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AOL rate increase maybe not as dumb as it looks

Bumping the price for the low-cost dial-up plan by 20 percent could drive members away--but it also could help AOL grow out of its Internet service provider phase.

AOL is raising the subscription fee by 20 percent for its low-cost dial-up service plan, a move that illuminates an awkward phase of its transition from an Internet service provider to an online media and advertising company.

The Time Warner division told subscribers last week that beginning July 27, it would raise its monthly dial-up rate from $9.99 to $11.99 per month. Subscribers who specifically sign up for a plan with limited technical support can keep the $9.99 rate, though, but they won't get phone-based help unless dealing with an Internet connection issue.

Time Warner CEO JEff Bewkes Time Warner

The move obviously could hasten the exodus of subscribers from AOL. But critics may be wise to take a deep breath before deriding AOL for a boneheaded membership disincentive for people who have abundant other options.

The change could wring more revenue from low-value subscribers, lower AOL's costs for those who stay at the $10 rate, and shuck the least active, least valuable AOL members. Overall, the rate change could play a small role helping make AOL's Internet access business look more appealing to would-be buyers as Time Warner seeks to "enhance...strategic flexibility."

Bye-bye subscribers
AOL lost 647,000 subscribers in the first quarter of 2008, dropping to a still impressive 8.7 million in the United States, but clearly the company hopes not to lose more.

"This plan is still a great value, saving you at least $3 to $10 per month over comparable plans from other major Internet service providers," the company said in the e-mailed notice, which touts features such as online storage, parental controls, and antivirus software. And AOL spokeswoman Anne Bentley pointed out limitations on various rival plans such as technical support fees and low prices that are introductory only or that are contingent on signing up for a full year.

But still, the move could indeed drive some subscribers away, either to broadband Internet service or to dial-up competitors such as NetZero, Earthlink's budget PeoplePC subsidiary, and Microsoft's MSN Dial-up, said Forrester analyst Sally Cohen.

"This really brings into question, for the price-sensitive consumers still on dial-up, 'Maybe we should just upgrade to broadband,'" Cohen said. "In some markets you can get DSL for cheaper than $12 a month."

Losing subscribers and their $120 a year is an obvious downside for AOL. But a more subtle problem is that losing subscribers could hurt the online business that's AOL's future. That's because AOL subscribers happen to own a lot of the eyeballs visiting AOL's Web properties and watching AOL-delivered advertisements.

"AOL's Advertising revenues associated with the AOL Network, in large part, are generated from the activity of current and former AOL subscribers," AOL parent company Time Warner said in a regulatory filing regarding AOL's not-so-hot first-quarter results. "Therefore, the decline in subscribers also could have an adverse impact on AOL's Advertising revenues generated on the AOL Network to the extent that subscribers canceling their subscriptions do not maintain their relationship with and usage of the AOL Network."

AOL is a significant business for Time Warner, but it's shrinking. In the first quarter of 2008, AOL generated $1.13 billion in revenue--10 percent of Time Warner's total but down 23 percent from $1.46 billion in the year-earlier quarter. It also generated $284 million in operating income in the first quarter, a 74 percent drop from $1.08 billion the year earlier.

AOL's plans
Protecting the dial-up business at all costs clearly isn't a great long-term strategy. More than half of U.S. homes with Internet access now use broadband, Cohen said, and clearly it's the wave of the future, and AOL knows it.

"AOL's strategy is to continue to transition from a business that has relied heavily on subscription revenues from dial-up subscribers to one that attracts and engages more Internet users and takes advantage of the recent as well as anticipated growth in online advertising," Time Warner said in the filing.

To help make the move, AOL is splitting in two, the access business such as dial-up and the audience business that includes the Web sites and advertising. All necessary decisions to split the two parts' operations and finances should be done by now.

"We're doing this for two reasons. First, to increase the accountability and operational focus of each of those businesses, and, second, and just as important, to enhance our strategic flexibility," said Time Warner Chief Executive Jeff Bewkes in a conference call after reporting last quarter's financial results.

So in short, AOL is packaging up the dial-up business for sale or some other significant change, and fine-tuning the subscription plans is part of an effort to make the package look as tempting as possible to a would-be buyer.

Subscribers still worth money
Given what AOL has built up over the years--still an impressive property if not a high-growth company like Google--it would be foolish to lose its link with people as they ditch their dial-up.

Those subscribers already have a potentially strong AOL affiliation through their own e-mail addresses and instant-messenger nicknames, not to mention a social network of sorts through e-mail address book and IM buddy lists.

So AOL would be wise to work hard to keep ex-subscribers part of the AOL network--not just with marketing but with education to help people figure out how to ditch AOL's all-in-one software for dialing up, checking e-mail, browsing the Web, and using AIM. It will take time for people to find and install the standalone version of AIM, to figure out how to use AOL's Web-based e-mail, and to download and print that picture of the grandchild.

If AOL handles the transition well, though, it could keep those AOL members and the revenue they generate even as dial-up fades into technology history.