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Firms jump on free ISP trend, but are users biting?

The success of NetZero, plus Microsoft's interest in the trend, has sparked much buzz about the future of accessing the Net.

In just a few months of operation, free Internet service provider NetZero has skyrocketed to more than a million subscribers, becoming the fastest-growing Net service provider in history.

That company's success, even if it has yet to show profits, has sparked a new round of interest in no- or low-cost Internet service, as well as new fears about the viability of the average pay-by-the-month Internet service provider (ISP).

Today's news that Microsoft might be planning free or discounted ISP service--despite its limited success with the full-service Microsoft Network--was enough to send giant America Online's stock sliding today, down more than 6 points at midday.

Some are wondering today if an aggressive Microsoft ISP plan could have the same kind of impact that its landmark browser decisions had.

But many analysts say this trend's danger to traditional ISPs--at least the biggest ones with established brand names like AOL--has been overstated.

"The lowest churn rate around comes from ISPs that charge $20 or more," noted FAC/Equities financial analyst Jeff Sadler, who closely follows the ISP market. "Churn rate" is an industry term for subscriber turnover in the service provider business. In other words, people at those ISPs seem reluctant to switch.

But this situation could change if Microsoft does decide to get into the game, throwing its billions in cash reserves behind a business that now lives on small or nonexistent profit margins, analysts say.

Big bang or niche players?
To date, free ISP companies have supported themselves though advertising and by using tracking data on their customers to target their ads very closely.

In NetZero's case---and with a planned AltaVista offering---the companies collect subscriber data on an individual, allowing them to sell valuable information to advertisers so they can subsidize the free connection.

A combination of ad cash flow and venture capital funding has allowed NetZero to operate without profits--the company has said it would likely reach the break-even point sometime toward the middle of next year, somewhere near the 7 million subscriber mark. But this has led to lower expenditures on customer support and marketing than is the case for more established ISPs like AOL, EarthLink, or MindSpring Enterprises.

Thus far, analysts and competitors have said these trends have helped segment the ISP market. Much of NetZero's use has come as a second ISP account, analysts say, as well as attracting the most price-conscious subscribers on the Net.

But the bulk of Net users have either been leery of giving up their privacy through the ad supported service, or fall into the growing convenience-minded consumer demographic served by America Online, leaving the free offerings in a limited niche market, analysts said.

America Online executives have consistently noted they are undisturbed by the free and discounted ISP trend--at least for now.

They point to the fact that their own subscription rates and customer retention rates have gone up over the last year and half, even since raising their own prices by several dollars to $21.95 a month, and that the company still attracts about 60 percent of new Internet users.

Competitors note that free ISPs' subscriber figures--like those of free email services--are somewhat inflated, because they include all those who have signed up but don't take account of lapsed or inactive subscriptions.

NetZero does provide numbers on how many people use the service, however: They say that in June, about 600,000 actually logged in to their servers.

Microsoft could change the picture--again
But all this could change if Microsoft enters the picture, analysts say.

Microsoft executives have said they are considering entering the cheap or discounted ISP market, largely as a way to combat AOL's dominance in the access market. The talk--still very preliminary at this stage--is reminiscent of the company's entry into the Web browser market with the freely distributed Internet Explorer, in the days when Netscape's Navigator still held absolute sway.

"I think that could well turn the ISP market upside down," said Joe Laszlo, an industry analyst with Jupiter Communications. "That's a real threat."

Much depends on the final form of a Microsoft offering, however. The company's earlier effort with Microsoft Network has done well, but not spectacularly, in the market---even after being bundled with every Windows-based computer. That service currently has about 1.8 million subscribers, according to Jupiter Communications estimates, a far cry from America Online's roughly 17 million users.

But if the software giant throws significant long-term resources behind a free or discounted service, and eschews the ad-supported model that has raised privacy concerns about NetZero and others, it could radically change the dynamics of the ISP business, analysts said.

Nevertheless, it may not be America Online--Microsoft's ostensible target--that has the most to worry about. AOL has done an excellent job of settling into the broad consumer market, targeting relatively unsophisticated subscribers that want an unthreatening, familiar Internet experience.

This demographic has already proven it is willing to pay for AOL despite cheap or free options, analysts say.

"If you've been with AOL for two years, and you're not shopping around, I don't think you're likely to leave," Laszlo said. "I think this is less likely to be true if you're with a MindSpring or Bellsouth.net or one of the smaller players. There's less reason to stay with one of those guys."