internet access services, advertising sales, and e-commerce, it's an enormous leap into the unknown.

But leap it must. If AOL were content with just expanding its base of 21 million members who connect via PCs, the computing world would soon pass it by. It can't risk having other players become the gateways to the Web from such things as Palm handheld computers, the Sprint personal communications systems (PCS) smart phone, or the Excite@Home cable-modem service. "While AOL is the 800-pound gorilla in the PC space, the info-appliance space is wide open," says analyst Kevin Hause of IDC.

It's crucial for another reason, too. AOL Anywhere could help AOL best Microsoft Corp. Now the two rivals collide in Web portals, dial-up access, and the corporate software business. Microsoft has a distinct advantage, though, thanks to its Windows monopoly in PC operating systems. Every time a PC gets turned on, people see Windows software--no matter what they do with their computer. And the PC is likely to remain the most important computing device for many years despite the rise of info appliances.

Microsoft's immense wealth also makes it tough for AOL to beat--at least when AOL forages beyond its core markets. Microsoft has a big head start in the emerging interactive-TV market, for instance, thanks to its $19 billion in cash. It has invested $5 billion in AT&T and $1 billion in Comcast Corp., helping fuel those companies' efforts to upgrade cable pipes to provide Internet services. And analysts expect those investments and others like them to give the software giant a leg up when cable companies place new orders for software for their set-top boxes.

That's why AOL is counting on Web devices to help level the playing field. Since many of the new machines are expected to run on operating software other than Windows, AOL now has a chance to make it the brand that people see on their way to the Web.

Analysts are betting this huge gamble will pay off--eventually. As info appliances spread beyond so-called early adopters, its strategic importance will jump dramatically. AOL is banking that its members won't want separate e-mail accounts, stock portfolios, and calendars in every device they own and will opt to stick with AOL for all of for all of them. And since AOL collects fees for the sales done on its service as well as for advertising, every member counts. "Once you can access AOL content from multiple locations, you'll probably be an AOL customer for life," says Merrill Lynch & Co. analyst Henry Blodget.

"EXPERIMENTATION." Don't expect a quick spike in revenues, though. Analysts figure the earliest buyers will be existing AOL users--so the company won't pick up a lot of new membership fees at first. That could become a problem if AOL decides to stoke sales of the new machines by subsidizing their cost in exchange for multiyear subscriptions from customers, says analyst Van Baker of Dataquest Inc. Barry Schuler, AOL's president for interactive services, says the company is considering subsidies, but he admits that he doesn't know exactly how it will approach selling new AOL Anywhere services. "There's a lot of experimentation now to figure out what the business models will be," he says.

That's not slowing AOL's investments any. It won't say exactly how much it plans to invest, but so far it is plunging $800 million into Gateway and $1.5 billion into Hughes Electronics Corp., both key partners. Merrill's Blodget estimates that half of the $330 million that AOL will spend on product development this year will go to AOL Anywhere, too.

Now, it has to forge alliances with a host of new device manufacturers, cable operators, and Baby Bells offering fast Web connections. Up to this point, it has worked out arrangements with a small circle of players--the phone companies that carry its dial-up connections and PC makers. But it's now picking up the pace. In October, AOL agreed to offer its popular Instant Messenger, used to track friends and workers online, and set up one-on-one chats on Motorola Corp.'s smart phone and two-way pagers--due out early next year. And in June, it agreed to put AOL e-mail on 3Com Corp.'s Palm computing handheld organizers.

The key pieces of AOL Anywhere are likely to come from the company's close collaboration with Gateway. One of the first products that's expected from the alliance is a small, inexpensive Internet terminal that dials up directly to AOL. Gateway says it hasn't decided yet whether to include a Microsoft operating system in these devices. But it's likely AOL will call for a non-Microsoft option. Software possibilities include Java, Linux, BeOs, and Gateway's own Amiga.

Microsoft's Windows CE operating system for devices hasn't done well so far. According to IDC, CE's share of the U.S. handheld computing market last year was 14%, vs. 73% for the Palm operating system. And this year, CE's share is expected to slip to 13% while Palm's rises to 80%.

LINING UP. A critical element of the AOL Anywhere strategy is rolling out a new version of its Netscape Web browser. Microsoft's Internet Explorer browser, which is bundled with Windows, holds 64% of the market today, compared with a 35% share for Netscape. But AOL is hoping that the next version of its browser can play a role in info devices where Microsoft's grip is still weak. "In the new-device world, there's a lot of opportunity to make Netscape's technology the center of the browsing experience," says Schuler. Using the Netscape browser in AOL devices is important because AOL can then be the first brand customers see when they go online, analysts say. "They want to make sure you stay in an AOL universe as long as you can," says William E. Whyman, an Internet analyst at Legg Mason's Precursor Group.

Case downplays the fact that AOL's expansion will challenge Microsoft in the software arena. "We have no interest in being in the operating-systems business--not now, not ever," he says. Yet everywhere you look, AOL seems to be lining up against Microsoft. By mid-2000, AOL expects to launch AOL TV, a new rival to Microsoft's TV initiatives. With the help of partners DirecTV, Hughes Network Systems, Philips Electronics, and Liberate Technologies. AOL is expected next year to start marketing a set-top box--using a non-Microsoft browser--that can bring both AOL's interactive service and DirecTV's satellite broadcasts to the same TV screen.

Expect the competition to be ferocious. Already, Microsoft is ahead in some respects. On Nov. 14, Microsoft beat AOL in announcing the MSN Web Companion, an inexpensive Internet terminal that will dial up directly to the Microsoft Network online service. "I'll beat my chest a little bit," says Yusuf Mehdi, director of marketing for Microsoft's Consumer & Commerce Group. "We're a bit of an underdog in the online space, but we're ahead with this stuff."

And AOL is playing catch-up to Microsoft's two-year-old, million-member WebTV service. It's also trailing DISH-Player, a new interactive satellite-televison service launched in June by WebTV and partner EchoStar Communications Corp. According to Sean Badding, a market researcher with Carmel Group, DISHPlayer has had mixed success so far. Only 1 in 30 of EchoStar's new subscribers are opting to take the WebTV service. But Microsoft has such deep pockets that it's trying to jump-start the market by subsidizing the $199 satellite receivers to the tune of $250 apiece, he says.

CALLING CARD. AOL has a couple of key advantages over Microsoft, though. Its 21 million members are its calling card with Web appliance makers. MSN has only 2 million subscribers. And Microsoft is wrestling with conflicting goals. It wants to maintain the PC's dominance while it goes after info appliances. "Microsoft doesn't want to cannibalize the market," says Rob Enderle, vice-president at Giga Information Group. "If Web appliances are too good a solution, they lose revenue."

Meanwhile, AOL faces another worthy adversary in the leading Web portal, Yahoo! Inc. Yahoo! is stronger internationally. And it has scored about a dozen partnership deals--more than AOL--to deliver Web content via handheld computers, smart phones, and pagers. The Sprint PCS phone service, for example, chose Yahoo! to provide content over its phones because the portal symbolizes the openness of the Web, while AOL is a proprietary service.

That hasn't slowed AOL down much in the past, though. Now AOL has to leverage its golden brand to entice users to its service just when information appliances begin to populate the world. If it pulls that off, AOL Anywhere might turn into AOL Everywhere.

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