The AOL-Time Warner merger is being concluded in a very different economic and market environment than when the merger was first announced.
We believe the combination of Time Warner and AOL will enable the two organizations to gain some short-term advantage through cross-selling to each others' customer base. In the long run, however, we do not expect this merger to provide the business advantages that officials in both companies hope to see. In two years, when the numbers become clear, we believe senior management will be hard-pressed to find any lasting advantage from the combination of AOL and Time Warner, and this merged media giant may be breaking back up.
The FCC's instant messaging requirement--that AOL open up its instant-messaging services to connections with other IM services across the Internet before it offers "advanced IM-based high-speed services"--speaks to a long-term concern raised by this merger. Although we believe AOL could stimulate a commercial market for IM by connecting with the other major Internet IM services--such as MSN and Yahoo--we do not expect the Federal Communications Commission to vigorously enforce this rule.
Michael Powell, the Republican member of the FCC whom President-elect George W. Bush has nominated to head the commission, has said publicly that he does not believe that the FCC's requirement for AOL to open up Instant Messenger has legal standing. When the current, Democratic FCC chairman resigns, President Bush will appoint a new, presumably Republican, member, giving the Republicans a 3-to-2 majority on the panel. In addition, it is hard for government regulators to make a case for requiring AOL to open its IM offering when the rest of the industry has failed to agree on an IM standard.
The need for an IM standard
We believe that the IM Unified Coalition needs to proceed with or without AOL and deliver and implement an IM standard. The government's role is to ensure open access, but it is unlikely to act on the pontifications of a standards group. A real, healthy and vibrant IM market will force AOL to open its network to acquire and retain consumer and business partners.
Until then, there is no incentive for AOL to undertake any significant effort to interoperate. IM Unified and other standardization efforts need to move forward and achieve market success to create a better business case for the government to act on--especially a Republican administration that is likely to favor business competition over governmental intervention.
If AOL does not open its IM service, on the other hand--and if it does succeed in increasing its dominance of the consumer Internet market--it may face eventual antitrust action. AOL's IM tool is free (so was Internet Explorer); it has deep market penetration across consumer desktops (so did Internet Explorer); it is bundled with third-party software (so was Internet Explorer); it represents a "next wave" in peer-to-peer and collaborative computing; and it stands ready to become a business platform (as Web browsers were positioned years ago).
While it's true that differences exist between AOL's IM situation and the Microsoft antitrust case, there are many similarities in core issues. The industry cannot have it both ways, selectively forgetting principles that foster competition. Business cannot exploit external IM networks until they achieve base-level interoperability and reliability.
Beyond the IM issue, however, is the validity of the core value proposition of the merger: combining content, services and delivery channels. This combination will be difficult to differentiate in the long term. AOL can try to provide "tiered services" at an extra cost, but when CompuServe tried that years ago, it failed. The merged company may be able to provide key Time Warner business content before that content is provided to other services (MSN, Yahoo, etc.), but ultimately Time Warner needs to sell its content over as many services as possible to reach the widest audience, while AOL needs to provide the content that its users and potential markets want, regardless of the content's source.
After the merger, the breakup
This basic conflict is what makes the merger's long-term prospects seem doubtful to us. Each side could achieve what it needs through a simple, nonexclusive marketing alliance. As a result, we expect the merged company will break into multiple pieces--an independent AOL and an independent Time Warner, with the cable company either part of AOL or independent--within two years.
AOL will win in the near term with marketing, but market efficiencies will win out in the long term. It is doubtful that long-term advantage exists for AOL to own content or cable. Similarly, Time Warner will not find enough efficiencies in being part of AOL or owning its own cable. All these essentially independent business organizations need is alliances with each other--and the freedom to make similar alliances with their partner's competitors.
Meta Group analysts Dale Kutnick, Val Sribar, David Cearley, Mike Gotta, Peter Burris, Jack Gold and William Zachman contributed to this article.
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