
WINDING DOWN
An idiosyncratic look at the week's net and technology news and 
comment
by Alan Lenton
December 15, 2002

By the time you read this I will be comfortably ensconced in New York City, 
looking forward to a nice Xmas. This column looks at a contemporary issue in 
more depth that I usually have space for. No Winding Down next week, or 
over the holiday period; the next column will be on January 12.


Analysis:

AOL - Grown Ups Back in Charge!

OK - first a declaration of interest. I have a soft spot for AOL. One of our 
games, Federation, was available on AOL for several years, and we would go 
back with newer games if we got the chance.

Early this month AOL held a big press conference at which they revealed 
what their situation was and explained what their proposals were for dealing 
with the problems.

AOL has a number of underlying problems, but probably the most pressing is 
the way in which AOL financed itself during the dot com boom. What it did in 
the main was to sell access to its customer base to third parties. That is to 
say, AOL did a series of extremely lucrative deals with other companies to 
allow them to display, and sell, their wares to AOL's customers.

At first sight this strategy seemed a brilliant stroke. It was, after all, the height 
of the boom, and the dot com kiddies queued to sign five year deals and pay 
the millions it cost from what appeared to be an endless supply of venture 
capital. At the same time, advertisers had not yet realised that no-one was 
buying as a result of their banner ads, and they continued to pour money into 
on-line advertising.

It seemed like everyone had arrived in the land of milk and honey. AOL was 
able to post the high level of growth that was so characteristic of the dot com 
boom. Share price soared.

But behind the glitter those who were perceptive could see problems growing. 
The first problem was that most of the existing content providers couldn't find 
the sort of money AOL wanted them to pay to stay on AOL, so the existing 
content evaporated off AOL and on to the web. That wouldn't have been too 
much of a problem, had it not been for the fact that the incoming 'content' 
providers had no content! They weren't short of imagination and creativity, as 
their spread-sheets testified, but they didn't actually have any product.

AOL always (correctly in my view) aspired to be a total experience. The 
problem it faced was that with diminishing content they were starting to feel 
like just another ISP, albeit a very large one. Of course, the money continued 
to come in, the deals had been done and they ran for years. Where the 
problem really showed up was in a very high 'churn' rate. AOL was churning 
through its subscribers. OK, it was getting more in than were leaving, but a 
worryingly high proportion were leaving. This didn't seem to matter at first, 
because the number of new people coming on-line was very high, and a large 
proportion of first timers went to AOL because of its high profile. 

As the proportion of the population on-line grew though, the growth of new 
subscribers slowed down and the problem became more obvious. The 
analysts started to notice and draw attention to it.

The fact was that AOL was carrying too much baggage to be a straight ISP, 
and not enough content to be more than an ISP.

The second problem took longer to become obvious. It related to the 
sustainability of the 'partner' payments (made by those who coughed up 
millions for access to AOL subscribers). Although it was not obvious at the 
time, these were one-off payments, made out of working capital, not out of 
sustainable revenue streams. As such, they weren't going to be renewed 
when they ran out. Of course, at the time the deals were done five years 
seemed a long time into the future. But now the future has arrived - and there 
are no replacement deals. The venture capitalists have all packed their bags 
and the dot com companies have softly and silently vanished. 

Underpinning all this has been an ongoing struggle within AOL about how you 
actually make money when you have tens of millions of subscribers. At the 
bottom line there are two views. On the one hand there is the view that the 
way to handle it is to sell your customers extra, value added, services on top 
of their basic subscription. This is sometimes called the 'cable television' 
model. On the other hand there is the concept that you make your money by 
selling access to your customers to third parties. This is a precarious route to 
go down, because it comes perilously close to selling your customers to those 
third parties.

Over the past five or so years it is the latter strategy that has predominated at 
AOL, and, as I indicated earlier, at first it seemed very successful. However, 
over the last eighteen months the downside has begun to show, while the 
chances of continuing to raise money from it diminished. This precipitated a 
struggle at the very top levels between the proponents of the different 
strategies with first one then the other side getting the upper hand. While this 
was going on AOL zigzagged all over the place. 

The turning point arrived when it became obvious that chunks of income were 
going to have to be restated because they weren't 'real' income. At this point 
the supporters of the cable television model finally gained control at a senior 
management level, if only because it was obviously that the alternative model 
couldn't even deliver on its own terms.

So, is all going to be sweetness and light?

Well, not exactly. Quite apart from the sheer scale of the problem of changing 
the culture of a behemoth like AOL, the new controllers of the company have 
to deal with the problems they inherited from their predecessors.

Not least of these is the yawning hole in the income left by the five year 
partner contracts running out. AOL themselves estimate that it will take until 
2004 for them to sort it out and restore growth. This may be optimistic.

Then there are an extremely unhappy bunch of Time Warner senior 
executives who have seen the value of their shares slump since the merger. 
They want fast solutions, possibly even to break the company back into two 
independent entities.

The new team at the head of AOL have defined their strategy in the phrase 
'compelling, exclusive content'. It's a good description of what they need, but 
it's not a rapid turn around strategy, or in any sense a silver bullet. There are 
two reasons for this. 

First of all, compelling content is not a single simple thing in the sense of a 
killer application (spreadsheets were the killer app for desktop computers, e-
mail that for the Internet). Compelling content is a package, and it takes time 
and experiment to find out what the components of that package should be. It 
took the cable networks years to figure out exactly what combinations of 
services their customers would pay extra for. While I don't think it will take 
AOL as long as the cable companies, I still think it's going to take time.

The second reason is the lead time on the development of media content. To 
give one example from my own trade, producing a new game in less than two 
years would be considered quite an achievement, even for a large and 
dominant company like Electronic Arts. And that leads to another problem - 
the technical possibilities at the end of that two year cycle may be completely 
different from what they were when the game was designed and specced - 
and not always in an obvious 'forward' direction. For instance the growth of 
SMS text (txt, as it's called over here in Europe) messaging means that the 
version of the Federation text game we developed ten years ago for a client 
who charged customers by the 256 byte data packet could come back into 
fashion!

So... Is it all hopeless?

No. I don't think so. AOL has 35 million subscribers. Even if you screw up, it 
takes a long time to burn away that sort of asset. More importantly I believe 
the new strategy is fundamentally sound. The problem is whether those in 
charge can make themselves the time and space to sort out their inherited 
problems and bring the components of their new strategy on-line. Frankly, it's 
not going to be easy, and it will be painful, as the recent round of layoffs 
indicate, but I think they're in with a chance.


Have fun on the web!

Alan Lenton
alan@ibgames.com


Past issues of Winding Down can be found at 
http://www.ibgames.net/alan/winding/index.html.


