AOL's squeeze play

 
By Jim Hu and Mike Yamamoto
Staff Writers, CNET News.com
March 1, 2000, 4:00 a.m. PT

Mark Elderkin thought an eight-year relationship with America Online would get him better terms when renegotiating his contract. He was wrong.

The president of Online Partners recently got into a bitter contract dispute with the Internet giant involving OnQ, a gay and lesbian online community his company is acquiring. America Online insisted that OnQ--which has resided on AOL since 1992--refuse all advertising from Internet service providers deemed competitors, Elderkin said.

"It seems funny to me that they want to take so much control over our business and restrict what we do," he said. So he decided to sever his "132"="" border="0" align="left" hspace="5" vspace="5" alt="Regardless if AOL's putting pressure or not, there's a fear of losing business. Many don't want to risk that relationship."> company's ties with AOL and go it alone.

Such is the price of doing business with the world's largest online service. At least two companies that have ended long-standing distribution deals with AOL allege that the online monolith routinely bullies smaller businesses into accepting contractual limits involving other ISPs, according to interviews and correspondence forwarded to CNET News.com. Others have left the service because it found AOL's terms too stringent or expensive.

Legal experts say AOL's demands do not appear to violate any laws, but some believe that the company is risking a backlash among its smaller partners. Just last month, AOL was hit with a class-action lawsuit alleging that its new software surreptitiously disables connections to other ISPs.

Moreover, the accusations are emerging at a critical juncture for AOL, whose proposed merger with Time Warner is being examined by federal regulators. Although it has eluded the kind of antitrust scrutiny brought upon the likes of Microsoft and Intel, AOL will likely face increasing pressure over its market domination if content-related mergers continue to concentrate media power into a handful of large corporations.

"We've already seen the Internet go through dramatic transformation because of the role of advertising and marketing. Media consolidation will only accelerate that process," said Jeff Chester, executive director of the nonprofit Center for Media Education. "Those Web sites that don't have resources to market themselves like big media companies will fade into the digital twilight."

The lesson, if there is one, could be learned from the so-called old media. "Whenever (content) becomes very important to a commercial merchandiser, I think we have to be a little fearful," said Ben Bagdikian, professor emeritus at the University of California at Berkeley and author of "The Media Monopoly." "That influence will be used to discourage individual noncommercial use."

AOL denies that it has done anything improper, let alone illegal, in its negotiations with partners, though it declined to discuss any particular contract. Spokesman Andrew Weinstein noted only that AOL was "unable to find a mutually acceptable resolution to the outstanding issues" regarding OnQ.

Others say smaller businesses have little choice but to meet AOL's demands or face relative obscurity by losing such high-profile exposure. As companies such as AOL have emerged as the standard-bearers of the Internet, clout has become an undeniable factor in determining who gets which pieces of their valuable real estate--and at what price.

AOL has encountered antitrust concerns before, in the online gaming market. Kesmai, a subsidiary of Rupert Murdoch's News Corp., sued AOL in 1997 charging "flagrant violation of federal antitrust laws" but later settled the case for undisclosed terms. Another gaming company, MetaCreations, blasted AOL that same year for abruptly canceling its contract after demanding "excessive fees, when none were previously charged."

Content partners essentially rent space in topic areas on AOL's subscription-based service, often in multiyear, multimillion-dollar deals. In return, they get exposure to an AOL membership that leads all ISPs, with 21 million subscribers. CNET, publisher of News.com, is a paying tenant on AOL's Computing channel.

"AOL's a pretty strong force out there," said Danny Robinson, whose company powers BlueLight.com, the free ISP offered by Kmart and Yahoo. "Regardless if AOL's putting pressure or not, there's a fear of losing business. Many don't want to risk that relationship."

Robinson, chief executive of Spinway.com, said he has not witnessed any strong-arming by the online giant. But he and others say content companies are wary of striking deals with Net access services that AOL views as competition.

Latest demands called "escalation"
Elderkin said AOL has always restricted content partners with conditions in their contracts. But he said the demands asked of OnQ were an "escalation" of AOL's existing restrictions.

In one email exchange, an AOL account manager asked OnQ to remove a link to Gay.com, another site owned by Online Partners. Gay.com was offering a free-ISP promotion by 1stUp.com that was deemed "competitive" to AOL.

"I have no problem with continued linking to Gay.com to supplement content offerings, but the FREE ISP references and Pop-up must be struck on the site since it is competitive with AOL," the account manager wrote. "We don't allow other partners to do this and cannot allow OnQ."

In addition, Elderkin said AOL instructed OnQ to stop offering free ISP deals of its own. Online Partners is acquiring QView, the parent company of OnQ.

AOL spokesman Weinstein said OnQ has ended its partnership but would not confirm the contents of the emails or comment further on the negotiations.

According to a second email correspondence, a QView representative argued that PlanetOut, which has an investment from AOL, regularly runs a "Free Internet Access" ad banner.

The account manager responded: "As for PlanetOut promoting a free ISP from their AOL mirrored site aol.planetout.com, I will follow up with them directly. They are fully aware they can't do that?"

Megan Smith, chief executive of PlanetOut, confirmed that the gay and lesbian site carried advertising from free ISP WorldSpy. But she said the co-branded AOL-PlanetOut site would not sell ad space to a rival ISP because it is prohibited by contract.

"It's standard AOL policy to ask all their partners to not directly solicit on AOL's service in its partner area for people to go to other ISPs," Smith said.

Rather than agree to the restrictions, Elderkin said Online Partners decided to part ways with AOL and build its own presence on the public Web.

Online Partners is not the only site to walk away from a contract over this issue. The Pet Care Forum, a 10-year content tenant on AOL, says its relationship ended after it was served restrictions in selling advertising to companies determined to be competitive.

"They won't let you sell advertising to a competitor," said Paul Pion, president of the Veterinary Information Network, which ran the forum. He said he asked for a list of competitors but was denied.

The terms of the negotiations kept changing along with AOL's evolving business model, Pion said, and talks finally collapsed shortly after the Pet Care Forum's contract expired at the end of 1998. He accused AOL of abandoning sites like his in favor of advertising and e-commerce because "community didn't pay."

A similar story is recounted by Craig Goldwyn, vice president of Tastings.com, which was formerly called the Food and Drink Network on AOL. A content tenant since 1989, the consumer reviews site used to get a cut of royalties to remain on AOL's service when members were charged by the hour for access.

But once it switched to flat-rate subscriptions, Goldwyn said AOL suggested that the site move to the Web. Then AOL informed Food and Beverage that it would take over their areas on AOL and essentially evicted them in February 1999 after a series of renegotiations, he said.

"I think AOL was trying to build a profitable business by owning the most valuable real estate, and they didn't want to stab long-standing partners in the back, so they gently eased us out without really telling us what they were doing," Goldwyn said. "I do not believe they're ogres. I just believe they're hard-nails, smart business people."

Legal experts tend to agree, saying that the courts give companies wide latitude to set contract terms unless they are found to be a monopoly. And as investigations into other market leaders have shown, strong-arm tactics are hardly unusual throughout the Internet and high-tech industries.

"They can pick any criteria that they want, as a general rule," said Jesse Markham, head of the antitrust department at law firm Orrick, Harrington & Sutcliffe. "The right to choose one's partners and contract parties is an unlimited right."

He said AOL's practice in barring advertisements from potential competitors seems sensible, especially on the relatively nascent Internet. "If Newsweek wants to put in a full-page ad saying, 'Get a free year's subscription,' Time would say, 'No way!'" Markham said.

Jupiter Communications analyst Patrick Keane agreed, saying, "I don't think this is unique to the Internet." However, he added, "All these little things are going to be amplified because of the merger with Time Warner."

Others may be priced out of AOL
Regardless of legal issues, other analysts say the high price of AOL real estate could inspire rebellion. If content and commerce companies do not see an adequate return on investment, many could go to other ISPs for distribution, Yankee Group analyst Emily Meehan warned.

"We will see content merchants not renewing their deals because they may not be able to afford to stay on AOL's start page," Meehan said.

In inking content or commerce partnerships, companies typically pay AOL millions of dollars over a fixed period to be featured exclusively or prominently on its service. For example, in July last year, online health site Drkoop.com agreed to pay AOL $89 million over four years for such placement. In October, Stamps.com agreed to pay $56 million over three years as AOL's exclusive postage provider.

To veterans like Pion, AOL's behavior reflects the Internet's evolution from community to commerce. The online giant, which once paid his Pet Care Forum and other site thousands of dollars a month to remain on its service, has been cutting ties with smaller-scale content partners viewed as extraneous.

Pion acknowledged the sound business reasons behind AOL's actions, but he disagrees with the way the company has quickly turned away from smaller partners that contributed to its growth.

"They grew it on the backs of these people," Pion said. "There's a nicer way of doing it." 

News.com's Jeff Pelline contributed to this report.