Part 1: Whither AOL?

Can AOL survive the 'New Net'?
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One of the constant themes in my mail from

TSC

readers is "What's going to happen to

America Online

(AOL)

?" That nonstop stream of emails doesn't change much as AOL trades up or down. It's not tied to dips or rallies. The mail just continues, regardless of what's happening on the Street ... or down at AOL headquarters in Dulles, Va.

America Online has been a fabulous growth and profits engine and has made a lot of people rich. In a sense, that's odd because few large American companies have been so vilified so publicly -- let alone by their own customers! -- as AOL. From lousy technical standards and constant dropped connections in its early years to lousy customer service in its midyears to today's fairly steady connections, much-improved phone support but still largely soporific content, AOL has often looked like a textbook case of how

not

to manage a big Net company in the 1990s.

And yet, today AOL, with more than 18 million users, is worth more than a hundred billion dollars on the market, and almost half its shares are held by institutions. It's one of the "gotta-have" stocks in most growth-fund portfolios, lest those funds' managers receive an avalanche of unhappy mail every quarter from their investors when their lists of holdings are published.

America Online, simply put, has become an American institution. I can even push that analogy a little harder, saying its strengths and weaknesses reflect those of our society as a whole: Largely averse to technical things, we look for simplified answers (e.g., the spectacularly successful

Dummies

books from

IDG

). We build big economic successes, often, from ideas and enterprises that we nonetheless wildly suboptimize. We too often go for a lower-than-necessary common denominator, then find large numbers of us trapped for a long time in those sweaty climes. And when we do enjoy big financial successes, we crow about them as if we gained them through merit, perspicacity and genius, largely ignoring the critical roles that blind luck and good timing played.

AOL fits every one of those tests ... just as, too often, we all do. Maybe it's a cultural thing. Maybe it's just the '90s.

In any case, AOL is now emerging from a decade of luck, prosperity and fame into a world very different from the one in which it was born, a world also very different from the one it helped create. How it meets this test of change -- indeed, if it

can

meet these tests and prosper still -- will be fascinating for everyone interested in the Web to watch.

It seems to me that AOL has to address successfully four big issues. And this isn't a three-out-of-four series: AOL has to win big on all four counts. Investors, of course, have to come up with their own answers to how AOL will address these four problems and thus how AOL will perform in the market. As always, these problems are complex and intertwined in messy and sometimes dangerous ways. Solve A and you make B worse; fix D and C falls apart.

Good luck, Messrs.

Case

and

Pittman

: You're going to need it. The four problem areas:

    Broadband access: As we move into the Broadband Era, AOL's world turns upside down. The more it pushes into broadband access through other entities, the more it reduces its monthly-fee income from subscribers; the more it stays stuck in the dial-up-access world, the higher and more rapid its attrition rate. AOL can't leap ahead to tomorrow too fast, but it can't become the laggard of the online business. Tough line to walk. Anti-Net? American Online management can deny it all it wants, but AOL is widely seen, including among a great number of its customers, as profoundly anti-Net. And with good cause: Born in the pre-public-Web-access days, it built itself around the notion of the value of its proprietary content. Indeed, most of the justification for its $21.95 per month "membership" fee is that presumably valuable content, plus its easy-to-use email. But we are squarely in the Web Era now, when a portal site's content is ... well, let's just say it's a lot less important than the window to the entire Web created by that portal. To continue in its present model, AOL has to continue to argue, in effect, that its own content is a lot more valuable for its members than all that other stuff Out There on the Web -- a patently ridiculous argument. Microsoft: America Online isn't at risk so much because Microsoft (MSFT) - Get Report is voracious (though of course it is) as it is because it has put itself, very consciously, squarely in Microsoft's sights. In part, this is because Microsoft's reinvigorated MSN will be a strong competitor to AOL's market dominance. (Anyone who doubts that Rick Belluzzo is going to invigorate Microsoft's online businesses is, excuse me, nuts.) In part it's because the free dial-up Web-access offers that Microsoft and others are about to announce will draw a large number of users out of AOL's user base, reducing AOL's monthly subscription-fee income and, ultimately, its preferred-provider income. And in part the danger is because AOL has repeatedly taunted the Microsoft bear, rattling the bars of its cage for PR reasons ... and, certainly, for childish self-gratification. Declining fees: AOL cannot much longer sustain a membership consisting mainly of $21.95 per month dial-up subscribers. It provides a $9.95 per month "bring your own access" alternative for those who want to come in via another ISP, but until the recent broadband push, that hasn't been very popular. Now, though, AOL subscribers who sign up with Excite@Home (ATHM) - Get Report or RoadRunner for fast cable-modem access, can be expected to shift quickly to the cheaper AOL option ... if they stay at all. And as ADSL is pushed harder by regional Bell operating companies and competitive local exchange carriers, AOL members will be pulled in that direction as well; if they stay with AOL, they'll be paying $20 per month extra to add DSL access on top of their $21.95 AOL fee. But insiders say there's almost certainly behind-the-scenes revenue sharing going on there with the RBOCs that reduces the net cash to AOL well below its full-dial-up-subscriber rate of $21.95 a month.

Sounds pretty grim, doesn't it?

Initially, yes. So I'm not surprised by the vigorous cases made against the future of America Online by some analysts.

Steve Sherman's

blistering

piece here on

TheStreet.com

a couple of weeks ago is a fine example of a considered AOL slam. It wasn't personal or vicious, just a straight-talk-among-friends report by someone who sees all the cards coming up wrong for AOL.

But I disagree with Steve. I think -- this is both head and gut talking -- that America Online is going to come through this painful time of change just fine. AOL's management has demonstrated a remarkable flexibility over the years in adapting to, and often co-opting, changing circumstances. Moreover, AOL has been smart about putting into place alliances that will likely allow it to surf these changes rather than being swept under by them (apologies to

Alvin Toffler

). And though it's hardly visible today, AOL is internally remaking itself for the broadband world, for the "New Net" people are talking about.

Tomorrow, I'll run through that list of problem areas once again, with my spin on how AOL is going to handle them. Then, my vision of what America Online wants to -- and, I think, likely will -- become.

Jim Seymour is president of Seymour Group, an information-strategies consulting firm working with corporate clients in the U.S., Europe and Asia, and a longtime columnist for PC Magazine. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. At time of publication, neither Seymour nor Seymour Group held positions in any securities mentioned in this column, although holdings can change at any time. Seymour does not write about companies that are consulting clients of Seymour Group, or have been recently. While Seymour cannot provide investment advice or recommendations, he invites your feedback at

jseymour@thestreet.com.