ROANOKE TIMES
Copyright (c) 1997, Roanoke Times
DATE: Sunday, February 9, 1997 TAG: 9702070026
SECTION: BUSINESS PAGE: 1 EDITION: METRO
DATELINE: CHICAGO
SOURCE: JAMES COATES KNIGHT-RIDDER/TRIBUNE
"If you think of AOL as an electronic community, AOL is now among the largest `cities' in the world."
- Steve Case, chief executive of America Online, announcing the signing up of its 5 millionth subscriber on Feb. 16, 1996
For the minority of gridlocked America Online Inc.'s 8 million cyber-citizens who can actually get to their "homes" on line, an Information Age big-business cautionary tale unfolds with a mouse click.
To read all about it, click on the icon named "keyword," then type the word "press." There, in chronological order, are more than 400 news releases AOL has issued since Aug. 4, 1994, each touting one small part of what - until last week - had become one of the biggest success stories in American business history.
"It's a classic story of a business that was bold and brilliant for a long time before something they did didn't turn out as brilliant as they expected," said Michael Krauss, a principal in Chicago-based OmniTech Consulting Group.
"Now it's a classic story of crisis management, and we don't know the ending to that one yet."
The crisis played out as a major news story when Illinois Attorney General Jim Ryan spearheaded an offensive against AOL by law enforcement officials from 36 states.
The attorneys general acted in the wake of an onslaught of complaints from people who were being billed $19.95 a month for a service they simply could not use because of busy telephone lines.
AOL created the problem by failing to anticipate just how many of its customers would rush to log on - and stay logged on - after the company began to offer a flat $19.95 monthly rate, when users previously had to pay a monthly fee and nearly $3 for every hour they were signed on after their allotted time.
The resulting gridlock produced widespread consumer complaints, and the subsequent agreement last week with the three dozen attorneys general forced AOL to acknowledge formally that it can't handle its customer load and to offer a costly refund package.
Ryan bluntly warned AOL that if the company doesn't find a way to provide its customers with the services they pay for, the attorneys general will take sterner measures, up to and including seeking federal court injunctions to shut down the on-line service.
Robert Pittman, chief executive of AOL Networks, the division of Dulles, Va.-based America Online Inc. that runs the dial-up service, acknowledged in a telephone interview that he and others erred badly in failing to anticipate this crisis.
"We are stepping into unknown territory every day we go to work," Pittman said. "Nobody has ever done in this world what we do, which is to run a network of our type at our size. But we are learning to make it work."
He promised that the current problems would be solved by late spring, which gives the company nearly six months to extricate itself from a crisis that could threaten its existence.
Although Ryan declined to say how long the states would wait for the company to stanch the flood of consumer complaints, he noted that many AOL customers want the service and said the attorneys general hope the refund program will buy the company the time it needs to stop the complaints. |n n| Looking back, Pittman noted that in slightly less than 21/2 years, AOL rode the Internet boom as it moved from the technological fringes to center stage.
In August 1994, AOL claimed 1 million subscribers. Six months later, that number had doubled. By November 1995, it had doubled again. AOL reached 7 million customers in mid-November last year and, just two months later, that had grown to 8 million.
Pittman joined the AOL board in November 1995 and became chief executive of the AOL Networks division last Oct. 28.
Pittman, who has a reputation as one of America's most effective entertainment industry marketers, invented and nurtured the MTV cable network in the 1980s, ran Time Warner's Six Flags amusement park division, then made a brief stop at Century 21 Real Estate before joining AOL.
His mandate as head of AOL Networks was to expand the service as fast as possible. As creator of MTV, the network widely viewed as the model for much of the cable boom, Pittman said he had hoped and still hopes to work the same magic on the Internet.
At the time Pittman joined AOL, one leading analyst of the on-line industry, Peter Krasilovsky of Bethesda, Md.-based Arlen Communications Inc., noted that AOL chief executive Steve Case and other America Online executives frequently liken their business to cable television when it was in its infancy.
"They are cable TV groupies at AOL, and Bob Pittman looks very good to them. They remember that there were about 15 million cable subscribers when Pittman took over MTV and turned it into the model for today's cable that now has 66 million subscribers," Krasilovsky said.
That was exactly the kind of growth AOL needed last fall. As part of a corporate realignment announced when Pittman took over AOL Networks, the company changed its accounting procedures at the request of many financial analysts. The company decided to stop amortizing the costs it incurs for landing new customers over 24 months and to report those costs on a quarterly basis, a step that will decrease the quarterly earnings that are particularly important on Wall Street.
Case said at the time Pittman took charge of AOL Networks that this change meant the company would be forced to rely more on revenues from advertising sales than from monthly fees paid by subscribers.
The new model means the service needs as large a subscriber base as possible in order to increase the amount it can charge for ads, similar to the cable TV model. But trouble hit almost immediately as AOL tried to implement on the Internet the strategy that had worked so well on cable television.
"What happened," Pittman said, "was that we failed to anticipate the demands that people hit us with."
Pittman said that, during board planning sessions beginning last summer, officials underestimated the amount of time an average user would stay on line.
"We thought 50 percent was absurdly optimistic, and we were really wrong. Instead, it went up 100 percent," he said.
As a result, he said, AOL has spent the last two months "scrambling to produce capacity for our customers" and has been forced to postpone aggressive marketing plans to curtail demand.
"Nobody in the media has ever grown like this place did," Pittman said. But he added, despite its current troubles, AOL remains committed to keeping the flat rate of $19.95 per month in place and intends to solve the capacity problems by "building out" the network of modems, telephone switching equipment and buildings to house them that AOL owns all over the country.
"By the end of December, we knew that this thing was unbelievably popular and that people really wanted it. So we know that it will work quite well eventually."
Many critics don't agree, as typified by Mohan Sawhney, a marketing expert at Northwestern University's J.L. Kellogg Graduate School of Management. He sounded a frequently heard warning that AOL ultimately may have to drop its highly popular $19.95 flat rate precisely because it is so popular.
"It is an unsustainable economic model," Sawhney said. "They are charging limited rates for unlimited access to a resource that is essentially limited."
He added, "They clearly should consider segmented service, charging different rates for different quality of service, like an airline sells first class, second class and coach."
Krauss, of OmniTech, a specialist in Internet commerce issues, said that, despite the current furor, the AOL planners have only made one major mistake to date: They should have offered refunds before being forced to do so by the attorneys general.
"This whole Internet industry is uncharted territory," Krauss said. "You can predict how many people want to buy Diet Coke on the North Side of Chicago and make sure you have enough cans for all of them, but you can't do that yet with on line."
LENGTH: Long : 143 lines ILLUSTRATION: GRAPHIC: 2 charts by AP.by CNB