Can Tim Armstrong Save AOL?

Tim Armstrong needs a new hip. Two decades ago the AOL chief executive absorbed a crushing hit on a high school football field. Over the years his discomfort worsened, and a few months ago his doctor told him that he should seriously consider a replacement. Armstrong, who is just 38, wasn't having any of it. He's too busy saving AOL, which on Dec. 10 will finally separate from Time Warner (TWX), bringing to a merciful end a dysfunctional marriage that lasted nine long years.

Armstrong may well have the most difficult job in media. Mention AOL, and people think: The Worst Deal of All Time! Ask them what AOL does nowadays, and most will say: I have no idea. "Tim needs to articulate the value of AOL," says Robert W. Pittman, a former AOL Time Warner chief operating officer. "He needs a strong selling proposition." Since leaving Google (GOOG) eight months ago to run AOL, Armstrong has busied himself coming up with one. It goes something like this: AOL is not some dot-com has-been selling Web access and e-mail. It's a digital media colossus with 80 Web sites churning out everything from personal finance advice to bedroom tips for women. With 100 million unique monthly viewers, Armstrong asserts, AOL has what it takes to lure blue-chip companies eager to reach multiple audiences with one ad buy.

Sounds great, right? And it might just work. But consider the challenges. Armstrong faces a landscape populated by giants, such as Yahoo! (YHOO), Microsoft (MSFT), and Barry Diller's IAC (IACI), and a slew of startups—all pushing their own content. Plus, Yahoo and Microsoft attract more eyeballs than AOL. And while Armstrong says content is at the heart of his strategy, AOL already tried that and failed. What's more, right now, advertising-supported content, according to one estimate, generates only 30% of AOL profits. Meanwhile, AOL employees, having endured multiple layoffs and strategies over the past decade, are demoralized and weary of yet another makeover. So, yes, the hip operation can wait. "This is a challenge, I know that," says Armstrong, a first-time CEO. "We have to create a company that doesn't settle for mediocrity."

Armstrong's arrival at AOL marks the latest chapter for a company that over the past 25 years has gone through multiple permutations. When it was founded in 1985, it provided software for Commodore computers; a decade later it had morphed into America Online. AOL introduced millions of Americans to the Web, and the slogan, "You've got mail," embedded itself in the popular culture. As AOL's stock took off, hubris set in, and the boyish CEO, Steve Case, developed a burning ambition to acquire Time Warner, one of the world's most powerful media companies. The deal closed on Jan. 11, 2001, amid much talk of synergies. We all know what happened next: AOL Time Warner shareholders watched helplessly as $100 billion-plus in value evaporated.

STANDING OVATIONAfter that, AOL stumbled along, adopting one strategy only to jettison it for another. Meanwhile, the likes of Yahoo, Google, MySpace (NWS), and Facebook came to define the Web. Finally, earlier this year, Time Warner CEO Jeffrey L. Bewkes had had enough. And Bewkes, who had criticized the merger back when he was running Time Warner's HBO, set in motion the long-anticipated divorce. He hired Armstrong as CEO. The choice was widely applauded because during nine years at Google, most of them as head of U.S. ad sales, Armstrong had made peace with Madison Avenue, then deeply suspicious of Google's motives. By doing so, he helped turn the search giant into a $20 billion advertising juggernaut.

On Mar. 17, a rainy St. Patrick's Day, Armstrong made his AOL debut before 1,000 staffers packed into a large tent outside the original Dulles (Va.) headquarters. Case and former AOL Vice-Chairman Ted Leonsis spoke first. They took pains not to dwell on what might have been but on how Armstrong would transform AOL. Then Armstrong, an imposing six-foot-four, took the podium. The crowd, some wiping away tears, gave him a standing ovation. A few days later he reported for duty on the fourth floor of the Wanamaker Building in downtown Manhattan and got busy figuring out how to turn AOL into a 21st century media company.

AOL faces a classic business conundrum: The original enterprise (selling Web access) is dying, but the new operation (selling ads) isn't big enough to replace it. AOL still has about 5 million subscribers but is losing several hundred thousand a year. Recently, the company has made up for the loss in subscriber revenue by cutting costs. Then came this year's advertising drought. For the first nine months of 2009, AOL's revenues dropped 24%, to $2.4 billion, while operating profits shrank 34%, to $765 million. The picture doesn't get any rosier. Over the next three years, according to estimates from equity research outfit Sanford C. Bernstein, operating profits will continue to decline, by 10%, to $880 million. You can see why Armstrong is under enormous pressure to rev up advertising.

When Armstrong took over the corner office, he was shocked to discover that AOL had stopped doing the most basic things. Nearly three years had passed since it did any market research. In fact, AOL had been without a chief marketing officer for 12 months. "We were dark for a very long time," says a senior executive who is helping find a new CMO. In those first days on the job, Armstrong relied on his gut. He came to believe he needed to reach three kinds of people. There are old-timers who still use AOL e-mail and regularly visit AOL news, music, and entertainment sites. There are younger people who hang out at pop-culture sites like FanHouse, Stylelist, Spinner, or PopEater but have no clue that AOL owns and operates them. The last group are folks who simply gave up on AOL.

To find out how people perceive AOL, Armstrong hired ad giant Leo Burnett to conduct surveys among 5,000 people aged 18 to 65. Burnett found that most people are aware of AOL but lack strong feelings about it. About half said they didn't know what AOL did anymore. "AOL has the awareness," says Pittman. "It just has to drive out the fuzziness."

Armstrong went looking for answers. In his first 100 days, he visited 16 cities around the world. By his count, he has spoken with 10,000 people—employees, advertisers, investors, even people he meets at conferences. He has reached out to fellow executives. David J. Stern, a friend and commissioner of the National Basketball Assn., told him not to be afraid of experimenting. Mickey Drexler, the CEO of J.Crew (JCG), also headquartered in the Wanamaker building, regularly drops by. He told Armstrong to listen to customers and workers.

Armstrong has become a student of corporate turnarounds. A favorite case study: Apple's (AAPL) resurrection. He asks employees to read a 1996 BusinessWeek cover story about Apple headlined "The Fall of an American Icon," a dour view of the company before Steve Jobs' return. Armstrong has taken much of his road map from the Apple turnaround, which he sums up as: "New products and services that people find necessary."

What he means by that is content—news, politics, sports, music. But isn't the world awash in content? Yahoo, arguably AOL's closest rival, has many similar sites. Yahoo and its ilk, however, are mainly aggregators, taking others' stuff and selling ads against it. Armstrong aims to stand out from the crowd by creating original content. A year ago, AOL licensed up to 80% of its content; today, the company says, it generates 80%. Bill Wilson, AOL's content chief, has exploited traditional media's implosion to hire seasoned journalists. Their expertise and voices, Armstrong believes, will enhance AOL's sites—and the brand. Each week some 30 AOL editors appear on TV and radio to talk about their areas of specialization. Of course, AOL once had access to Time Warner's original programming and journalism, and that didn't get it very far.

As local newspapers wither away, AOL is positioning itself as the go-to source for local communities. Its main vehicle is, a collection of sites with a hyperlocal focus that AOL acquired in June. (Armstrong was an investor but agreed not to take a profit on the sale.) The sites, each operating under a single editor, offer local news and sports, restaurant offerings, and events. AOL operates 25 Patch sites in towns with populations of 15,000 to 50,000. It plans to have hundreds more up and running in the next year. The idea is to lure national advertisers keen to reach local consumers. So far, though, advertisers are mostly local—colleges, arts centers, florists, and so forth. And a lot of other players, including Topix, a venture by McClatchy (MNI), Gannett (GCI), and Tribune, are vying for the hyperlocal market.

E-mail may seem a sideshow these days, but AOL says it drives people to its sites, particularly since visitors see a page of headlines hawking AOL content whenever they sign on. While instant messaging remains popular, regular AOL e-mail lost 15% of its U.S. market share in the last year to the likes of Yahoo and Google. To help reverse those trends, Armstrong recruited Brad Garlinghouse, a former Yahoo executive who helped the portal go from No. 3 to No. 1 in e-mail. One of the first things he did was reduce the advertising on AOL e-mail by 60% to eliminate the annoying clutter. He is also ditching a bunch of obnoxious rules that had chased away many AOL e-mail users. When somebody canceled an account, for example, AOL didn't allow anyone else to use that name. Now they will. Also, AOL e-mail users could never put a period or an underscore in their addresses. Now users will be able to.

Attracting eyeballs is just half the challenge. Armstrong needs to get advertisers to follow—and fast. To help sell the new AOL to Madison Avenue, Armstrong poached a Google colleague named Jeff Levick, calling him during a family vacation in St. Bart's to make his final and ultimately successful pitch. A former mergers-and-acquisitions lawyer, Levick brought with him valuable contacts, a clear sense of Armstrong's thinking, and a commitment to do for brand advertising at AOL what he had done for search advertising at Google.

Shortly after he started in April, Levick concluded AOL had too much advertising inventory—industry lingo for places to put ads. He and Armstrong agreed the oversupply was hurting the rates AOL could charge advertisers. So Levick did something unusual: He cut the number of ads on the home page from 10 to one. "You raise the quality," Levick says, "and charge a premium." Is it working? He isn't saying.

These days companies expect data proving that their ads are reaching the right people. Armstrong wants to go a step further by giving advertisers real-time information so they can tweak their messages on the fly. Once again AOL looked to a Google alum, this time Shashi Seth, whose job had been to wring as much money out of ads as possible. Seth gathered 55 computer scientists and ordered them to design algorithms that can do things like predict when demand for specific products and services peak. Intrigued by the technology, ad buyer Interpublic (IPG) Mediabrands struck a strategic partnership with AOL in October. Interpublic will share resources and research, as well as take advantage of AOL technologies. "What we're seeing here is a very novel approach to advertising," says Quentin George, Interpublic Mediabrands' chief digital officer. "We're excited about how they are looking at consumer demand when it comes to content."

As his team works feverishly, burnishing old strategies and creating new ones, Armstrong's big push in the coming months will be selling the world on AOL, the brand. He doesn't believe it will happen with a flashy TV ad campaign. "We don't want to put lipstick on a pig," says one of his aides. Instead, Armstrong believes AOL needs to approach consumers with humility: Yes, the company lost its way, but now it has plenty to offer. How will he get the message out? "Listen," says Armstrong, "we have 100 million unique visitors every month, so that is a huge opportunity to spread the word."

CONVINCING INVESTORSUnlike some of his predecessors, Armstrong seems unafraid to hitch sites to the AOL brand. "In the past, [our] services were like little speedboats racing away from the AOL name," he says. So does AOL's popular sports site FanHouse become AOL FanHouse? Still to be determined. "You may or may not see the AOL name on the title of our sites, but you will begin to see a more consistent effort to promote the AOL brand on the sites themselves," says Wilson. While some people wouldn't be turned off by having AOL attached to sites, it could hurt others. For example, consumers said if the Politics Daily site added the AOL name they might think the site is biased.

Armstrong is stressing all of this as he embarks on a 10-city U.S. road show. If consumers are apathetic about AOL, investors are bitter. Having been burned by the AOL Time Warner merger, money managers may require the hardest sell of all. Armstrong believes that simply being separated from Time Warner will put a lot of the ill will behind AOL. "Why would I buy AOL?" asks a large media investor. "It would largely be a bet on Tim, given what he was able to do at Google." AOL may never again be a $70 stock. And by some estimates, its market cap will be about $3 billion. That's not enough to make it into the Standard & Poor's 500, meaning AOL won't be able to tap the investors who buy that index. Still, Armstrong says AOL will have a chance to show Wall Street that it is the media model of the future. Needless to say, skeptics abound.

Armstrong knows he doesn't have much time to prove his case before AOL is written off as a legacy brand. That's why for now, as much as his old injury hobbles him on his worst days, the occasional acupuncture treatment will have to do.

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