How Aol Time Warner Will Shake Up The Net

There will be fewer ISPs, but a healthy rivalry will remain

The interminable haggling by regulators over the long-pending merger between America Online Inc. and Time Warner Inc. may seem like just the usual noise out of Washington. But as the Federal Trade Commission and the companies cobble together a settlement to unleash the $183 billion deal, the resulting blueprint could end up reshaping the future of the Internet industry.

The parties may not come to a final agreement until early December, but the elements of the regulatory compromise are now emerging. And they suggest hopeful news: The next generation of the Internet may not be as hypercompetitive as today's Web-access businesses, but neither will the lights go out on healthy rivalry.

MUST-DO LIST. That's because, according to industry sources, the FTC is demanding that AOL Time Warner hook up at least one independent Internet service provider (ISP) to Time Warner's high-speed cable pipes. That way, AOL, the nation's largest ISP, won't automatically dominate broadband. The FTC is also likely to require the new company to sign up two additional ISPs within 90 days. And the feds want some of those ISPs to be national-scale providers, not just smaller players that present little competitive threat. Already, Time Warner is trying to strike a deal with EarthLink, the nation's No. 2 ISP after AOL (table). And in Columbus, Ohio, Time Warner Cable is conducting a small-scale test of technology that allows it to carry multiple ISPs on its system there.

Then, to ensure that AOL Time Warner doesn't stop at just three competitors, any subsequent ISPs that may be having problems reaching agreement with the new company will be able to demand arbitration. Regulators are focusing on cable because it is more widespread than competing broadband technologies such as the telephone companies' digital subscriber lines (DSLs) and satellite.

True, the FTC's proposed provisions don't guarantee that the 7,000-ISP market of today survives intact--and may even hasten more consolidation. Indeed, unless the FTC requires AOL Time Warner to sign up at least one national, one regional, and one local ISP per market, the company may end up with just a handful of national ISPs--those with the biggest businesses, such as EarthLink, Microsoft Network, and Prodigy. "Most ISPs will never end up on Time Warner's networks," says Charles Ardai, CEO of Juno Online Services Inc., an independent ISP that is putting the finishing touches on an access agreement with Time Warner. "There are only 10 to 20 of any size." Adds Jeff Chester, executive director of the Center for Media Education: Most ISPs "would be digital toast. You might as well make room in cyberspace for 6,999 graves."

Yet the small fry, which make up the bulk of the ISP industry today, may not automatically wither on the vine. They could team up in joint ventures to capture the cable guys' attention or opt for broadband with DSL. Indeed, DSL operators may step up to the plate and vie more aggressively for these ISPs' business by undercutting cable's prices. Already, ISPs are dissatisfied with cable's terms. Typically the cable companies charge online services a big cut of their retail revenues. For instance, Time Warner Cable takes about 70% of Road Runner's subscriber fees, leaving the online service, a Time Warner unit, only 30%.

FATTER PROFITS. By contrast, DSL providers offer a more favorable wholesale pricing scheme--generally charging ISPs a flat fee for each subscriber, somewhere around $25 a month. That gives ISPs more flexibility to fatten profits, especially as phone rates head down because of relentless competition, notes Juno's Ardai. "We're not thoroughly convinced that cable would be a viable commercial option," says Stephen A. Heins, marketing director at NorthNet Internet Service in Oshkosh, Wis., an ISP with 2,500 subscribers. "There's no incentive for us to do it if it isn't profitable for us."

But regardless of how many ISPs are signed up by AOL Time Warner, Washington's goal isn't to replicate today's crazy-quilt dial-up ISP market in a broadband world. While regulators can't guarantee that tomorrow's Web access business will be as competitive as today's, they can try to ensure that AOL doesn't dominate the medium right off the bat. Ironically, through an AOL Time Warner pact, the FTC may be able to spur more competition in the high-speed Internet world than the market alone would have wrought.

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