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AOL defends kingdom with cheaper option

America Online's plan to launch a new discount Net access service spotlights the threat it faces from both cheaper alternatives and speedier broadband offerings.

America Online's plan to launch a new discount Internet access service spotlights the growing threat to premium dial-up providers from both cheaper alternatives and speedier broadband offerings.

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What's new:
With premium dial-up providers fighting a two-front war against discount ISPs and superfast broadband companies, AOL is considering a new budget, Netscape-branded service.

Bottom line:
AOL finds itself between a rock and a hard place. It must offer cheaper service if it's to keep budget-minded subscribers from jumping to another provider. Then again, it doesn't want to lure people away from its own premium offering.

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Word leaked Tuesday of AOL's plans to launch a stripped down dial-up service for $9.95 a month under the Netscape brand. The Netscape service is expected to launch in the beginning of 2004 and will offer few of the bells and whistles--such as instant messaging and multimedia content--found on AOL's $23.90 a month service, according to a source close to America Online.

The Netscape service is at a conceptual stage, and no product has been tested yet, the source added. But the idea points to the harsh reality AOL is facing as its dial-up subscribers unplug for lower-cost Internet service providers (ISPs) or upgrade to faster broadband services offered by phone and cable companies.

"Clearly (AOL's) premium ISP subscriber base is being nibbled on one side by broadband providers and on the other side by discount ISPs," said Joe Laszlo, an analyst at Jupiter Research.

At stake is the long-term future of AOL's profitable dial-up business, the largest in the United States, with more than 25 million subscribers.

Premium dial-up services charging $20 a month or more have been steadily losing subscribers to bargain services charging half the price or less, as well as broadband providers offering seven times the speed for just a few dollars extra. Most broadband providers charge between $40 and $55 a month. Leading the pack among broadband discounters, SBC Communications recently introduced a DSL promotion for $26.95 a month for one year, putting it within striking distance of AOL's premium rate for dial-up.

Dial-up doom and gloom
Consumer conversion to broadband is rapidly gutting the dial-up market in the United States, where total broadband subscribers are projected to jump to 21.7 million in 2003 from about 6.1 million in 2000, according to Forrester Research. Total dial-up subscribers, by contrast, are expected to fall to 40.5 million by the end of the year, from 48.9 million in 2000.

That's left price cutting as the last refuge for growth among dial-up providers. Even as the overall market for dial-up service contracts, business is booming for some of the cheapest services. In June, United Online, the biggest discount ISP, reported a 49 percent increase from last year in paid subscribers, who shell out $9.95 a month. United now has 2.55 million paid customers and 2.6 million subscribers to its free, ad-driven ISP.

These gains have come as AOL's subscriber base has slipped over the past two quarters. The trend culminated last quarter when AOL reported a loss of 864,000 members, primarily from new methods of subscriber counting, but also from subscribers unplugging.

Analysts said AOL is unlikely to take on discounters in an aggressive price war, however, a move that could undercut its own premium business even faster.

United Online saw its stock price tumble this week in anticipation of tough new competition from a marketing powerhouse. But analysts downplayed a bargain Netscape ISP as a pricing bellwether for AOL, noting that the online giant already offers discount services through its CompuServe subsidiary and in partnership with Wal-Mart Stores.

A new discount service would most likely be positioned as a modest defensive move to lasso defectors from its premium service, they said.

"I think from AOL's standpoint, if they don't capture those subscribers, someone else might," said Mark Zadell, an equity analyst at Blaylock & Partners.

Indeed, shuttling too many subscribers to a service that charges less than half the standard price of its flagship offering could have devastating effects on AOL's financial health.

Compounding this equation, AOL is trying to persuade people using third-party broadband services to pay an extra $14.95 to maintain their AOL accounts. AOL pursued this "bring your own access" strategy because offering its own broadband service offers slim returns per subscriber.

"Remember, they're fighting with one hand behind their back," said Youssef Squali, an equity analyst at First Albany. "They don't want to be overly aggressive to market this thing because they may cannibalize their more-profitable premium service."

An AOL representative declined to comment for this story.

The company has been arming itself with numerous initiatives aimed at retaining its dial-up subscribers, having recently released AOL 9.0, the latest version of its proprietary software and service.

New to the software are several e-mail and instant messaging features, such as new spam-filtering tools for its e-mail box and the ability to share photos and audio files through IM windows.

AOL 9.0 will also come with some exclusive perks that the company hopes will give people more reasons to sign on. The software will be bundled with security features such as virus protection and a firewall. Other features, including a cash card from Visa International and an "accelerator" caching system to speed up Web page downloads, are part of the package.

Content will play a heightened role as well. The cornerstone of the AOL 9.0 service will be its exclusive content from its magazine publishing cousin Time, with titles such as People and Entertainment Weekly now offering their articles only on AOL.

A history of experimentation
This is not the first time AOL has launched a discount ISP, nor is it the first time the company has dangled Netscape as an access brand. The reasoning behind relaunching the Netscape name, which originally graced the Web browser company AOL acquired in 1999, is to revive a well-known Internet brand for experienced Web users, the source said.

AOL currently has a plan through its CompuServe subsidiary that costs $9.95 for 20 hours a month, and its partnership with Wal-Mart offers dial-up Internet access for $9.94 a month. In addition, AOL has quietly begun offering a stripped-down version of CompuServe for $9.95 a month with no term limit to customers trying to defect. AOL will eventually swap out that CompuServe offering for the Netscape-branded service, the source said.

AOL has for years dipped its toe into the realm of lower-priced ISPs, but it has always hesitated out of fear of disrupting its profitable premium business.

In 1999 during the height of the Internet boom, Wall Street analysts criticized AOL for not embracing the free, ad-supported ISP business. AOL executives argued that consumers go with an ISP based on value, not cost and stood their ground amid a sagging stock price and investor skepticism.

AOL already had deals to offer $400 rebates on PC purchases if buyers signed up for three years with online subsidiary CompuServe. Those deals have since been discontinued.

Meanwhile, AOL launched a "free ISP" in the United Kingdom called Netscape Online. The service was not completely free because it took a percentage of access fees charged by British Telecom for local phone use, but it waived its monthly subscription fee.

Netscape Online lasted until March of 2002, when the service was shut down due to new ISP-friendly regulations in Britain that switched rated local phone call charges to a flat rate.

Whether or not the new Netscape Online will have a better track record depends on how AOL promotes it. AOL will not discuss its marketing strategy for the discount ISP, but its competitors seem to have their own take.

Despite watching his company's stock plummet nearly 20 percent on Tuesday's news, United Online CEO Mark Goldston said the launch of Netscape Online would help his company by legitimizing the market for discount ISPs. He's convinced that AOL will not put the full court press on with Netscape Online for the same reason AOL has always hesitated: market cannibalization.

"If they turn up the dial they'll eat up their own lunch," Goldston said.