A Kinder, Humbler AOL?

Oh, how the mighty…

When it comes to media coverage of the Internet lately, nothing succeeds like failure. The recent troubles at AOL Time Warner’s America Online unit are too luscious for financial journalists to miss — the perfect denouement in this ongoing pride-before-the-fall story that is the Internet.

Once seen as the centerpiece and driving force behind the biggest media merger in history, the sinew that would entwine all of the conglomerate’s properties and synergize them into the age of digital convergence, AOL suddenly became the company’s problem child this spring. Ad and commerce revenues at the online giant were off an unexpected 31% in the first quarter. The hoped-for expansion into high-speed services seems stalled, and even the rate of new member growth is slowing.

Some investors jerked their knees at the latest earnings reports and even suggested that the parent cut this upstart child off, spin it back out as an independent company, and essentially nullify the merger. As with much of the press, the attitude on Wall Street seems to be, let’s just pretend the Internet never happened.



To be sure, AOL’s challenges in the coming months and years are real. In this post-Enron period of corporate candor, incoming corporate CEO Richard Parsons admitted to investors, “Online advertising is a disappointment.” He estimates that revenues for the unit in 2002 will be between $1.8 billion and $2.2 billion, down significantly from $2.7 billion in 2001.

Even AOL/TW’s COO Robert Pittman, now AOL’s CEO, addresses bluntly the need to get “AOL back on track” to become again “the growth engine and innovation center” of the conglomerate.

Our New Best Buddy

Curiously, amidst all of the hand-wringing, AOL’s biggest defenders now come from the advertising community, the one group that the online giant had dissed for years. Echoing many industry executives, Jason Burnham, president and media director at Mass Transit Interactive, says, “They’ve improved 1000%.”

For much of its life, AOL was less about traditional advertising than it was about massive business development deals: co-marketing and content carriage agreements with the big manufacturing brands, overhyped dot-coms, and media companies. It tended to like big clients with whom it dealt directly, and thus had little use for the agency structure and bread-and-butter ad sales.

Recession and the dot-com crash have left those partners unable or unwilling to renew the multimillion-dollar deals of old, so AOL is turning to the ad agencies, apparently in a big way, because this is where its long-term revenue stream lies.

“In the last six months, I have seen a real mentality shift in general,” says Maggie Boyer, VP of media at Avenue A. Much of it has to do with AOL’s specific effort to woo ad agencies, an effort led by John Messina.

“John Messina was the best thing that happened over there,” says Burnham.

“He’s a great guy,” says Mark Mirsky, media director, Tribal DDB North America.

“John’s great,” says Boyer.

Talk to enough agency folks and this starts sounding like a lost episode of Seinfeld, with AOL as the Soup Nazi who suddenly discovers customer relationship management. While AOL did not respond to our request for executive interviews, media buyers praise Messina’s agency relations group at AOL for initiating systemic changes over the past six to nine months. In a complete turnaround from earlier practices, some AOL properties now accept third-party ad serving, and the company seems more willing to resolve measurement discrepancies and even cooperate in pre- and post-campaign analysis, says Mirsky. Boyer finds AOL more amenable to campaign optimization and competitive pricing. It is also agreeing to traditional sequential liability, recognizing that the advertiser, not the agency, is ultimately responsible for making payment.

Imagine the Soup Nazi offering patrons a second packet of crackers — the change has been that dramatic to agencies that used to avoid AOL unless a client specifically requested placement. “For the first time we can honestly say that we like working with AOL,” says Boyer.

Which is not to say that AOL has lost all of its 800-pound-gorilla characteristics. Substantial obstacles to an easy media buy persist, and agencies continue to complain that the service remains cagey about its audience composition and activity. “At some point the advertising community wants them to be a straightforward media company,” says Gartner Research director Denise Garcia. “They don’t have a published rate card. It’s that straightforward face that they haven’t put on very well.”

Nevertheless, media buyers seem to think that finally, after all of these years, America Online is seeing itself as a media company, one whose fortunes will rise and fall on traditional advertising revenue, not on outsized biz-dev deals. Parsons himself claims that the key to restoring AOL as the driver of corporate growth is to turn the corner on online ad revenues. A wave of executive shifts in April shows that AOL is not relying on young turks of the dot-com era so much as tested capos, made media guys. In addition to bringing back Pittman, who returns to the scene of his greatest success as CEO, the company tapped Jimmy de Castro, a 25-year radio industry vet (Evergreen and Chancellor Media) to become president of AOL Interactive Services. Bob Sherman, former CEO of Della Femina, was made president, interactive marketing. In announcing the appointments, Pittman himself signaled that they were aimed at deepening AOL’s new best buddy, Madison Avenue. “We will have a seasoned team to accelerate our efforts to reach advertisers ands agencies and work with them to fully capitalize on our relationship with our 34 million members,” Pittman said in a statement.

Changing the Story

Ironically, it is that massive subscriber pool — 26.1 million of whom are U.S. swimmers — that could be the company’s Achilles’ heel. “Being the biggest isn’t a bad thing,” says Mirsky, “but it isn’t the only thing they should be relying on.” Making nice with agencies is all well and good for getting onto clients’ media buy short lists, but even a kinder, humbler AOL needs to get smarter about how it moves from mass to niche marketing. With Internet penetration in the U.S. well above 60% by most counts, and direct competitors Yahoo! and MSN attracting similarly sized crowds, AOL’s audience reach is no longer a unique or even a compelling story for many buyers. “Advertisers are realizing they can create a media buy with mass reach without AOL,” says Garcia.

More to the point, the company’s story has to change. When the Web was young, reach was the favorite fable, but now that it has matured into a mass medium, buyers crave the more intricate tale of targeting and frequency. In order to compete in the next stage of online marketing, AOL is going to have to slice, dice, and serve its audience segments to advertisers much more effectively than it has. That may prove to be an expensive technical hurdle for the service. Weird as it sounds, the leading online provider still doesn’t cookie its members or personalize the user experience. To its credit, AOL did form the Vertical Markets Group last summer to exploit niches more effectively, and some buyers say that they have been putting together more customized packages lately, especially those targeted to the financial sector. Still and all, “AOL is very limited in its targeting capabilities,” says Burnham.

The Cable Key

For all of the internal tweaks and positive moves on the ad front, AOL’s ultimate fate still may rest with the parent company, particularly how it handles the Time Warner cable business. AOL/TW is hoping for a domino effect. Cable means broadband and broadband may represent a cure for many AOL ills: slowing subscriber growth, wavering subscriber loyalty, unrealized cross-platform synergies, and waning ad revenues. All the corporate brass admit frustration with the slow pace of converting AOL users to high-speed access. Only about 4 million members use the broadband content, Forrester says, and most of them are paying another ISP, not Time Warner Cable, those higher access fees. Parsons told a recent media conference that other cable providers resist carrying AOL’s high-speed service because they fear it will cannibalize sales of their own cable access brand. He wants to convince his competitors that AOL “can get deeper and faster penetration of broadband offerings” than they can. “It hasn’t happened,” he says. “The cable industry are not innovative marketers.” Many suggest that AOL/TW should spin the cable business off for an IPO, which could fund expansion and partnerships, but Parsons remains mum on that one.

Everyone does seem to agree on the importance of broadband to AOL’s future, however, especially as a viable ad platform. Dial-up subscription growth at the service slowed 9% in 2001, and unless AOL can grab a larger share of the crowds now flocking to broadband ISPs, “disaster looms,” says Forrester analyst Charlene Li, because “subscriber fees make up 75% of AOL revenues.” And the ad clients, who contribute much of the rest, are also looking for fatter pipes, say the agencies. Old-economy advertisers like packaged goods manufacturers and auto companies are falling in love with emerging rich media ad formats. Proctor & Gamble, GM, Verizon, AstraZeneca, and State Farm were among the top rich media ad buyers in Q1 2002. These formats have more impact and often are less intrusive than pop-ups. Financial and tech sites, which often get the majority of their daytime traffic from high-speed office users, are already grabbing this first wave of rich media spending, and agencies are confident that the proliferation of fatter pipes will bring online ad spending to the next level. “I think it will change things significantly,” says Mirsky. “We’re going to see digital advertising as we know it in a different light.” AOL risks languishing in the shadows of this new light if it can’t get the member base converted to broadband.

Like the Web, Only Different

As an ad seller, AOL needs to look and feel more like the rest of the Internet, but as a content provider the company is likely to come under increasing pressure to differentiate itself. In order to ensure value to advertisers and prevent leakage of users to other broadband ISPs, AOL must keep the flock within its walled garden of offerings. The service says that its members’ online time, now an average of 71 minutes a day, continues to rise. Less clear is how much of that time users spend within AOL’s own proprietary space and how much they are passing through the site links to the many content partners or just the Web at large. In either case, whenever subscribers go off the reservation, someone other than AOL probably is reaping the ad benefits.

Parsons assures investors that AOL will start making better use of Time Warner’s own magazine and film properties within the service, especially rich media assets that could differentiate its high-speed services. Previews of the next Harry Potter film trailer or a free downloadable music track from a Warners’ artist are the obvious sorts of value-adds the company is rumored to be considering. This could be critical, because as Microsoft’s MSN continues to gain subscribers and Comcast quickly becomes the largest cable provider in the country, prospects improve for a genuine ISP war. Many analysts feel that AOL’s subscriber base is susceptible to being picked off by competitors, which is why Pittman is said to be emphasizing customer satisfaction in the coming months.

Much as agencies may welcome AOL’s entry into their world, a more ad-friendly AOL could pose even more business complications for the company. From the time AOL and Time Warner began merger plans, the service bent over backward to reassure its own content partners that AOL would not become a house organ for Time Warner properties. CNN links would not overwhelm news anchor tenant CBS News, nor would Sports Illustrated nudge Sportsline out of bounds on the sports channel. The pitch was that AOL is an open platform for multiple brands, more a portal than a destination. Some media partners are happy to say that while AOL has more reach, it has only a fraction of the hang time of the content providers it passes audiences on to. If that tune changes and AOL comes to rely more on Time Warner properties, the landlord may have a houseful of disgruntled tenants. As it is, publishers are wondering about the prospect of going head-to-head against their supposed partner for the same ad clients. “As a content provider our biggest challenge is the conflict of interest created by AOL saying they are an aggregator and a portal while they are out there competing for ad dollars as a destination. A day of reckoning has to come there,” says Andrew Sturner, president of corporate and business development, Sportsline.

At Long Last, Synergy?

If indeed AOL’s future rebound is so entwined with the parent company’s cable and content assets, then recent suggestions that the online unit spin back off from the conglomerate are as silly as they sound. “That’s Wall Street talking,” says Gartner’s Garcia. “That’s not strategic planning.”

There was a day when Wall Street investors were the strategic thinkers, but in the case of AOL/TW that mantle has fallen, oddly enough, to Madison Avenue, much of which continues to support the long-range media picture this merger represents. Of course, there is a lot less talk about cross-platform ad sales synergy nowadays, and for good reason. According to Gartner’s research, only 5% of AOL’s ad base in 2001 represented integrated media buys. It is likely that online/print/cable packages will be powerful someday, says Boyer, but the ad industry’s own infrastructure just isn’t ready to execute the synergy dream. “Not enough marketers have fully integrated their strategies,” she finds. “There hasn’t been pressure on AOL to develop cross-channel [campaigns].”

And AOL/TW itself would just as soon take people’s eyes off of “synergy” and point them farther downfield to “convergence” — how the conglomerate’s print, music, film, TV, and online properties begin to merge more seamlessly within emerging digital technologies. Steve Case, chairman, AOL/TW, recently told Fortune that “the merger was never about cross-divisional promotion. It was about cross-divisional innovation.”

“Innovation.” That’s the big, vague, futuristic promise Bill Gates carts out when Senate subcommittees and prosecutors try to second-guess Microsoft strategy, and for the time being it seems to have legs among agencies who are looking to AOL/TW to lead us into the digital promised land. “In the long term, 10 or 20 years down the road, being aligned with AOL is going to benefit [Time Warner] when it comes to digital convergence,” says Burnham.

If the Internet crash and the deepest ad recession in recent memory have taught us one thing, it is to be cautiously optimistic about the future of media but doggedly imprecise about the exact form it will take. Even Parsons admits that the pieces of his puzzle have yet to jell, although clearly AOL itself is a key part of it. The sheer scale of the AOL/TW holdings continue to work in its favor, because most company watchers find it inconceivable that such a trove of content and technology assets will not be at the center of a media convergence future. As Boyer speculates, “If anyone is going to make it happen, they will. And they will have the first-to-market benefit there.”

Now all the company has to do is figure out where “there” is.

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