• by Diane Mermigas , March 13, 2009

By Diane Mermigas Randy Falco says he has accomplished what he was asked to do at the chronically ailing AOL against considerable odds.

The career broadcast network executive, who helped make NBC dominant for more than a decade, was brought into AOL two years ago to do some heavy lifting: convert its revenue base from dial-up subscriptions to advertising-supported open access, expand its low-cost content verticals, and integrate social networking to be more competitive with online's Big 3 - Google, Yahoo and Microsoft.

After eliminating $2.5 billion in cost (including this week's latest 10% work force cut) and making 16 strategic acquisitions worth $1.6 billion, Falco's reinvention of AOL has run headlong into what some are calling the Great Recession. Hounded by the constant murmur of critics that he was wrong for the job and in a no-win situation, Falco was already contemplating his departure from AOL when Time Warner Chairman-CEO Jeff Bewkes, who hired him in November 2006, abruptly replaced him Thursday with Googler Tim Armstrong.

In an exclusive interview with Online Media Daily, Falco expressed his frustration with the process and the circumstances surrounding it, "I have been reorganizing and restructuring AOL; changing the strategy and rebuilding it from scratch in the worst economy in a generation.

"My job was to turn the company around, and to give Time Warner a profitable Web business to spin off and a profitable access business that still throws off a tremendous amount of cash. I can check both of those boxes. I am done, and I feel good about what we've accomplished," Falco said in an interview conducted prior to Thursday's shakeup. Falco could not be reached for comment following AOL's announcement.

"When I arrived, the Web business was losing hundreds of millions of dollars. It now makes money. The margin has gone from negative 20% to plus 20% in two years. The access business margin has gone from 43% to 80%. We eliminated 50 content products on the way to creating more than 100 micro sites under the new umbrella of MediaGlow while growing the audience for the key verticals more than 30%," Falco said.

Amid claims Time Warner overpaid when it acquired Bebo for $850 million, the social networking site has become the center of a new Peoples Network integrating AIM and other AOL communications, "which is what other companies like Facebook are struggling to do," Falco said. The transformation of the Internet's first prominent portal into "a low-cost Web content company made up of publishing, video, social" has been undermined by AOL's own toxic history and brand name. "No matter what we accomplish here, all the press and analysts can think about is how AOL's merger with Time Warner in 2001 was the worst in history," he said.

Although mention of the AOL name, which may yet be changed, on the new content sites have been minimized, Falco has been helpless to ameliorate the devastating impact of the worst economic crisis of his generation.

"I have tried everything and taken a lot of chances here, which is the only way you can manage through change. I have been willing to make the changes and the tough decisions amid all the criticism," he said.

"No one appreciates how profound a change it is to take a company and completely re-pivot this way, from a subscription business into an ad-supported Web business. It requires an awful lot of moving parts. I would have loved to have sat pat. But we had to be bold. We had to take big swings at things, some of which didn't work," Falco conceded. "We have found ourselves in a completely different marketplace than we were two years ago."

AOL's efforts to differentiate itself with new behavioral marketing and measurement tools that provide advertisers with ROI and scale have been lost in the turmoil of trying to revamp its advertising business under the moniker of Platform A. Although AOL had secured twice as many upfront advertising dollars heading into 2009 and its new approach is gaining traction in new customized deals with advertisers such as Visa and Sears, the recent focus has been on the Internet company's greater than expected 20% decline in sales to $4.2 billion and its $1.1 billion operating loss in 2008. Much of it is an inevitable byproduct of shutting down the subscription business and trying to accelerate advertising income to offset those losses against the tide of a protracted financial crisis.

As AOL places more emphasis on branded premium display advertising and the economy begins recovering sometime next year, "everything else will fall into place," Falco predicted.

Falco said in better times, there will be a pay-off from building low-cost variable content sites, which he calls "the future of this business," and from aggressively having sales and content executives making combined calls on marketers and agencies to sell the benefits of customized niche (lifestyle, sports, personal finance) connections to consumers - a technique he employed as co-COO at NBC Universal. "Those efforts to lean into media's fragmentation will eventually be profitable," he said.

Before Thursday's shuffle, Falco was planning to embark on more agency-supported original webisodes (like "Sophie's Diary" on Bebo) and a round of grassroots entrepreneurial content from expert bloggers armed with video and other inexpensive, available applications.

"We have been making progress. The changes are starting to resonate with our customers - our new audience, as well as with agencies, advertisers and buying groups. Now AOL just need to go out and tell its story," he said.

Even his successor Tim Armstrong, who has been instrumental in growing Google into an advertising powerhouse, acknowledges AOL "has done a nice job of growing traffic. They are in a position to be a major player in all types of Internet-based advertising," Armstrong told the press late Thursday. Just this week, Google announced a major shift to behavioral advertising - connecting with consumers on the basis of their interests and traceable Web site visits - which is not unlike Platform A's new strategy. AOL is the fourth largest Web site behind Google, Yahoo and Microsoft, attracting 108.4 million unique visitors, according to comScore.

Barclays Capital analyst Douglas Anmuth said that while AOL's page views increased 14% last quarter, overall ad revenue dropped 6% and display ads at AOL's own sites dropped 15.4%. "Monetization of guaranteed inventory and challenges around Platform A continue to be an issue," said Anmuth, who projects AOL's ad revenue will decline at least 4% in 2009.

In a research note released Thursday morning, Pali Capital analyst Richard Greenfield continued his pounding of Falco and AOL President-COO Ron Grant as "spinning a turnaround story" and a strategy of "simply continuing to throw whatever they can find against the wall, in hopes that something sticks." Among other things, he faults them for the "serious mistake" of focusing on ad networks versus premium display advertising.

On the other hand, if the new three-pronged foundation (Platform A advertising, People Networks socializing and MediaGlow content) Falco has put in place actually works, Armstrong and Bewkes will reap the benefits on their watch.

Even as well regarded a Googler as he is, when Armstrong takes over for Falco April 7, he will wrestle with the same demons Falco did. In the end, Armstrong may build on what he inherits to explore "the right structure and future for AOL," as he told reporters Thursday.

Some on Wall Street believe Armstrong has assumed the job with a promise that AOL soon will be spun off into a separately traded public company, which eventually makes it easier to merge with or be sold to yet another entity. That would leave Time Warner as a pure content company, which is Bewkes ' ultimate plan for the company. That will involve the tricky business of Time Warner moving away from its dependency on the declining revenues of AOL's access business. Amid the recessionary obstacles, Armstrong's first challenges will include dealing with Google, which recently wrote down its 5% investment in AOL (now worth half the initial $1 billion investment it made) and negotiating to renew its search agreement with the company. Armstrong's appointment could be a precursor to Google acquiring AOL, some say. Alternatively securing a search deal with Yahoo or Microsoft instead could lead to alignment with those companies.

Bewkes' dilemma is more how to move AOL off of Time Warner's books. While Bewkes signed off on everything Falco did to transform AOL, "he might not have the energy and patience to stick with it," says an AOL executive. There is no getting around the legacy costs and operations Falco and Bewkes have been saddled with at AOL - more baggage from the 2001 AOL-Time Warner merger that institutional shareholders complain destroyed $100 billion worth of value.

Smart money on Wall Street says AOL, Yahoo and Microsoft eventually will merge their search businesses and Microsoft would take an equity ownership stake. Time Warner will have $9 billion in proceeds from its cable systems spin off to pay off debt, buy its own stock and acquire more cable networks - perhaps by acquiring NBCU for $20 billion-plus and getting the NBC TV Network off balance sheet or operating it as a dual-revenue super cable network.

Does it bother Falco that he may never get credit for what still could go right at AOL?

"It bothers me, of course. But it bothers me more for the people at AOL who have worked so hard and stuck with it to turn it around, and taken all the pain that comes from being part of a turn around. If they don't get their due, it's not fair," he said.

And what will he do next?

"I don't think there are too many traditional media guys who really understood what the new digital media is about. Having spent two years at AOL, I would love to be able to go back to that industry knowing what I know, and I think I would be able to help the traditional media side to better understand what is coming at them, how to deal with it. There are a lot of misconceptions about what to do about digital media."

Asked whether he would ever return to NBC Universal to apply his AOL experience, Falco answered, "I don't know that you can ever go back."