Free ISPs face numerous hurdles, with high costs for acquiring subscribers, massive turnover and ongoing questions about consumer tolerance for advertising, which typically pays the bills on such services.
In a largely anecdotal
"Free ISP services fared pretty dismally for the most part," IDC research analyst Steven Harris said in a statement. "With few exceptions, free ISPs have a long way to go to meet even the low expectations of U.S. ISP consumers, especially as they attempt to get started."
Analysts agreed that the sector is undergoing a shakeout and that providing services equal to for-pay competitors is crucial to survival. The recent failures of free ISPs have not deterred retailers from taking advantage of such offerings to market other online services. Kmart, along with Yahoo, offers BlueLight.com, which is powered by Spinway.com, another free Net service.
Some analysts said the market for the leading players remains strong because of a surge of lower-income Net users, who will gravitate toward free offerings to save money and will allow them to reach critical mass.
"The free ISP phenomenon remains strong," said Jeff Sadler, an analyst with FAC/Equities who rates free service NetZero a "strong buy." "We're approaching the second of three influxes of Net users: those with an income of between $30,000 and $50,000...It will be easier to attract this level of income to free ISPs."
Although the IDC report concluded that consumers are better off paying for an ISP, a study released today by The Strategis Group said that the market for free Internet access services would more than triple by 2005.
The Strategis Group study revealed that the number of free ISP customers is expected to represent about 23 percent of all residential Internet users by 2005, growing from 12 million to 37 million people.
"The falling cost of network bandwidth and the development of sophisticated tools for personalizing and delivering content to targeted users has led to a revival of free Internet access," Ty Cottrill, senior analyst of Strategis, said in a statement. "The market appears receptive to free access offerings, and the potential for expansion is great, but free ISPs must overcome many operational and financial obstacles to achieve longevity."
Some companies appear to be growing at a healthy clip. Juno Online Services, which offers both pay and free services, in a quarterly earnings report yesterday said its active audience jumped by 330,000 in June, reaching 3.38 million. It also reported 11.05 million registered members, a 3-to-1 division.
"Free Internet services fill a certain niche in the market, as do premium services," Juno chief executive Charles Ardai said. "It's not so much free Internet services are bad or good; it's that they appeal to a certain audience, and we think there's a place in the market for free, billable and broadband (services)."
The cost of "free"
At best, such services must learn to survive on thin margins. Free ISPs that rely mostly on advertising for revenues can squeeze about 25 cents per customer for each hour of use on the service--currently about cost. In addition, they generate only 15 to 18 average user hours a month, compared with 30 to 40 hours logged with pay services.
FAC's Sadler said free services that have broken past the 2 million subscriber mark, including NetZero, may be on the road to profitability. He notes that operating expenses are falling and predicts they will drop below 20 cents per hour, giving a comfortable profit margin including subscriber acquisition costs.
Here, free services face significant difficulties, however, as the steep 3-to-1 divide between registered and active members in Juno's quarterly numbers attests. Free ISPs sign up significant numbers of people who subsequently fail to use the service--a phenomenon known as churn. Juno, which has yet to post a profit, spent more than $82 million to acquire new subscribers in the six months ended June 30--by far its largest expense.
Analysts said the cost of acquiring new members is significant but necessary.
Free ISPs "have to market right now...In the early days, they were growing largely through word of mouth," said Zia Daniell Wigder of Jupiter Communications.
To retain customers, these companies need to significantly improve their services, some critics say.
Last month's IDC study, for example, found that free ISPs were more time-consuming than their for-pay alternatives. IDC's Harris, who tested six services, said that the time needed to download the dial-up software was often lengthy. In addition, slow login and connection times cause problems for subscribers.
Another cost is that free services often require people to provide scores of demographic information, according to the study.
Most of the services hit people with advertising, which often comes in the form of a bar that remains on the subscriber's screen through the duration of the Internet connection. The problem with the bar, according to Harris, is that the customer is forced to continually move the ad around the screen, as it often covers information on Web pages.
Harris said that the point of connecting online is to be able to see the content, and "interfering with that essential point lessens the quality of the experience."
Juno, which was among the services tested, has a different take on the study.
Five other free ISPs were tested: BlueLight, Excite@Home's FreeLane, Freeinternet.com, NetZero and the now-defunct WorldSpy.
FAC's Sadler also said the study was flawed.
"It was all anecdotes for one guy's experience," he said. "From the point of view of analysis, it was pretty weak."
Vijay Krish, general manager for Excite@Home's FreeLane, said that some inconveniences--such as advertising--are the price of using a free ISP, and that they are part of the business model.
"The report is valid in some regards?(but) the free service is much closer (to) the for-pay service" than the report makes out, he said. "The way that we're thinking strategically is that we're segmenting the market so the free ISP is sort of our low-price Toyota: It's reliable, it gets you there, but it's not as fast as the higher end of the @Home service, which is sort of the Lexus and Ferrari."