Corporate Idiocy
AOL Time Warner

Yesterday, Steve Case announced his resignation, effective in May, as chairman of AOL Time Warner. This closely follows the broadcast on CNBC of a documentary called “The Big Heist”, about the AOL/Time-Warner merger. CNBC’s take on things can be inferred from the title of the film. (And if you can’t, you will notice, if you follow that link, that CNBC is in bed with MSN, AOL’s biggest competitor.)

The merger has been a failure, to be sure. But I don’t agree with the conventional wisdom that the cause of the failure is the poor performance of the AOL unit. I’d say that what we’re witnessing is a victory, on an Atlas Shrugged scale, of Time Warner people who are afraid of change, over Steve Case & Co. and the future.

Remember, Time Warner is a company whose basic businesses are under attack from all sides, according it its own executives and lobbyists. TV viewers are committing “theft” when they don’t watch commercials. The threat to the music industry from piracy is so dire that government aid is needed to prevent a total collapse, and movies are expected to soon be in the same boat. “Harry Potter” fan websites must be some sort of threat, too, because Warners spends time and money trying to shut them down.

Yet it’s the AOL online unit, we’re told, that’s dragging down the company.

At the time of the merger, I’d been predicting AOL’s doom for years. In 1995, I was firmly of the opinion that proprietary online services like AOL – there were still several others in business, in 1995 – would be killed off in short order by open-standards-based systems like internetMCI. It just seemed inevitable: internetMCI and similar ventures had the potential to offer everything AOL offered, only instead offering it through a proprietary interface, you’d offer it through web pages. You get the bonus of not having to maintain a huge custom-built system, and you can throw in the wonders of the Internet for free (in 1995, AOL had just barely dipped its toes into the Internet water, making access to non-AOL content very painful for AOL subscribers).

As it happens, I was right, except for the timing. I thought that we’d have seen the last of AOL – then a small operation behind a Cadillac dealer in Tyson’s Corner – by 1997. I now think 2004 is likely.

What I predicted has largely come to pass, except that there’s really no role at all for the online service – these days, the ISP – to play in providing content. (I am afraid that I use the word ‘content’ a lot here, sorry. Deal with it.) The online banking, the online news, the online shopping is all provided directly by the banks, news organizations, and merchants themselves. The ISP is just a conduit. A lot of ISPs try to offer some kind of ‘portal’ at the same time they’re providing the conduit, but none of them are good at it.

AOL has, at various times, prospered because it offered something that people wanted. What this something was has changed over the years.

In the early days, AOL offered a much more user-friendly experience than the competing online services. While on CompuServe, to get to a specific content area, you’d type

Go mxlfxj

(or go whatever-you’re-interested-in), and be transported there, after looking at a message that said

Request recorded, one moment please

For a while at $6 an hour. On AOL, the same process involved clicking with your mouse on an icon, and moments later being presented with a different easy-to-understand graphic page. This was big stuff in 1990.

Eventually, CompuServe cobbled together a graphical interface, and more people started getting on the web, and AOL’s pretty graphics were no longer so special. This wasn’t a problem, though, because AOL had a large stable of content providers as partners.

Back then – I’m thinking of the early-to-mid nineties – AOL charged by the hour, and if you provided content for the service, AOL would cut you in on the take from time users spent reading your stuff. It’s easy to forget this now, but in the early days of the web, it was damned hard to find certain classes of information. The web then consisted mainly of home pages of engineers, and corporate sites for a few forward-thinking computer companies. If you look at the registration dates for the domain names for certain companies, you’ll see how little really was out there in the early days:

nytimes.com:\tJanuary 1994

wsj.com:\t\tMay 1994

espn.com:\t\tOctober 1994

yahoo.com:\tJanuary 1995

aol.com:\t\tJune 1995

washingtonpost.com:\tNovember 1995

Those dates are just the dates for the registration of the domains, of course; they shouldn’t be taken to mean that ESPN, for example, started offering online services in October, 1994. They definitely didn’t start offering them before October, 1994, though.

To compete against all this exclusive content that AOL was offering, most ISPs then, as now, offered all-you-can-eat pricing. This was a big change: up until then, most online services were pretty expensive, with charges ranging from $6 an hour for AOL and CompuServe to $12 and more for things like Dow Jones News/Retrieval. CompuServe even charged you more if you were using a faster modem, and more yet if you used the service during ‘peak’ hours in the daytime.

Eventually AOL had to meet the pricing challenge from the ISPs; they moved to a flat-rate model in December 1996. Charging users a flat rate per month meant that it was no longer possible to share hourly revenue with content partners, and those relationships went down the drain.

Making matters worse, part of AOL’s strategy for making up revenue lost by moving to flat-rate pricing was to charge content providers for the privilege of having their stuff on AOL. It’s as if your employer sent around a memo telling your salary was being reduced to zero, and that if you wanted to continue working there next month, you’d be expected to pony up a few grand.

It didn’t take long for the content partners to leave. Since AOL users by that time had some rudimentary web access, and since you’d have to pay to stay on AOL, it suddenly was more attractive to build your own website. If you were going to spend the money, you could spend it this way, have greater control, and be accessible to more people.

This is where AOL’s decline began. Flat-rate pricing led to greatly increased use, which led to busy signals and class-action lawsuits. By April of 1997, AOL was in the position of having to spend millions of dollars beefing up its network and apologizing to customers on television.

Subscriber numbers kept rising – though whether AOL’s subscriber figures were ever accurate is open to debate – as people continued to take advantage of what was now AOL’s competitive advantage: its dialup network.

Nationwide unlimited-use dialup service from a ‘real’ ISP like UUnet or MCI was very expensive. For $20 a month, you could get effectively the same thing from AOL.

Trouble was, people who paid their $20 a month and then used the Internet and not the AOL service – and were thus not exposed to AOL’s copious advertising – weren’t very valuable to AOL. People who did use the service weren’t happy that their experience was now more ads than actual useful content. AOL started looking around for a way to replace the content they’d lost by moving to flat-rate pricing, and by the increasing prevalence of consumer broadband Internet access, which made AOL’s dialup network less valuable.

After a few years, they’d found the big steaming pile o’ content they’d been looking for in Time Warner. Thousands of songs, hundreds of Bugs Bunny cartoons, hundreds of movies, books, TV shows, magazines, etc., etc., etc. Time Warner was and is one of the world’s great collections of content, and AOL bought it.

Or was it the other way around? To read the news coverage surrounding Steve Case’s resignation, you’d think that he was a huckster who managed to sell Time Warner a pig in a poke, and that now that Time Warner has managed to rid itself of this idiot, the company will be free to go along with its plans for world domination – unless the boat-anchor that is AOL (the hated, despised, horrible money-losing AOL) drags it down first.

That’s not the case at all, of course; Steve Case, as chairman of AOL, bought Time Warner because its back catalogue, so to speak, was just what AOL needed. AOL then failed to take control of Time Warner, and the Time Warner people have spent the last few years pissing in the bathwater.

Case likely isn’t blameless in all this; he did, after all, allow Time Warner to destroy the value of the merged companies. But the proximate cause of AOL Time Warner’s woes is not in Virginia, it’s in New York.

Let’s look at exactly what AOL Time Warner is. It consists of, as I’ve said, an incredibly rich collection of all kinds of entertaining and informative content; the apparatus for generating more entertaining and informative content; several different distribution channels for this content; a beefy IP transit network; software development divisions that produce web browsers, media players, and communications programs; a large cable-television network; one of the country’s largest networks of cable-modems; and the last of the walled-garden online services. The company operates an enormous amount of bandwidth into nearly every home in America, with TBS, TNT, Cartoon Network, TCM, WB, CNN and affiliated networks, HBO, and Cinemax, before you even start thinking about what we’d ordinarily call a data network.

What challenges does the company face? Well, the entertaining and informative content is being pirated at an increasing rate as the costs of duplication and distribution drop to near zero; Time Warner, like all media companies, is constantly talking about the dire threat to their survival posed by people listening to MP3s and trading . The transit network, like all transit networks, doesn’t make any money on its own. The software developers are under competitive pressure, primarily from Microsoft. The cable-TV network has regulatory problems, the cable-modem people are in the position of offering a commodity product in a competitive market, and nobody in interested in walled gardens anymore.

Clearly, the solution to this is situation is to offer one or two Christina Aguilera videos on AOL each week, to plaster CNN and Comedy Central with ads for the online service, to continue to pummel your customers on the media front, and to roll over for the cable-TV regulators.

A quick check of AOL’s stock price since the merger will show you how well that’s been working for them.

The trouble is that the Time Warner people are still firmly in charge, and they see AOL Time Warner as a big media company with an AOL hung on the side of it. Steve Case’s view, and the view that leads to wealth, is to see the company as a hell of a communications network that happens to also be able to create its own world-class content.

If you insist, as the Time Warner execs do, on preserving and growing every one of your current revenue streams, of course you’re going to see a communications network as a millstone. Time Warner and AOL were, ultimately, in the same business: moving data around. The Time Warner people who are in charge of moving data by selling DVDs don’t want to see that data-moving channel threatened by another division of their own company. Someone who catches up with The Sopranos by watching a full-screen, full-motion, surround-sound version over their AOL cable modem from and AOL media server is less likely to buy the DVDs.

The thing is, though, you make more money from the guy who doesn’t buy the DVDs, but who instead pays you, each and every month, for a Super-AOL subscription.

AOL is in the position of being able to provide you with phone service, cable-tv service, Internet service, and a huge library of video-on-demand titles, without having to win the cooperation or paying a dime to any other company.

If you add up what you spend on communications, movie rentals, and some fraction of media purchases every month, it’s probably a fairly substantial amount. AOL could potentially get that amount out of you every month in a combined phone/cable/HBO/AOL bill, if it only had the corporate will to do so.

It would once again be offering a compelling, unique, useful product, and before long people who aren’t on Time Warner cable systems would be demanding the same.

I don’t expect any of that to happen any time soon, because it threatens too many of Time Warner’s existing revenue streams. Like most companies there days, they want growth, but they want growth on their terms. They want to sell you more DVDs, and at higher prices, rather than sell you something that will cost them less to produce and that will give you added value that you’re willing to pay for.

Eventually, someone will do it – the unified data stream into your house is just too obvious and too potentially lucrative an idea to be passed up forever. It’s a shame, though, that since the merger, AOL Time Warner has been sitting in the catbird seat and wilfully ignoring the possibilities of its position.

Posted by tino at 17:34 13.01.03