AOL: Scrambling to Halt the Exodus

Its 9.0 software is a step up, but content is key to its survival

America Online (AOL ) is in a fight for its life, and lately it has looked like it's losing. After dominating the market for Internet access for nearly a decade, AOL has seen its 25 million U.S. members begin to defect in droves to cut-rate dial-up competitors and to broadband rivals who are beginning to slash their monthly fees in a burgeoning price war. In the second quarter, 846,000 AOL subscribers departed -- the largest quarterly drop ever.

Now, AOL is launching a new effort to stem the tide. On July 31, the company will release the most significant upgrade to its software in years, certainly since the disastrous merger with Time Warner was unveiled in January, 2000. AOL 9.0 will boast over 100 new features, including faster downloads, free e-mail storage on AOL's computers, and an easy way for subscribers to keep blogs, or online journals. Subscribers even will be able to plug a phone into their computer and make free phone calls via AOL's instant-messaging service.

Most important, AOL 9.0 will be the doorway to a brand-new world of online content. It's designed to help subscribers tap into a growing number of music, video, and magazine offerings from Time Warner. They include live online performances, like recent concerts by the Foo Fighters and Michelle Branch, which are tripling to 15 a week from 5. Warner Bros. television is making Net-only vignettes and extras from TV shows like Smallville for the first time ever. AOL 9.0 also will bundle content -- such as ABC News and People magazine -- that would cost $130 if users bought it à la carte on the Web. "9.0 is the biggest leap at the company from one release to the next," says CEO Jonathan F. Miller, who joined AOL last August.

It had better be. AOL is a narrowband company in what's rapidly becoming a broadband world. Almost all of its $9 billion in revenues come from subscribers who typically pay $23.90 a month to log on to the Net via their phone lines. The number of these so-called narrowband subscribers is expected to slide 6% this year, to 45 million U.S. households, and will keep falling for the foreseeable future, according to Goldman, Sachs & Co. Meantime, broadband subscribers are projected to increase nearly 40% this year, to 25 million households, and surpass narrowband subscribers in 2006.

Up until now, AOL's strategy for dealing with this has looked like a quick route to oblivion. The company has been trying to persuade people to pay $14.95 a month for its service on top of the $30 to $50 a month they pay the phone or cable company for broadband connections. But AOL has offered little extra for the fee, and only an estimated 1.4 million members have bitten so far. A package deal for broadband and AOL brought 800,000 more subscribers. AOL 9.0 is supposed to give consumers more bang for the buck.

Will it work? AOL will never regain the dominance it had in narrowband in the broadband market. Only 10% of broadband subscribers get its service now, a big comedown for a company that once had 50% of the Net-access market. AOL 9.0 is a step forward, but much better content is needed to justify $15 a month. Richard Greenfield of Fulcrum Global Partners, the only analyst who has made such projections, thinks the company can improve its content enough to boost its broadband market share to 25% of the expected 40 million subscribers in 2006, while retaining about half its narrowband base. Under such optimistic assumptions, AOL would have about $5 billion in 2006 revenues, down from Greenfield's estimate of $8.7 billion for this year. Without more compelling content, the more likely scenario is that AOL's share of broadband subscribers will stay at about 10%. Then AOL's revenues will plummet to less than $3 billion by 2006, and its cash flow will be crunched.

Pressure will come from MSN and Yahoo! (YHOO ) Inc., which sell their broadband services cheaper. No. 2 rival MSN goes for $9.95 a month on top of broadband. In May, MSN started selling its service with Verizon Communication's DSL connections for as low as $29.95 a month. Yahoo comes with SBC Communications (SBC ) Inc.'s broadband service for $39.95 a month. "Ultimately, everyone is concerned about their pocketbook," says Lisa A. Gurry, MSN's group product manager.

Rather than cut prices, Kevin Conroy, the COO at AOL's broadband unit, is running hard to add exclusive content. Conroy is one of the people most responsible for thawing relations with Time Warner's execs. After arriving from Bertelsmann last year, the former music exec started working with Warner Music Group (AOL ) to build innovative, cooperative ventures. What resulted was AOL's First Listen series, which has premiered 50 new songs by artists such as Christina Aguilera, and Sessions@AOL, which has showcased 300 artists in live online performances.

These days, Conroy is using his what-can-we-do-for-you approach elsewhere at Time Warner. The movie business is a natural. AOL is promoting New Line Cinema Inc.'s low-profile teen flick How to Deal this summer -- and it got exclusive previews of Warner's Terminator 3 blockbuster. "A sister company that offers exposure [to 25 million members] is a great leg up," says Barry M. Meyer, CEO of Warner Brothers Entertainment (AOL ) Inc.

Time Warner television is taking advantage of that exposure for the first time. In April, Warner TV's Smallville launched online vignettes starring the show's character Chloe Sullivan to stoke the buzz between episodes. The Chloe Chronicles is viewed 200,000 times weekly. Likewise, Turner Networks has turned its rights to the NBA, NASCAR, and the British Open into 3- to 4-minute behind-the-scenes video clips, including live streaming of Tiger Woods' rounds.

AOL's latest efforts are encouraging. But it'll need to keep developing new content to ensure its place in the broadband future.

By Catherine Yang in Dulles, Va.

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