In Strategy Shift, AOL Makes Most Services Free

By Sara Kehaulani Goo
Washington Post Staff Writer
Thursday, August 3, 2006

AOL said yesterday that it will abandon the practices that made it the gateway to the Internet for millions of early users, moving to a risky strategy that relies on advertising instead of subscriptions to support the company.

The Dulles company said it would give away e-mail accounts and other Internet services, such as parental-control and security tools, on its Web site over the next few weeks. The long-rumored moves come as AOL struggles to reinvent itself as millions of dial-up Internet users cancel their subscriptions and jump to high-speed connections. The company said it would cut $1 billion in costs through the end of next year, mostly by ending its marketing efforts to sign up new subscribers.

"Now we offer AOL services for free; there is no reason for anyone to leave AOL," said Jeffrey L. Bewkes, president and chief operating officer of AOL's parent company, Time Warner Inc.

Executives said the cost-cutting will include layoffs among AOL's global workforce of 19,000, but they declined to say when those would occur and whether they would affect the company's 4,700 employees in Northern Virginia. "There will be a reduction in force -- no doubt about that," said AOL chief executive Jonathan F. Miller. He added that the company wanted to share those plans with employees first.

Some analysts said AOL's new strategy was long overdue in a crowded marketplace where Google Inc., Yahoo Inc. and Microsoft Corp. are aggressively trying to lure members and advertisers to their sites. It's also a far cry from the company's roots in the 1990s as a service that helped non-tech-savvy people access the Internet using dial-up phone connections.

Since 2002, AOL's subscriber base has dropped dramatically, to 17.7 million from nearly 27 million. In the past three months, AOL has lost nearly 1 million U.S. subscribers, according to the company's financial documents. The company laid off 1,300 employees this year at call centers in Arizona and Florida, citing declining volume related to dial-up customer service.

AOL had already taken steps toward today's announcement. A year ago, the company launched with such free content as clips from TV shows and celebrity news for Internet users who are not subscribers. It also has given away e-mail addresses, but it had resisted opening up its valuable e-mail or other popular services. Now AOL is gambling that throwing its gates open wide will attract enough users to make the site irresistible to advertisers.

AOL said customers who want to upgrade to high-speed Internet using Verizon, Comcast or any other service provider will be able to keep their AOL e-mail account for free. The company still charges dial-up subscribers a monthly fee for Internet access, and some services, such as live customer support, would continue to carry a fee even for broadband users. The free services will be rolled out over the next few weeks, with e-mail becoming available immediately.

As subscriber numbers have dropped, AOL has come under scrutiny for using aggressive tactics to try to keep customers. The firm agreed to a $1.25 million settlement last year with New York Attorney General Eliot L. Spitzer, after an investigation by his office found that AOL made it too difficult for subscribers to quit. For instance, AOL offered cash incentives to call-center employees who were able to talk customers out of canceling their service. Recently, a taped phone call from an AOL customer who tried in vain to cancel his service circulated on the Internet, raising questions about AOL's continued practices.

"AOL has come to the realization that if they have to compete with the likes of Yahoo, Microsoft and Google, advertising is the future. The outcome depends on the management execution" of the new plan, said Tuna Amobi, senior media and entertainment analyst at Standard & Poor's, which has a "hold" rating on Time Warner stock. "The first year will be very critical. The erosion of the dial-up business doesn't give management any wiggle room."

Richard D. Parsons, Time Warner's chief executive, said AOL's advertising revenue surged 40 percent in the three-month period ended June 30 compared with the same period a year ago, marking a gain in U.S. market share "for the first time in a long time." The gains give him confidence that the new strategy will pay off, he said in a conference call with analysts yesterday.

Members of the parent company's board, who met last week to discuss AOL's new business strategy, gave it "their full endorsement," Parsons said.

Parsons has been under pressure to fix AOL, which has been a drag on Time Warner's otherwise rapidly growing businesses, such as its cable offerings. Earlier this year, shareholder Carl C. Icahn ended his bid to try and take control of the Time Warner board, break up Time Warner's units and cut costs, but Parsons remains under pressure to improve Time Warner's performance. Under a deal with Icahn, Time Warner leaders agreed to a $1 billion cost-cutting program.

Time Warner yesterday reported a second-quarter profit of $1 billion on a 1 percent growth in revenue, at $10.7 billion. Shares of Time Warner closed up nearly 3 percent, at $16.67.

"My problem with AOL and [it being] inside Time Warner is they haven't been able to work together well enough to really grow AOL and make it successful," said Jonathan Schrader, senior analyst at Morningstar Inc. "Time Warner is one of the biggest and best content companies in the world, yet it never worked well to ensure AOL has access to that content."

Time Warner's Bewkes said that much of the company's content is already on AOL's Web pages and that he did not plan to make any Time Warner content exclusively available on Instead, all of the content needs to be "on all digital outlets," Bewkes said. "There's no need for exclusivity. It's not the nature of the Internet. The Internet is about portals, and portals are doors, not gatekeeping items."

As part of the new plan, AOL said it would continue to offer dial-up Internet service for subscribers, who would pay $9.95 for basic service or $25.90 a month for "premium" service. But it said it will end active recruiting of new subscribers because it found that such efforts were not profitable.

Fees from subscribers still make up a majority of the company's revenue, but the strategy shift is not expected to affect AOL's earnings for the year, mostly because the company said it could cut much of its marketing costs related to signing up new subscribers. One of the biggest problems with its old strategy, AOL said, was that customers who upgraded to broadband Internet complained that AOL charged too much for services they could find elsewhere, such as a free e-mail account. That drove customers to competitors. AOL said that it has saved e-mail addresses from former customers over the past two years and that it will try to lure them back.

"We're using the existing base of people who use service today, and we're simply saying, 'You don't need to leave for any reason anymore,' " Miller said.

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