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Will AOL be forced to go free in Europe?

To compete in Europe, analysts say AOL may have to offer services free, which could create an awkward situation with regard to the company's subscribers in other countries who still have to pay.

With the proliferation of free Net access services in Europe, America Online may be forced to do as Europeans do.

Many ISPs in Europe, such as Dixon's Freeserve in the United Kingdom, offer less expensive alternatives to AOL's subscription-based service. AOL, which boasts a subscriber base of 17 million, mostly in the United States, is looking for ways to be more competitive in Europe.

In contrast to the United States, local phone service in the United Kingdom is metered, which means phone calls are billed on a per-minute basis. Thus, the longer someone stays online, the more expensive the phone bill. U.S. callers pay a flat monthly rate for local calls, so users pay only $21.95 for unlimited Internet access via AOL.

AOL has said it will offer flat-fee packages in Europe that fulfill both subscription and phone charges in an effort to compete with the "free" services such as Freeserve, which get a cut of the phone charges Europeans have to pay for Net access. But analysts say AOL may have to offer services free, which could create an awkward situation with regard to the company's subscribers in other countries that still will have to pay their monthly fee.

However, AOL U.K. is dismissing the idea of offering a free service. The business model will not last once more Europeans get online, according to Maggie Gallant, a spokeswoman for AOL Europe.

"We think that the business model is not a structure that will remain in place," she said.

In May, AOL U.K. cut its flat monthly subscription fee by 40 percent, from about $27 to about $16.25. In addition, the company is undergoing trials to introduce a toll-free access service into the United Kingdom, according to a source. With toll-free access, U.K. users only have to pay a subscription fee--not metered phone rates.

Analysts say AOL also could challenge the free ISP price point if it partners with a global backbone provider such as UUNet. With such a partnership, the backbone provider could partially subsidize network costs, allowing AOL to offer low phone rates in exchange for subscribing to AOL.

This model, according to David Phillips, president and managing director of AOL U.K., could make AOL "cheaper than free." Phillips declined to say whether any deals are imminent.

Some analysts expect changes to take place soon. "AOL believes Freeserve has discovered a 'nice' market, therefore we expect AOL to launch a free service as well and likely market it in Europe," Henry Blodget, an equity analyst at Merrill Lynch, said today during an analyst call.

The stakes are high in Europe, as Net use continues to increase. The number of homes with Internet access in Western Europe is expected to triple over the next five years, from 14 million at the end of 1998 to 47 million by 2003, according to research firm Jupiter Communications.

But a number of new companies in the United Kingdom offer Internet services that are more affordable than AOL. AOL U.K., once the region's most popular ISP, is being left in the dust by services such as Freeserve and Virgin Net.

AOL U.K., formed in 1995 as a joint venture with European media giant Bertelsmann, has 600,000 members. Freeserve, which launched in September 1998, has reached 1.5 million members, according to Jupiter estimates.

AOL says the local pricing advantage is both unfair and anticompetitive, according to AOL's Phillips. The company has turned up its lobbying efforts in the United Kingdom and in other European countries such as Germany to pressure governments to abandon metered phone calls.

"The biggest obstacle that we face is the telecom regulatory regime, and that's throughout Europe," Phillips said. "It's an antiquated structure that's a remnant of the state-owned telecom monopoly."

AOL U.K. is exploring its pricing options but wants to maintain a subscription model, according to Phillips.

Analysts also point out that the free ISP model has not proved successful. In fact, according to David Simons, managing director of Digital Video Investments, success could be the free ISP's worst enemy.

"Once you have a bunch of players coming in, and free becomes no longer the hook, but the norm, how do you differentiate yourself?" Simons said. "Spending more on marketing and adding more services to differentiate themselves becomes almost self-defeating."

For now, Phillips said AOL Europe will continue lobbying governments to end metered calls. The company also will continue its efforts to fight telecommunications giants, such as Germany's Deutsche Telekom, that are leveraging their regional dominance to outprice the competition.

In March, a German court granted AOL Europe a permanent injunction against Deutsche Telekom. AOL alleged Deutsche Telekom was using its phone monopoly to drive down metered phone charges for its T-Online ISP. T-Online was ordered to separate its local phone charges from its service charges, and Deutsche Telekom's plans to market the service were halted.