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ISPs caught in rebate frenzy

Led by CompuServe and Prodigy, many ISPs are offering large rebates to computer buyers who sign long-term contracts for their service. These deals initially bring the companies precariously close to the red--but the ISPs say the risk is worth winning valuable new subscribers.

The fight for Internet consumers has gone as far as this: ISPs are willing to buy you a PC if you'll sign up for their service.

Led by CompuServe and Prodigy, many Net service providers have jumped squarely on the "free" PC train, offering subsidies or rebates to computer buyers willing to pay for long-term subscriptions. As with bargain PC offers, these deals initially bring the companies precariously close to the red--but the ISPs say the risk is worth winning valuable new customers.

PC free for all Other ISPs are seeking to boost their market share by offering service for free, subsidized by advertising. This model, while popular with consumers, requires attracting a huge subscriber list--much like a TV or radio business model.

PC manufacturers, retailers, and ISPs are all getting into the act, partnering to offer discounts or rebates. Some of the big names involved in the cross-marketing frenzy include CompuServe, Prodigy, Emachines, IBM, Sony, Best Buy, and CompUSA. Usually, consumers receive rebates of $400 on the purchase of a PC. For the lower-priced brands like Emachines, this can give the buyer a machine for close to nothing.

Prodigy says it signed up 120,000 customers in the six weeks following the launch of its rebate offer, with the vast majority coming through the rebate programs. That means Prodigy is already on the hook for up to $48 million in rebate checks, if it sends them immediately. The company declined to discuss the financial details of its program.

In return for receiving such rebates, the buyers agree to a standard three years of Internet service for $19.95 a month, or about $720. If the rebate was $400, that leaves the ISP with $320, or less than $9 each month over the three-year life of the contract.

The bottom line for the companies? If it costs the ISP more than $9 per month to provide service to the customer, and it paid a rebate of $400, it is losing money on each new customer for those three years. (This assumes that the company does not derive some other form of revenue from each new customer.)

And that $9 mark is hard to clear--some low-budget ISPs report costs in the $8-to-$9 range, but a major access provider with quality infrastructure and customer support is likely to spend more like $8 to $12, industry executives say.

Let's make a deal
Deal Downside Who offers
The "Free" PC:
User gets a free PC, but signs up for three years of ISP service.
Some customer complaints about long waits; unknown PC brands; restrictive contracts. Gobi, DirectWeb, Microworkz.
The Marketing PC:
User gets free PC, and sometimes ISP service, but must accept advertising and possibly receive a branded credit card.
Not open to everyone--they select you; lots of free advertising. Free-PC, FreeMac.
The Rebate:
User gets $400-plus rebates for a PC/ISP package.
Three-year contract; deals seem to improve by the week. Nearly every major player is involved: HP, IBM, Compaq, Emachines, CompuServe, Prodigy.
Free Service:
User gets a year of free ISP service, sometimes followed by discounted prices.
PC is fully priced. Gateway, Dell, Compaq.
Source: staff research

In their defense, ISPs respond that the numbers are not so simple to calculate.

"We would not be in this business if we were not able to make money doing so," Prodigy CEO David Trachtenberg said plainly.

The profits, Trachtenberg and others say, come from reducing the cost of acquiring new subscribers and from holding onto those subscribers for the full three years--and more.

Name of the game is growth
The golden rule for a large service provider is growth, but even the best lose between 3 percent and 7 percent of their customers each month. This translates into serious loss of cash.

Grayson Hoberg, EarthLink Network's chief financial officer, estimated that if monthly churn could be reduced by just half of one percentage point, those retained customers would add about $50 million in annual revenue for an ISP of EarthLink's size.

To counteract this churn and keep growth rates up, ISPs spend considerable amounts of marketing dollars to win even a single subscriber. For EarthLink, which has about 1.3 million subscribers, this figure hovers around $150 per customer. MindSpring Enterprises, which is about the same size, says it spends about $60.

Prodigy and CompuServe are betting that holding onto a customer for the duration of their contract--and ideally beyond--will offset the churn and marketing expenses it took to get them, thus making their $400-a-head investment worthwhile.

Still, some ISPs question how valuable this strategy will be in the long term.

Lance Weatherby, executive marketing vice president for MindSpring, said his company has so far chosen to stay out of the rebate game, unsure that people will stay on board long enough to justify a $400 investment.

"I think you would wind up with some dissatisfied people who feel like they're trapped," he said.  

Go to: The rebirth of CompuServe