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AOL, here's how you screwed up

The online pioneer is once again on the comeback trail. CNET looks back at the mistakes, lawsuits, and changing tides that ruined its dominance.

Tim Armstrong, AOL's CEO (right) during an interview last year, doesn't seem to have the company turned around yet. Ina Fried

Nobody epitomized the AOL of the late 1990s better than David Colburn, the foul-mouthed, bully-boy deal maker who oversaw the company's ad empire. Soon after AOL acquired Time Warner--a deal that was presented to the public as a merger, creating a company with a market cap of $350 billion--a Time Warner executive scolded Colburn for being disrespectful.

"You talk like you're buying us," said the Time Warner exec. Legend has it that Colburn fired back: "We are, you putz!"

"Windows is the past. In the future, AOL is the next Microsoft"
--Steve Case, AOL founder

Colburn's underlings had T-shirts made with his statement emblazoned on the chest. In Silicon Valley, techies snickered too. The comment was at once a rallying cry and benediction. New media had officially buried old media. Back then, that kind of swagger was part of AOL's mystique. The company's software helped 30 million people worldwide dial-in to the Internet. Dozens of dot-coms paid AOL millions just to put their links on its front door. The company would one day dwarf Microsoft--or so AOL execs believed.

AOL has spent the past 10 years trying to recapture that earlier success and is working on its latest rebuilding effort. This one is off to a rocky start: on Wednesday, AOL reported second-quarter earnings that failed to meet already lowered analyst expectations. Revenue, which analysts projected to come in around $602 million, fell 26 percent from a year ago to $584 million.

"We may or may not be able to meet Wall Street expectations for the rest of the year," CEO Tim Armstrong said in an interview, according to Reuters. "But we will meet our expectations for making AOL a healthier company."

Investors typically don't care about companies meeting CEO expectations. They want growth and Armstrong didn't deliver. But even the most passionate investor must recognize that Armstrong has undertaken a daunting task. He is trying to rebuild a company that has never fully recovered from the mass adoption of cheap, high-speed Internet access, an event that rendered it's Internet-access business all but obsolete. So, Armstrong is saddled with a brand best known for an outdated consumer proposition (dial-up Web access) and a long list of alleged anti-consumer practices.

If you aren't at least 25, you may not remember how dominate the company became. In the late 1990s, AOL was unlike the many flimsy dot-coms for which the era was famous. It had been around for more than a decade at that point and had generated real profits. In one of the great Internet marketing campaigns, AOL circulated software discs that became ubiquitous and enabled mainstream consumers, unfamiliar with technology, to easily access the Internet. People paid monthly fees for that access.

Founder Steve Case became a celebrity entrepreneur, and he regularly appeared on TV and magazine covers. It's not too far a stretch to compare the AOL of 1999 to the Facebook, Apple or Google of today. AOL's top executives were just as confident and aggressive and could match influence and bank accounts with many of the current tech stars.

"When I cast my vote for 100 million shares, I did it with as much excitement as I felt the first time I made love...I voted for it because we will have a stronger company that will create value. It's not so easy to go out and recreate AOL."
--Ted Turner, AOL stockholder

The pinnacle for AOL came when it announced that it would "merge" with Time Warner, parent company to some of the country's best known media brands, including Warner Bros. Studios, Time magazine, and CNN. In reality, AOL took majority control of the combined company. The move was stunning for its brashness as well as for being--with the benefit of hindsight--a little crazy.

The marriage was a disaster. The dot-com bubble burst, the economy collapsed and AOL leaders began to be ushered out as its influence waned. Later, government investigators accused AOL execs of attempting to inflate its earnings reports. By the time that surfaced, AOL had already seen its fair share of controversies.

In 2000, AOL was hit with an $8 billion lawsuit after it was alleged that the company's software, when loaded onto a computer, rigged it so competitors' software couldn't replace it. AOL settled for $15 million.

AOL's billing practices drew numerous lawsuits, including one from the state of Ohio. If an AOL user was on the Internet for 18 minutes and 50 seconds, AOL charged them for 20 minutes. The company tacked on 15 seconds to every online session and then rounded up to the next minute. AOL justified it by saying it had to account for the time customers signed on and off. Managers settled the case with Ohio's attorney general in 2005 and changed its policy.

The most major setback to AOL's reputation sprung from the company's long-standing efforts to discourage subscribers from canceling.

In 2005, AOL agreed to pay $1.2 million in restitution to New York state after authorities discovered the company had paid employees to prevent customers from canceling their service. People would call to cancel and customer service employees would go to great lengths, even hang up on them, to try to "retain" the customer. For this, AOL paid bonuses.

That wasn't the end. A year later, a man named Vincent Ferrari called to cancel his AOL service and recorded the conversation in which the AOL representative badgered him repeatedly. The clip spread virally on YouTube. "Cancel the account," Ferrari told the rep over and over. "I don't know how to make this any clearer."

AOL denied it encouraged customer-service reps to treat people this way. Nonetheless, some media outlets noted that AOL lost 800,000 subscribers in the quarter prior to Ferrari's phone call.

Paid subscribers continue to leave. Armstrong said that this means not only is AOL losing subscription fees but fewer subscribers means fewer search queries and fewer people to look at ads. That subscription numbers are tumbling isn't new. It's gone on for years and that Armstrong is only bringing it up now, more than a year into the job, will erode his credibility with Wall Street, says Henry Blodgeta former analyst who now runs Silicon Alley Insider.

"What investors feeling that a CEO does not have a handle on the business or is not being forthright with them," Blodget wrote.

Whatever Armstrong's shortcomings are as a CEO, he certainly can't be blamed for steering AOL into its long malaise. The past decade, AOL has flip-flopped from being an ISP and a media company. Five years ago, YouTube triggered the Web-video craze. NBC Universal, News Corp., Viacom, Netflix, Google, and Apple all jumped in while AOL, which was sitting on a gold mine of Time Warner film and TV content, made hardly a peep.

Armstrong has won praise for some of his moves. He sold social-networking site Bebo for $10 million, a disastrous acquisition that cost AOL $850 million just two years ago, before he took over. Some of AOL's media properties have fared well, including Hollywood-gossip site TMZ. Armstrong, a former star at Google, has assembled a respected management team, including David Eun, formerly Google's content chief, and Brad Garlinghouse, the outspoken former Yahoo executive.

However it goes for AOL, it might be wise for today's tech entrepreneurs to remember that Colburn, AOL's one-time golden boy, was fired after the SEC accused him of participating in a scheme to overstate the company's earnings. He later settled that suit. The obvious lesson Colburne and AOL teach is never believe you, your technology, or company are irreplaceable. It might help to remind yourself of those facts before dealing with unhappy customers or calling a coworker a putz.

Note to readers: The quotes in bold from Case and Turner were collected by former New York Times reporter Saul Hansell and you can read his story here.