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ISP deals demonstrate market frenzy

Just a few days after EarthLink pulled out of its contract with Microworkz, filing an acrimonious lawsuit against its former partner, AT&T has rushed in fill the gap.

It's time to coin new motto for the Internet service provider industry: Once burned, not shy at all.

Just a few days after EarthLink Network pulled out of its contract with PC maker Microworkz, filing an acrimonious lawsuit against its former partner, AT&T has rushed in to fill the gap left by the ISP?s departure.

If this is anything more than simply a risky business decision, it is a sign of how desperate ISPs are to sign up subscribers. Dial-up ISPs are being squeezed by high-speed Internet providers on one side, and the encroachment of free ISP services like NetZero on the other---and are doing all they can to gain the vast subscriber lists analysts say they will need to survive.

In AT&T's case, this even means signing on board with a PC maker with an alleged track record of unpaid bills and flawed dial-up modem equipment. An AT&T company spokeswoman yesterday called the new deal a "great contract," despite EarthLink's complaints that Microworkz hadn't yet paid a dime on its previous agreement.

The scramble to sign these distribution deals has reached a pitch that some analysts and ISP insiders say should be scaled back, in the interest of caution.

"To some degree, ISPs should be assessing these deals more closely," said Joe Laszlo, an industry analyst with Jupiter Communications. "Maybe they should look more carefully at the companies they're partnering with."

Market share first, caution later?
Despite the drumbeat of hype behind high-speed--or "broadband"--Internet access, most analysts predict that most Net users will continue using dial-up modems well into the future. Jupiter Communications forecasts that 81 percent of Internet access will be dial-up at least until 2002.

As a result, top ISPs in the country are still vying with each other to be the No. 2 provider behind America Online, which has an indisputable lead in the market with more than 17 million subscribers. AT&T, the next closest ISP, has about 1.8 million subscribers. Most analysts say the companies with the largest subscriber lists are most likely to survive into the broadband era, and the biggest ISPs want to make sure they're among this group.

A common way for ISPs to gain subscribers is to distribute their software though partners, using methods such as icons placed prominently on a computer's desktop.

EarthLink has led the market's ?second tier? of ISPs in striking these kind of distribution deals, with more than 600 contracts now under its belt, including top-brand computer manufacturers like Apple, Compaq and IBM. It also signs deals with scores of other companies, ranging from Sony to Discover to local radio stations, to give those companies' consumers special rates on ISP service.

The company says it gets about 10 percent of its business from computer companies, along with another 17 percent from non-computer manufacturer affiliates.

But these distribution deals present something of a risk, analysts say. Internet service providers live and die by their reputation, and if this reputation is linked to another company with poor customer or poorly functioning equipment, it can hurt the ISP's overall business.

As EarthLink's situation shows, this potential has become even more severe with the rise of the "free," or heavily discounted, PC market. The start-ups that are offering these machines--often cross-subsidized by ISP service--have unproven business plans and little or no track record with customers.

"It is a potential risk," Laszlo said. "ISPs should be prepared to take action quickly when dealing with small start-up companies."

Treading lightly
EarthLink executives, who are still smarting from the Microworkz incident, say they are likely to be more careful about partners in the future.

"It doesn't make sense to partner with someone who can't handle the demand," said Kirsten Kappos, the company's vice president of corporate communications. But the company has not soured on the subsidized PC market, she noted--it still is the ISP for FreeMac.com, a company that has promised to give away 1 million Apple iMac computers.

This strategy of hundreds of small distribution deals does make sense for the company, even with the attendant risks, most analysts say. "Their philosophy is that they'll win by hitting singles," said Jeff Sadler, a FAC/Equities financial analyst who covers the ISP industry. "It takes a lot of base hits to win a game," he added.

Some other large ISPs are exerting more caution towards the discount PC market, however. MindSpring Enterprises says it has looked at the market, but has yet to find any partnership that makes sense.

"I don't understand how you can make that model work and make any money," said Lance Weatherby, executive vice president of sales and marketing for MindSpring.

"It's very likely that [Microworkz] could be the first of similar things to come from people who are trying to bundle Internet access and computers for very low prices," he added. "It's too soon to say for sure. But in this industry, we'll probably know in another two weeks."