Does AOL Need to Patch Up?

Disclosure: The author is a shareholder in AOL.

It’s been funny watching the financial press and the tech community eviscerate AOL’s since last week’s disappointing earnings call. The irony is that Patch is AOL’s last, best chance to build a growth engine. Investors shouldn’t be calling for AOL to back off the business. They should be calling for AOL to double down — not by increasing Patch’s $150M+ yearly cash burn, but by increasing commitment.

Patch has the potential to be a truly disruptive business. The startup is trying to build a platform that could replace a disaggregated network of local news sources. Consider the market. There are approximately 54 million school-aged children in the U.S. Most of those children don’t care about the articles featured on or HuffPo, but almost all of them are online. They do care about the news that is featured on their Patch. Those children have parents who care about the goings on of the world, but also need to know about the community issues that will affect their families. They care about the issues Patch is covering and it shows: In just one year, Patch’s readership has grown to six million monthly uniques.

Individually, each of these local news publications is not worth much. But a player that could aggregate and then displace the entire industry could create real value. That’s what disruptive businesses do; they displace their upmarket competitors by coming in with a low-cost, scalable offering. Almost all of these disruptive businesses are ridiculed or ignored in their initial years of operations by existing players. It was crazy to think that the world’s biggest auction house would find its beginnings as a trading ground for Pez dispensers (eBay). It was out of the question to think a company could rent movies and not charge late fees (Netflix). In that same vein, who would try and build a media empire on the back of 1,000 miniature websites instead of a handful of national properties?

While I believe in the market Patch is addressing, some of the outcry in the press is warranted. Most important, Patch’s current business model is unsustainable. Patch is building a network of journalists and salespeople, and it’s costing the company a lot. This is not the way to build a disruptive business and it’s an open question as to whether Patch must grow this way to win in local news. Patch doesn’t need to be spending money this way to win in the space; it could adopt a model that better suits its disruptive nature by cutting back.

To right this ship, Patch needs to engage in some serious business model innovation; or in non-MBA jargon, Patch needs to align its resources with the value it creates for customers. It needs to dramatically lower costs, increase (already impressive) growth, and find novel revenue sources. The Patch network can’t be run like a network of miniaturized Huffington Posts.

A successful Patch might have deep integration with high school newspapers to source content and editors. It might source local advertisements from the likes of Foursquare, Groupon, and Adsense. It might partner with innovative service sites like Redbeacon so you could find contractors in your area. It would have significant mobile capabilities. It might facilitate community groups in listing events, ticketing, and collecting payment.

Fundamentally, Patch needs to become scalable. A successful Patch likely can’t be created by building a large sales force and trying to source beautiful Project Devil ads for the site. It’s difficult to imagine that the owner of Ledo Pizza in Maryland worries about brand advertising at all, let alone the aesthetics of his banner ads.

How can AOL help Patch achieve its potential without burning cash? Like most disruptive businesses that start out under corporate parents, if Patch is going to have a chance, AOL is going to have to give it some serious freedom. Patch needs some of AOL’s smartest managers; they need to be separate from AOL, they need to have their own (limited) resources, and they probably need upside in Patch’s success. It’s going to have to be out of the reach of the existing media execs who have a traditional way of thinking about how these companies should make money. It needs to be run like a real startup.

If AOL takes this course, Patch could surprise the world. AOL would create a burning platform for the startup to get to profitability, give it the freedom to make the tough choices it will take to get there, and build a growth engine unlike anything it has in its portfolio.

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