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AOL to withstand rate backlash

While Internet advertising and commerce revenues are stronger, America Online maintains they still aren't enough to make up for increased costs.

Why did America Online (AOL) choose to raise its prices now? The answer just may be: Why not now?

AOL needed money to offset the rising costs of its unlimited service, and, at about the same time, it was finding its revenues growing and its membership turnover rate stabilizing.

Given such events, AOL executives felt that any backlash from raising its monthly rates by $2, or 10 percent, would be short-lived.

AOL's Robert Pittman on price increase and timing
When the online giant started offering unlimited access for one price 14 months ago, executives said they would make up for the resulting shortfall in revenues through advertising and commerce, both of which were then unproven methods of bringing home the virtual bacon.

Today, while Internet advertising and commerce revenues certainly are much stronger than a year ago--and especially for AOL, which brought in a record $108.8 million from those categories last year--they still aren't bringing in enough to make up for what AOL says are the increased costs associated with members spending much more time online.

"The good news is we're trying to get people to use us more," said Bob Pittman, AOL's president and COO. "We want them to embed us in their lives. The only issue affecting cost is that that's happening at a faster rate than the growth of other revenue. It's happening at a faster rate than our ability to bring down the cost of connectivity on a per-unit basis and per-hour basis. But at the end of the day, I think that's what we're driving for--to make the service valuable."

At $21.95 per month, $2 more than most Internet service providers and $7 more than some, AOL had better be making the service more valuable.

"The price hike will increase members' sensitivity to all aspects of service quality, from log-on and email to perhaps pop-up ads," said David Simons, an industry observer and managing director of Digital Video Investments.

Subscribers who might have been willing to overlook those parts of AOL's service about which they constantly complain--the barrage of advertising and unsolicited email, occasional outages on portions of the service, chat rooms that can sometimes be chaotic--might not be so willing if they're asked to pay more. But AOL has some cash reserves, thanks in large part to the deals it has been cutting with its advertisers and other Internet businesses.

If the online giant must take a hit over price increases, this is as good a time as any. This time of year traditionally has been slow for new AOL memberships, so even if new users are turned off by the service's increased price tag, the net effect shouldn?t be huge.

AOL's Steve Case says members will understand
Additionally, it's quite possible that, by the time the next Christmas season rolls around--traditionally the most popular time for online signups--many other ISPs will have followed AOL's lead and bumped up their prices. Even if they don't, and analysts seem split on whether they will, new users might not even remember the service's increased fee by then.

Then again, it's too early to know for sure how the price increase will affect the market. Some are saying that this could be the proverbial kick in the pants that telephone companies such as Sprint and ATT need to prompt them to market their services better.

"I expect we'll see a flurry of competition," said Kate Delhagen, analyst with Forrester Research. We'll look back on this as a turning point when...some of the local telcos got serious about getting consumers online."

AOL executives say that customers are ready and willing to pay more for their supposedly superior service. That may or may not be true, but under the tutelage of Pittman--who has founding MTV to his credit--they are counting on AOL's ubiquitous brand name to carry the day.

Go out on the street and ask the average person to name an Internet service provider, and he or she is most likely to mention America Online. Chances are he or she also has an AOL start-up disk or two sitting in a desk drawer. AOL software may already be loaded in his or her computer, which makes it tough for competitors to stand a chance of winning over even disgruntled AOL subscribers.

On the other hand, people have been complaining about AOL for years. But the service continues to grow every day and dwarfs its closest competitor, Microsoft Network, which has about 2 million members compared with AOL's 11 million.

Analysts, for the most part, are in agreement that AOL's current members will stay on board. However some caution that it's impossible to predict what will happen in this particular situation, and warn that it will be months before it becomes apparent just how the price increase affected AOL and the market as a whole.

While some AOL members are bound to view the latest price increase as a last straw, others will complain but retain their memberships because it's simply easier to stay and because $2 a month is not enough to spur defections. AOL, which has been largely successful in attracting less Internet-savvy consumers, is most likely banking on that, even if its members want to leave, many of them would have to go to a lot of trouble to switch services.

Clearly, it is these members that AOL had in mind when it raised its rates. Pittman said the company had looked at other cost-saving options, such as putting a monthly cap on the number of hours a member could stay online for $19.95, echoing a move made by IBM; or charging premiums for certain aspects of the service, such as the ability to create five different screen names.

Ultimately, AOL decided to keep the unlimited pricing model, which, with the exception of several turbulent months back when it was so swamped that many members couldn't even access the service, largely has worked for users.

"Of course nobody likes a price increase. But our testing and the preliminary response to our $2 increase announcement indicates to us that the vast majority of our members will find this increase reasonable and acceptable," Pittman said. "However, even if we do get a bump in churn [the rate at which users leave the service] when we introduce it, we will still be at a very strong financial position."