AOL: You've got VoIP

America Online is expected to launch an Internet phone service in the United States next month, leapfrogging rivals in a fast-growing market as it seeks to evolve from an also-ran provider of dial-up Internet access to a broadband services powerhouse.

Like Yahoo and Microsoft, AOL already offers voice chat on PCs as a free feature of its instant messaging services. AOL's new phone service, by contrast, will take a different path, charging customers a monthly fee to make calls over the Internet using an ordinary handset and a small analog-to-digital telephone adapter.

AOL has been testing a U.S.-based phone service with volunteers since last summer, and it launched a similar service in Canada in December. The online giant plans to introduce its VoIP, or voice over Internet Protocol, product to U.S. subscribers in mid-March and then offer it to nonmembers later this year, according to sources familiar with the plan.

Sources said the cost of AOL's service will be competitive with other VoIP offerings in the market, where one low-cost provider, Vonage, charges $24.99 a month for unlimited local and long-distance calling. The AOL service will cost less than the $40 Internet phone service offered by corporate cousin Time Warner Cable, the sources added.

AOL declined to comment for this story. But analysts said VoIP is a business AOL cannot ignore, as one of the most recognized Internet services in the world.

"They already have customer service people plus a brand name," said Paul Kim, an analyst at Tradition Asiel Securities. "It's a no-brainer for any ISP."

AOL needs to build new businesses fast, and VoIP is one of the most promising developments around.

Still, Internet phone service highlights both opportunities and dilemmas for AOL. The world's largest Internet access provider is working to offset declining subscriber rates for its core dial-up service while regaining the good graces of parent Time Warner after the rocky merger of the two companies at the height of the Internet boom in 2000.

Consumers began signing up for commercial VoIP services in large numbers for the first time last year, offering companies like AOL the chance to create a new line of business with the potential for strong revenue growth at relatively low risk.

Cablevision, one of the first cable companies to launch VoIP services over its broadband network, saw subscriptions jump from about 28,000 at the end of 2003 to more than 270,000 by 2004--a growth rate of 1,000 percent. Time Warner Cable also jumped from a negligible number of Net phone subscribers in 2003 to 220,000 by the end of 2004.

The prospect of tapping into growth numbers like those holds understandable appeal for AOL executives. Since its numbers peaked

at 26.4 million U.S. dial-up subscribers in 2002, AOL has watched those numbers collapse to 22.2 million at the end of 2004, a trend that's only expected to get worse. That's forcing the company down a difficult path of reinvention.

AOL has begun to aggressively pitch new products as an alternative to its core $23.90 a month dial-up service. It has created a $14.95 a month package that it markets to broadband subscribers, regardless of the service provider they use. It also has launched a $9.95 discount ISP under its Netscape moniker, revived Netscape's Web browser, and is pushing much of the content behind its "walled garden" onto the free Web through AOL.com.

Phone services would seem to be a timely update for AOL's image as a communications company, highlighted by its "You've got mail" marketing campaigns of years past, and a natural extension of its popular AOL Instant Messenger software.

Unlike traditional phone services that require considerable maintenance, VoIP runs on a broadband Internet network typically provided by a local phone or cable company. The service is relatively cheap to maintain, with the bulk of the cost stemming from marketing and customer service, two areas with which AOL is intimately familiar.

Still, analysts cautioned that VoIP on its own won't likely be enough to bolster AOL's flagging dial-up business. "I don't think this one's the massive lure that kicks its subscriber numbers back to positive," said Rob Sanderson, an equity analyst at American Technology Research.

Merger friction redux?
AOL will not only need to battle a wide array of VoIP competitors outside the company; it could find its efforts complicated by internal corporate rivalries, given sister company Time Warner Cable's ambitious VoIP plans.

For the past year, Time Warner Cable has earmarked Internet-based voice calls as the top priority for the division. Unlike other VoIP services, such as AOL's or Vonage's, Time Warner Cable's will operate solely in its cable network, which executives say will give better quality calls to its customers. However, because AOL's VoIP service can run on anyone's broadband connection, Time Warner Cable customers could choose AOL's cheaper plan over the cable company's $40 a month offering.

It's unclear how AOL and Time Warner Cable will split the VoIP baby. The two companies have had a contentious history under the same roof at Time Warner, although there have been recent signs of detente. In January, Time Warner Cable agreed to package a custom version of AOL to its Road Runner broadband ISP customers.

The two may yet be able to work out some sort of peaceful coexistence regarding VoIP, some analysts said. But the twin offerings

pose potential complications for both sides.

"It creates an enormous amount of tension," said Matthew Harrigan, an equity analyst at Janco Partners. "The last thing cable companies want is to get disintermediated by a Vonage" type of service.

Time Warner Cable declined to comment for this article.

Look to Canada
Last December, AOL Canada launched "Total Talk" in the greater Toronto area, with a promised Canada-wide rollout by the end of the year. The service could be a glimpse of what's to come.

Total Talk bears a striking resemblance to most mainstream VoIP services. For one, it's available to anybody with a broadband connection, whether it came from AOL or not. This "bring your own broadband" model is typical of most commercial VoIP services nowadays.

AOL Canada sells two plans on Total Talk. The first is $16.11 ($19.95 Canadian) per month for the first three months, then $28.26 afterward. It includes unlimited local calls plus 60 minutes of talk time to anywhere in North America, then it's 4 cents per additional minute. Another plan costs $24.21 a month and includes 1,000 North American anytime minutes.

Free features include ringing calls through to three different locations and Voice Mail Plus, which lets people listen to their voice messages on a PC, forward or reply to them via e-mail, and archive them for future reference.

In the United States, AOL has sent beta testers installation kits that include an adapter the size of a CD Walkman that people plug their broadband connection into on one side and their phone cord on the other, according to message board postings by testers.

Standing room only
AOL has many advantages and possible speed bumps in becoming a VoIP player. Because operating costs are low, many companies big and small are squeezing into the VoIP market, including Vonage, Packet8, Covad Communications and AT&T, to name a few. Cable companies have either launched or plan to launch digital phone services on their networks, and some of the Baby Bell phone companies plan to package VoIP into their future upgrade plans.

To stand out from this clutter, AOL will use its powerful brand name and its wide reach on the Internet to grow the service.

"A player like AOL...does have an advantage because of its customer base and brand name," said Kate Griffin, an analyst at market researcher The Yankee Group. "There are a lot of me-too players building brands from scratch, and marketing costs could swamp a start-up."

AOL's VoIP plans could also spur similar offerings from Yahoo and Microsoft's MSN Web portal, although neither company has announced anything yet.

Like AOL, Yahoo and MSN already offer digital phone calling services through their instant messaging software, although those services haven't garnered the attention that the new breed of VoIP operators have gotten. Each service charges a few pennies a minute for calls to phones. But traffic and revenue is "minimal," according to a source at Net2Phone, which still supplies each IM maker with the technology for these calls.