Topstory 1

Internet portals face
new urgency on profits

November 20, 2002

As the three largest portals seek to squeeze profits from the Internet, they are turning the clock back in some respects: bundling Internet access with content, offering tiered pricing to attract more users and emphasizing community-building tools, while at the same time downplaying advertising.

Whether these retread models will ever attain the elusive long-term profits has been debated since the dawn of the commercial Internet. But the question takes on new urgency now as AOL, Yahoo and MSN retool their business strategies in the wake of the technology bust.

The high-profile October release of new software tools from AOL and MSN, and Yahoo’s quieter September launch with SBC of a co-branded high-speed Internet access service, underscores the increased competition as growth of the Internet audience slows and these three large online entities struggle to hack a new path to profits.

In some ways, they are taking many of their business cues from cable television: Bundle offerings in attractive ways to convince people to pay for something that used to be free.

Enter tiered pricing: Broadband services are being priced based on Internet connection speeds and access to content now comes in pre-paid packages, more closely tying the two services than in previous incarnations.

‘‘If you ask people if they are willing to spend a few dollars a month more for a package of cable channels, most say yes,’’ said Charlene Li, an analyst with Forrester Research. ‘‘Now Internet companies are bundling like cable TV.’’

What’s still missing in this formula, say analysts, are any offerings - beyond basic dial-up access - that a mass audience might actually be willing to pay a few dollars a month for. Broadband access is only in 12 percent of U.S. households and a recent Commerce Department report said its adoption was largely driven by people wanting to work at home.

‘‘What is so compelling that people will be willing to pay for? Quite frankly, I don’t think we still know,’’ said Mark Kersey, a senior analyst with ARS, a technology research firm. ‘‘These guys are promoting convenience more than content; faster, always-on connections without having to tie up the phone line.’’ But, say Kersey and others, the odds of success may be improved this time.

For better or worse, the technology-stock bust has virtually cleared the playing field of all but the largest competitors.

Here’s a synopsis of the strategies AOL, MSN and Yahoo are using to increase users and revenue, and the challenges that lie ahead for each:

AOL is at crossroads. It remains the nation’s largest ISP by a huge margin, with 26.5 million subscribers, but its bread-and-butter business of dial-up Internet access is growing slowly and others are undercutting its price. Its marriage to Time Warner may be under scrutiny, but it gives AOL access to a vast array of exclusive music and video content.

However, AOL has no clear-cut broadband strategy; the dial-up business has much healthier profit margins than broadband, posing a dilemma for the money-losing company when it decides how hard it should push broadband conversion.

Most of the new features offered in AOL 8.0 focus on rebuilding the company’s reputation for fostering an online community. They include efforts to keep the dial-up audience from bolting, promising, for example, to no longer allow advertisers to use pop-up advertising on the site.

On the broadband front, AOL recently struck a partnership with AT&T Broadband and Comcast for high-speed access, which it also provides through Time Warner Cable. Broadband gives users such offerings as CD-quality radio and live streaming performances of popular musicians. Unlike the dial-up market, where AOL, as market leader, essentially sets the price, broadband is a different story. AOL’s prices are high and, for now, it offers no tiers.

Analysts say AOL has two choices: Go the so-called HBO route, and offer premium packaging of Time Warner content online or retool itself as the premier online access provider, offering simple connectivity and communications services at an attractive price.

Last month, a third option emerged, when AOL Time Warner chairman Steve Case, who originally popped the merger question two years ago, reportedly posed the possibility of dissolving the Internet’s most-hyped marriage.

No major Internet company has retooled its Internet strategy as often or for such enormous cost as Microsoft.

The software giant’s MSN service remains a distant second to AOL with 9 million subscribers, although an intensive marketing campaign including undercutting AOL’s dial-up and broadband pricing, has shrunk the gap.

Returning to its software roots, MSN’s Internet strategy now lies predominantly in creating a broadband network over which to sell software services, giving it a leg up in the race to capitalize on online transactions, such as bill paying or streaming media, instead of relying on Internet access fees or online advertising. MSN said it has spent $500 million alone developing and promoting MSN 8.0.

The theory goes if consumers are willing to pay for one service, they will be more open to paying for others down the line. Microsoft is even offering discounting on home networking gear for connecting to DSL and cable service.

To build the broadband network, Microsoft is partnering with Verizon Communications and Qwest Communications, setting the stage for head-to-head competition with the recently launched SBC Yahoo DSL service.

With its introduction of 8.0, MSN now will separate for the first time what features it offers on the free MSN site from those available to Internet access subscribers. Paying customers will get the more technologically advanced features. Consumers who use a different ISP can access them for $9.95 a month.

Forrester’s Li predicted MSN’s features and pricing, along with a similar offering from the Yahoo SBC partnership, together will lure away nearly one in five AOL subscribers who want broadband access.

Yahoo CEO Terry Semel thinks the best route to a paying audience is through an ISP, which led him to partner with SBC in the Web portal’s boldest move since Semel left Hollywood for Sunnyvale 18 months ago.

It’s a gamble for Semel who is gradually rebuilding the foundering business by turning large parts of the popular portal into for-pay services.

Although off to a slower than anticipated start, revenues from the SBC partnership could account for as much as half of next year’s forecast growth in revenues, analysts say.

SBC’s broadband subscribers receive a range of Yahoo services, from online photo and e-mail storage to three free classified ads, as part of an Internet access package, which is priced based on the speed of the Web connection.

Once it has them hooked, Yahoo hopes to sell premium services, many entertainment based, to access subscribers on top of the Internet connection, starting with games-on-demand and moving eventually to movies.

Bolstered by the ISP partnership with SBC, Yahoo is expected to attain 2 million paying customers by year’s end, up from 500,000 a year ago. But hooking up with other ISP providers for similar arrangements has proved elusive so far for Yahoo. SBC is in 13 states, but Microsoft’s access partnerships span a far greater number of households.

Tech firms on a mission for broadband

WASHINGTON - With the economy in the doldrums and the tech sector feeling the pain, Intel Chief Executive Craig Barrett has enough on his plate in Santa Clara, Calif., without a messy regulatory battle in Washington.

But Barrett, Chairman Andy Grove and other top company executives have crossed the country on a series of trips over the past year to send a personal message to the Federal Communications Commission - ease up on regulation of broadband networks, or risk throwing the tech industry and the economy as a whole into further turmoil.

Intel is part of a coalition representing 15,000 tech companies that’s on a mission to spur investment in the fast, high-capacity networks. Their enemy: a complicated morass of decades-old regulations designed for monopoly phone networks. Intel, Cisco, Microsoft and dozens of other tech companies say those regulations are a disincentive for the largest local phone companies to invest in broadband networks. The high-tech industry has responded with an unprecedented lobbying blitz at the FCC, hoping to persuade the four-person commission to free broadband from those restraints.

Broadband connections to the Internet hold the promise of rejuvenating the sector, sparking innovative new technologies and driving sales for companies that make network building blocks, personal computers and software. Universal access to those high-speed, always-on networks also would benefit consumers by as much as $500 billion, according to a study by economists Robert Crandall and Charles Jackson.

‘‘Everyone understands that getting some serious movement in deploying broadband is critical to restoring growth in our industry,’’ said Cisco lobbyist Jeff Campbell. Right now, the tech sector is in a vicious cycle. Content-rich applications aren’t being developed because few people have the high-speed connections needed to use them. Yet, consumers aren’t signing up for broadband in part because of the lack of new applications.

Another hindrance is price. As competition for broadband takes hold, the monopoly local phone companies say the price for broadband service - typically $50 or more a month - will come down, spurring more consumers to sign up.

FCC Chairman Michael Powell last year made promoting broadband one of his top priorities, and pledged to quickly reexamine the regulations to determine where changes should be made. He has stated his preference for keeping nascent technologies free of old-style regulations, though he needs the support of two other commissioners to move forward. FCC officials expect the commission to complete its review within the next few months.

The battle over broadband falls along traditional industry lines, with the monopoly local phone companies including SBC Communications in one corner, and the long-distance phone giants AT&T, Sprint, WorldCom and upstart local phone companies in the other.

The tech industry, at first, mostly watched from the sidelines. But as the telecommunications sector began to crumble, the leading tech trade associations joined the Bells in their effort to scrap regulations for broadband service. Among the faltering companies, the Bells stood on the firmest financial footing and held out the best hope for near-term investments in broadband networks. And what they say they need to drive that investment is freedom from the FCC’s regulations.

‘‘The collapse of long distance left the Bells as the only strong client base going forward,’’ said Scott Cleland, managing director of Precursor Group, an independent policy analysis firm. ‘‘Their futures are joined at the hip.’’

Under attack is an FCC requirement that the Bells lease pieces of their phone network to new rivals at discounted wholesale rates, including equipment they use to offer digital subscriber line, or DSL, broadband service. The Bells are trying to convince the FCC to throw out that requirement for new technologies, arguing that it leaves them with no incentive to invest. They argue: Why spend the money to develop these broadband connections if competitors can reap the rewards by leasing the equipment at steep discounts and reselling it under their own brand name?

‘‘For the old wire, old rules should apply. For any new fiber that’s laid, the new rules should apply,’’ said Business Software Alliance President Robert Holleyman.

It’s also an issue of fairness, they say. The local telephone monopolies are getting trounced in the marketplace by cable TV companies, who offer broadband service but don’t face the same regulations as the phone companies. The most recent FCC data showed that only about one-third of the U.S. households with high-speed Internet service got it through DSL.

There are 15.2 million broadband subscribers in the United States, according to ARS, a La Jolla-based technology consultant.

‘‘We have dramatically scaled down any further deployment of DSL,’’ said SBC Senior Vice President Jim Smith. ‘‘We couldn’t make a good business case to go forward.’’

But AT&T and other competitors to the Bells say the tech industry has missed the mark by siding with the Bells. Scrapping those regulations will only make it more difficult for fledgling companies to invest in new technologies and develop alternative broadband networks, they say.

The Bells are being disingenuous in their lobbying effort, said AT&T’s chief Washington lobbyist Len Cali.

‘‘Broadband isn’t what they’re after. They’re after deregulating everything, most significantly their voice services,’’ he said.

Tech ramped up its lobbying effort in April, assembling a coalition of six industry trade associations representing 15,000 companies. Its members covered the breadth of the tech industry, from chip makers and telecom equipment manufacturers to software and hardware companies.

They’ve pitched their views through four detailed legal filings, and paid dozens of personal visits to FCC commissioners, their staff and agency lawyers.

Since Labor Day, Intel’s chief lobbyist on tech and policy issues, Peter Pitsch, has visited agency staff to discuss the issue at least five times. Microsoft Senior Vice President Craig Mundie, one of the top ranking officials at the company, also flew to Washington three times over the past six weeks to personally lobby FCC Commissioners Kevin Martin and Michael Copps and staff.

The efforts could be paying off. Senior FCC officials say tech’s involvement has broadened the debate beyond the typical industry in-fighting.

‘‘It’s not just a telephone battle, but an issue about the economy, investment and growing the high-tech sector,’’ said Link Hoeing, Verizon assistant vice president for Internet and tech policy issues.

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