AOL: LOSING THE MEDIA BATTLE?
An Investment Opinion by Randy Befumo (MF Templar)

AMERICA ONLINE (NYSE: AOL) has been waging a battle for the hearts and minds of the American public. Leaping from the obscure number-three position in 1994 to become the dominant proprietary online service in the world, pundits are now tripping over themselves to toll the Internet bell that will signal the company's demise. The persistence of media misperception and misunderstanding of America Online's product has been nothing short of staggering. The list of stupid comparisons and patent fabrications could go on for days. But despite the fact that they can be refuted point by point, one disturbing fact remains.

The fact that they exist undaunted suggests that America Online is losing its media battle.

Outside the numbers and business models of any great consumer company there is one quality that transcends traditional valuation measures -- brand. Brand is the difference between the caramel-flavored caffeinated beverages of COCA COLA (NYSE: KO), PEPSICO (NYSE: PEP), COTT CORP. (NASDAQ: COTTF) and privately-held Royal Crown Cola. Brand is a misty rubric that includes name awareness, customer perception and the ambiguous but ever-present mass conception of what a company is all about. Whether or not the facts agree, what is emerging in the mass media as a perception of America Online's core product is, in a word, frightening. Right or wrong, people think that America Online is ripping them off and that they can get it cheaper and better through an Internet Service Provider (ISP).

THE MEDIA ATTACKS AOL

A recent article by Stephen Pizzo in the Santa Rosa Press Democrat is typical of a line of specious reasoning that stretches from the hip, urban realm of The New York Times to the hallowed newsrooms of The Washington Post. Pizzo states that proprietary online services like America Online, Prodigy and COMPUSERVE(NASDAQ: CSRV) are doomed and lists a few reasons why. Pizzo argues that, "these online services are like training wheels" and that consequently, once people become big kids, they will want to ride their bikes on their own. Pizzo states that the growing availability of Web content, which admittedly takes longer to load, drove subscribers in a wave away from America Online towards $19.95 flat-fee ISPs, where they could surf the 'Net to their hearts' content. Mentioning the thriving anti-AOL community on the Web, Pizzo highlights anger towards AOL's billing practices and censorship.

All this could have stood up fine if not for more recent developments, Pizzo reasons. The coup de grace in Pizzo's mind was the $19.95 flat-fee offering from Microsoft two weeks ago for Internet access -- one of seven options in a pretty complicated billing structure. "At $19.95 a month for unlimited connect time, MSN beats AOL's best deal," Pizzo concludes, "[which is] $19.95 a month for 20 hours of connect time. No one, even newbies, can enjoy surfing the Internet with a meter ticking away in the background." He then softens a bit and states that America Online will not go away, but will simply start offering unlimited connect time products and will move to the World Wide Web, where everyone can see it, in effect becoming a giant ISP. As for the riddle of how to charge for premium content while offering it up on the Web, Pizzo has no answer. He simply concludes that unless it follows his bitter prescription, America Online will simply have to, "sit back and watch its subscriber base hemorrhage off into cyberspace."

Although perhaps not the highest-profile commentator, Pizzo is representative of the growing conventional wisdom regarding America Online. "It needs to offer a flat-fee," they whisper. "It needs to go on the Web." Until I am blue in the face, I can sit here and quote demographic statistics which show that the average American only has about seven hours a week to watch TV or go online, arguing that AOL's $20/20 is a de facto flat-fee. If customer perception remains that it is somehow a rip-off, it does not matter. As for the contention that AOL has to move to the Web, that is flat-out ludicrous. Certainly, improved Web access would be a plus, but why should America Online give up a hybrid network that allows it to optimize functionality and usability for the customer? Of course, if AOL cannot articulate the advantages of the hybrid network in its PR, it might not ultimately matter whether it is true or not -- although I believe it is. If people don't perceive the value in a consumer product, it might as well not be there.

The fact remains that in its entire multi-million dollar marketing campaign, America Online has done absolutely nothing to counter these wrong-headed perceptions and dozens of others. It has not articulated the value of the hybrid network, of built-in integrated content, of a flat-fee for all content versus a la carte models on the Web, and about a hundred other improvements over the Web that AOL has to offer. Thus, America Online has, in effect, handed a crucial advantage over to its enemies, allowing them to begin to snatch defeat from the jaws of victory. Jetsons theme music and the nifty "AOL: The Internet and a whole lot more" are sorta in the right direction, but the company actually needs to demonstrably prove this in their ads, in order to begin to turn the tide of negative public opinion.

ALIENATING PARTNERS COSTS NECESSARY ALLIES

Many writers often compare America Online to Apple Computer, although often for all of the wrong reasons. Apple Computer's stubborn refusal to see the market reality of Macintoshes piling up in the warehouse because of a price point almost two times that of a comparable (albeit inferior) IBM-compatible was simply symptomatic of the hubris that blinded the company's management. The desire to make both the hardware and the software, not to license the operating system, to keep high margins over high volume -- all of these were human decisions made by a management too blinded by pride to confront market realities. Anecdotal incidents of similar management bullheadedness at America Online continue to pile up, mainly centering on the widespread unhappiness of the company's Information Providers (IPs). These reveal a company that seems to want to fail in spite of itself.

Stories abound through the rumor mill. Frustrated content providers gather monthly in New York to compare AOL horror stories. America Online has begun to systematically insert itself between its partners and their advertisers, sometimes attempting to take the advertiser completely away. A recent pitch to an AOL Channel to offer a premium service that would review user-supplied writing for a fee met with skepticism from the channel head who stated that AOL did not do stuff like that. Until the presenter pointed out a service already online in that channel head's area which already had the service. Whether or not these and dozens of other IP gripes are legitimate or not, by poisoning relationships with dozens of so-called partners, America Online has unfortunately lost a legion of potential supporters who could assist it in spreading its message. Already suffering from the "57 channels and nothing on" syndrome, AOL has disincentivized IPs from concentrating on making their daily AOL content fresh and new over just focusing on their Web business.

America Online's business model depends on maintaining a growing base of happy subscribers that it can leverage in all sorts of other realms beyond simply charging them usage. By allowing the media free reign to spread blatant misinformation and by disenfranchising a crucial group of potential proponents, America Online has effectively allowed its enemies to conduct an anti-AOL marketing campaign that has gotten more attention than any efforts that the company has attempted in recent months. That a multi-billion dollar business could be brought to its knees because of a perverse combination of pride and poor marketing is a potential reality.

WHAT DOES AOL NEED TO COMMUNICATE TO ITS CUSTOMERS?

America Online's current advertising campaign, although snappy enough, lacks the crucial focus which the company needs to bring to the current Internet-versus-AOL debate. Although the company believes that this is a false comparison, it is one that the media insists on making nonetheless, and in the end it will simply be something they will have to confront head-on. "The Internet and a whole lot more" communicates the message that America Online is the Internet with value-added. Unfortunately, the ads that go with this message rely on hip graphics and professional camera angles to communicate this message, failing to actually clarify what it is that America Online has to offer beyond Internet access.

The problem is a relatively simple one. It ultimately does not matter whether or not America Online's interface is actually superior to the standard ISP-browser arrangement. What matters is whether or not people believe this is the case, and the media war that America Online is losing has people convinced that America Online is nothing more than another way to access the ultra-hip Internet. America Online has to convey the superiority of its interface in their marketing, something all of its commercial ad campaigns have failed to do. The first set of ads that took a user through the basic functionality of the system had the person performing functions you could do just as well on an ISP -- send e-mail, go to EasySABRE, look up information on dinosaurs. The second ad campaign simply tried to make AOL seem cool. The current ads have changed the tagline but again have succumbed to hip visuals over communicating what truly differentiates the service.

When I talk about why I think America Online is a better interface, sometimes I feel like someone defending the beauty of the Macintosh operating system. I really believe that rather than fear the "Internet on training wheels" label which Internet proponents give to America Online, they should rather embrace it wholeheartedly. Most things in life are done on training wheels. For some reason, the peculiar culture of technophiles that has grown around the Internet resists this wholeheartedly, but frankly Windows is DOS on training wheels, Jiffy Lube is oil changes on training wheels, and bottled water is your faucet on training wheels. Time and time again, people have proven that they will pay for convenience and brand if the price point is right. This means that America Online has two primary tasks at hand -- communicating that it is more convenient and working on the price point issue.

Communication is the ad campaign, the price point is simply coming up with something that will stop half of America from believing (mistaken or not) that they are getting ripped off. I think $9.95 for 5 hours, $20 for 20 hours, $30 for 30 hours and somewhere between $40 to $50 for unlimited flat fee access would present a nice tiered system that would give everyone what they want without overloading the network capacity, but this is all a guess on my part. The thing is, $20/20 helps but is clearly not enough -- the darn media articles still have not stopped. Like it or not, AOL might be being bullied into providing a flat fee by the frenzy of mass opinion, in spite of the fact that for many lower price points a fixed number of hours is really cheaper. I am reminded of a friend of mine who told me about an acquaintance who was switching to an ISP from AOL. She had used AOL for fewer than five hours a month for e-mail for $9.95 and was going for the $20 monthly flat fee to do the same thing. Why? Because she thought she was being ripped off. When confronted with the economics, she recanted... but somebody had to make her think about it. She would have otherwise made a decision that made no economic sense because of the existing climate of public opinion. AOL needs to face this irrationality head on, rather than reasoning it away.

THE AD CAMPAIGN THAT SHOULD HAVE BEEN

A much better ad campaign would feature two people using online services, one on AOL and one on an Internet provider. The scenario would be simple -- Joe Internet has just signed up with his ISP and wants his friend Jack AOL to come over and check it out. From this one general scenario, all sorts of humorous opportunities to distinguish AOL's ease of use over the Internet arise:

- Joe Internet goes to get stock quotes and starts to type in an url, turning to Jack AOL halfway through to ask, "Which way do the slashes go?" Jack AOL simply smiles and the commercial cuts to him going to keyword: quotes or simply hitting the darn button on the function bar.

- Joe Internet says, "Hey, on the Internet I can communicate with people from all over the world! I just have to download this application and install." When Joe is done, he turns to Jack and asks if he thinks he knows anyone who might be online. Jack mentions one name and Joe eagerly types it in, but halts confused. "What is the IP address? What's an IP address?" Then you cut to Jack happily checking his buddy list, seeing that "JacksDad" is online and sending his father and instant message in a few quick keystrokes.

- Joe Internet goes to the latest hot Web site, only to learn that the server is down. Cut to Jack AOL happily accessing the Motley Fool with a voiceover saying that on AOL, an individual site's server is never down because it is an integrated network.

- Joe Internet smiles and says, "I can send e-mail... look!" Jack AOL says, "That sure doesn't look like my e-mail." Joe says, "Yeah, 'cause it is the Internet and it is better." Then Jack shows Joe his rich-text enhanced e-mail, pointing out how he can even include a hypertext link if he finds something real cool. Needless to say, Joe is bummed when he looks back on his plain-text little ISP e-mail package.

Other spots could point out the limitations of Internet Relay Chat, point out the difficulty of downloading various add-on applications to your browser and successfully installing them and so on. The point is that America Online needs to embrace the ease of use in its ad campaign, not the World Wide Web. Frankly, most people don't even understand the distinction, with half of the population not understanding the difference between a closed, hybrid and open architecture and the other half, like Mr. Pizzo mentioned yesterday, believing that for some reason AOL has to put its content on the Web and destroy its exclusivity to survive -- a questionable argument that fails to grasp the fact that you can get on the Web via America Online and still view the proprietary content.

CONCLUSION

It is my personal belief that there are two reasons to use online services: communication and information. The World Wide Web, the world's largest library, is all about information. In order to communicate via the Web outside of e-mail, you have to download all sorts of confusing applications that need to be installed. America Online makes it simpler to communicate. America Online also in many ways makes it simpler to get to information -- although it has not done quite as good a job of this as it will ultimately need to. For instance, it is great that I can get to urls by typing them in the keyword screen. But why should I need to type in http://? The Netscape browser is smart enough to fill this in for you, for AOL it should be a snap. America Online's marketing money is better spent on making the service easier to use and adding sound before Web Radio completely takes off, not throwing tailgate parties and renting out Planet Hollywood in a perverse attempt to appear hip. As one person said to me in an e-mail yesterday, AOL needs to have more sound than just "Hello!" and "You have mail!"

Ultimately, I am probably the biggest America Online bull on the planet. But more and more I look at all of the times I have made fun of people who used the Macintosh -- and who said it was easier and more fun -- and I have an eerie sense of de ja vu. The point of the Apple Computer comparison is not to say that the Web is Microsoft. It is not. Rather, it is to say that the Web is like the IBM-compatible personal computer -- no one really owns it so everyone ends up championing it. Because one person does not own it, there is a lot more competition and the price per PC becomes lower. Apple failed to communicate that its computer was easier to use in a believable way, instead relying on self-congratulating ego and snazzy ads in order to carry the day. I think the key points that America Online needs to address are communicating the ease of interactivity and convincing people that whatever pricing strategy they choose is really a value. If AOL cannot win this media war, you can almost throw all of the business fundamentals out of the window.

-- Randy Befumo (MF Templar), a Fool