AOL Europe: Well, It's Not America

Stiff competition, pricing difficulties, and strategic miscues have cast doubt on the parent company's overseas strategy

Six years ago, America Online invaded Europe in hopes that its consumers would embrace its online service as enthusiastically as Americans were. Establishing a beachhead first, the company thought, would give it the edge by the time come-lately competitors such as Microsoft and Yahoo! showed up.

Oops. AOL's hopes of prospering as a European Internet service provider cum information portal have run aground thanks to tough competition, expensive Internet access, and the American company's own miscues. That has left AOL to tend to its wounds, buy out a German partner at a steep premium -- and continue to search for a strategy that will succeed.


  The picture isn't pretty. In 2001, AOL Europe had losses of $600 million, on revenues of $800 million. The business expects to pass $1 billion in sales this year, but AOL won't guess when it'll break even across its three European markets -- Germany, France, and Britain. In fact, some analysts now question the long-term viability of AOL Europe, which in turn casts a shadow on the overseas expansion plans not only of the AOL service but of parent company AOL Time Warner.

The media giant's goal is for half of its total sales to come from overseas within a decade, up from less than 20% now. But AOL's poor showing in Europe could be a sign that hitting that target will be much harder than the company imagined.

Granted, AOL isn't the only Internet company having difficulty making headway in Europe. Microsoft and Yahoo aren't yet profitable, nor are the Internet businesses of most of Europe's telecom giants. Still, those companies seem to have bitten off less than AOL has.


  Rather than competing in the no-margin business of selling Internet access, Microsoft and Yahoo are producing Web portals that rely on revenue from ads and premium services. Thus, while Yahoo and Microsoft each had about 30 million unique visitors to their online sites in December, AOL had less than 6 million, according to Jupiter Media Metrix. Most of the big European ISPs outpace AOL on portal traffic, too.

"Market penetration is really the biggest challenge"

"AOL still has tremendous potential in Europe because of the huge resources it has," says Hellen Omwando, an analyst with Forrester Research in Amsterdam. "But I would have thought by now they'd be in a much better position. Market penetration is really the biggest challenge for AOL Europe."

One reason is Europe's pricing model for online access. In the U.S., AOL buys phone-line capacity from the big telecom carriers, then includes that charge in the flat fee of up to $23.90 a month it charges its customers. In Europe, most customers pay twice. First, they pay the ISP (in Britain, AOL, No. 1 in terms of paying subscribers, charges about $21 [U.S.] a month). Second, they pay the phone company by the minute when they're online. That has retarded Web usage: In Europe, less than 25% of households are hooked up to the Net, vs. close to 50% in the U.S.


  The slow growth has allowed phone companies and other competitors that got a much later start than AOL Europe to catch up -- leaving AOL in the middle of a money-losing pack. AOL Europe's inability to grow as quickly as its U.S. counterpart has precluded it from enjoying the same economies of scale.

To top things off, the "free" ISP business has hampered AOL Europe. In some European markets, ISPs offer services without charging subscription fees, instead receiving a bounty from the phone company for each new customer who signs up for an Internet connection. While this works fine for a phone company, the business is considered unsustainable for independent ISPs because their cut of the revenues is so small. With AOL at a pricing disadvantage, it can't compete for the free ISPs' customers. The combination of all these forces accounts for the huge losses at AOL Europe.

AOL's European portals are in many cases a disjointed mix

The company has compounded the problem by uncharacteristically failing to find the formula for audience satisfaction -- a point AOL strongly contests. In the U.S., AOL benefits from homogeneity -- most people speak the same language and are interested in the same range of subjects. In Europe, AOL's portals are a mix of content from hundreds of local-language partners, in many cases a disjointed mix.

Early on, analysts say, the company put more emphasis on signing as many deals as possible with content providers rather than asking the question: Does it all add up? Such a strategy worked long enough in the U.S. for AOL to grow into a much more focused and disciplined company. In Europe, analysts say the company hasn't made that transition. AOL, however, says it clearly has found the right formula -- pointing to traffic numbers showing that AOL users on average spend more time online than do the customers of most other European ISPs.

"It's a question of displaying enough cultural sensitivity," says Ron Sege, CEO of Ellacoya Networks in Merrimack, N.H., which develops billing technology for the Internet. "The European telecom market is still a place long on culture and personalities. For that, the entrenched competitors in the marketplace have real advantages over a company with a name like America Online."


  In fact, incumbents such as Telecom Italia, Spain's Telefonica, and France Telecom are building economies of scale. Not only are they monopolies but they're presenting a mix of Web content with strong audience appeal, says Omwando, the Forrester analyst.

Broadband is also giving them an advantage. In Germany, Deutsche Telekom's ISP, T-Online, has more than 8 million subscribers and dominates the rapidly expanding broadband market. AOL, meanwhile, has about 2.5 million customers in Germany and must rely on Deutsche Telekom to provide its broadband connection. "Right now, AOL is having a difficult time marketing broadband in Germany," Omwando says. The European cable industry also has made strides in offering high-speed Internet service -- Spain, Portugal, and the Netherlands all have it and are enjoying brisk demand, while AOL has yet to make a significant leap into European cable.

Within the company, Europe is gaining the reputation of a financial black hole

Wireless is also a weak point for AOL Europe -- on a continent where these devices are ubiquitous. "Much of the success on the Internet in Europe depends on the marriage of broadband and wireless," says Stephen Killeen, president of Terra Lycos USA, owned by the Spanish telephone giant Telefonica. "A lot of European [phone] companies are buying cellular, which gives them a big advantage in reaching customers who want or use Internet services."


  AOL Europe is still the centerpiece of AOL Time Warner's overseas expansion on the Net: It accounts for more than 65% of the AOL service's international customer base. But within the company, it's gaining the financial-black-hole reputation that Time CEO Don Logan ascribed to Time Warner's Internet efforts years ago -- before AOL came along. That impression was only heightened by German media giant Bertelsmann's decision last fall to exercise its option to sell its 49.5% stake in AOL Europe back to AOL for $6.75 billion -- about twice what analysts say it was worth.

At some point, the parent company will have to stanch the bleeding at AOL Europe. It won't say when exactly, but AOL Time Warner Chief Financial Officer Wayne Pace recently offered a clue. "At this point," he said, "we're not speculating about what will happen to it beyond 2002."

By David Shook in New York

Before it's here, it's on the Bloomberg Terminal.