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AOL gambles on big ad deals

The No. 1 online service has cut many lucrative deals with advertisers and content providers, but analysts question the strategy's viability.

America Online (AOL) has persuaded advertisers and content providers time and again to pay millions of dollars for space on AOL.

But the question is: how long will this work? Some analysts question the AOL fights search rivals long-term viability of this strategy, while AOL remains confident that it has only begun to tap the market potential.

AOL, when it went to flat-rate pricing in December 1996, started pursuing a strategy of getting money not just from subscriptions but also from advertising and commerce.

On a regular basis, AOL has been announcing deals such as yesterday's in which Intuit agreed to pay $30 million to AOL over three years. The deal calls for Intuit to be the anchor tenant in the Personal Finance and WorkPlace channels on AOL.com, the online service's Web site.

Other recent deals include AOL getting $20 million from Cybermeals over four years; Barnes & Noble paying AOL $40 million to be AOL's exclusive bookseller for four years (Amazon.com, Barnes & Noble's chief competitor on the Net, has a separate deal with AOL.com); and American Greetings cutting an $18 million deal to provide online greeting cards through AOL.

AOL's strategy has been to build itself into a brand--a consumer product name that increasingly attracts advertisers. So far, that plan has worked well.

Companies wanting a mass audience only have a few places to go, and AOL is "the easiest single place to go and make the big distribution deal," said Kate Delhagen, an analyst with Forrester Research.

But that may not last, she added. Delhagen wonders if the very deals AOL is making eventually will cause the plan to backfire.

"We're seeing the rapid commercialization of AOL," she said. With each deal AOL cuts, it puts more ads on its service, including banner ads and the mostly reviled pop-up windows. Eventually, AOL consumers could get fed up, especially since AOL just raised its price from $19.95 per month to $21.95 per month, effective with the April billing cycle.

"They're pushing the limit right now," Delhagen said.

Internet service providers that have been nipping at the heels of AOL for a long time might not be able to focus as much on AOL's poor access as a selling point, since that part of the online service has improved. But those competitors now can focus on AOL's incessant advertising and its higher price, she said.

Others also point to another potential pitfall to AOL's strategy: ad dollars, contrary to some thinking, are not unlimited.

AOL executives have said the online giant has only begun to tap into the advertising market and skeptics need not fear that those funds will dry out. AOL also has a several-pronged strategy for making money. Advertising is one of many revenue sources, so if there is a bad quarter here and there, AOL can survive it, they have said.

But David Simons, managing director of Digital Video Investments, observes that a number of AOL's big deals have been with Internet start-ups that paid for the ads with cash from initial public offerings.

"Some day the bull market is going to be over," he said.

There are other risk factors, he said. Advertisers have been coming onto the Net in big numbers, but the biggest spenders in traditional media such as print and television still are not convinced.

"There's a presumption that growth of Internet advertising will be endlessly exponential," he said. "There's real risk that projected growth rates won't come to pass."

Plus, as AOL grows, so does the rest of the Internet, added Simons and others. Strong Web sites could pull away advertising money from the current leader.

Gregory Wester, an analyst with the Yankee Group, added that the multiyear deals are being cut with the expectation on both ends that AOL will continue to grow.

If AOL does maintain its growth, the partners wind up with a great deal. But AOL in many cases won't be able to pursue other deals based on new membership numbers because it has signed exclusive contracts.

"There's a bit of rolling the dice in all these deals," Wester said. "The financial value is based on a snapshot with a decent amount of betting on tomorrow's traffic. It's kind of like buying a billboard on a highway--what it's worth is based on how it's placed, where the traffic is coming from and going to, and who else is building highways that could circumvent your value."

"If you don't lock up the customer, someone else will lock up the customer--the deal may not be profitable early on, but to exist in the future you need to eliminate your competitors that could lock up those customers," he added.

Internet copy editor Beth Lipton contributed to this report.