Are there Limits to "Unlimited" Service?

It must have seemed like a good idea at the time. America Online, the world's largest Internet service provider, announced it would change its U.S. subscriber rates. Instead of paying $9.95 for five hours of free online use, and $2.99 for each additional hour, subscribers would get unlimited time on the service for $19.95.

For high-volume users especially, it sounded like a gift. Then came the bad news. A San Francisco television station first reported what AOL users already knew: since the new pricing structure, it had become decidedly more difficult logging onto the system, and once you got on, you might get booted off. Calling customer service often meant waiting long periods of time: a friend reported a 50 minute wait one afternoon. Reporter Tom Vacar of television station KTVU invited AOL subscribers to write him about their experiences, and promised to forward all letters to AOL. And soon, news outlets from one end of the country to the other were reporting about AOL's travails. It was--and in many ways still is--a textbook public relations disaster. So much bad publicity did AOL receive that during the much-watched Super Bowl football game, rival CompuServe ran an ad that featured a blank screen and a busy signal. The ad never mentioned AOL, but it wasn't hard to guess who CompuServe had in mind.

AOL's response to all of this was quick, but not always sure- footed. It said that it simply didn't anticipate the amount of usage that the rate change would generate, and it promised to remedy the situation by adding thousands of additional modems and more support personnel over time. AOL chairman Steve Case didn't need reporters to tell him the problem. He himself experience delays trying to log onto the system, and at one point asked subscribers to "try to show some restraint" during peak hours--a request that only infuriated the subscriber base even more. After all, they were offered unlimited service--and unlimited means 24 hours a day if you are so inclined.

The following January, 36 state attorneys general meeting in Chicago threatened to sue America Online for breach of contract. "Someone turned on the TV in my office and CNN was breaking in live to the press conference in Chicago with the attorneys general," Case told Time Magazine. "They were treating it like it was a verdict in the O.J. Simpson trial."

At this writing, the company has committed to a $350 million upgrade program, including increasing its 200,000 modem pool by 75 percent. It has also pledged to add 600 additional support personnel, bringing staffing up to 4500. But such a massive expansion could not be done overnight, and in the meantime, AOL has stated publicly that it hopes its customer base will hang in there.

To avert action by the state prosecutors, AOL agreed to hold its subscriber base at its current level. Many thought that meant a temporary end to AOL advertising, but some advertisements still continued, as well as mailings of AOL's ubiquitous software disks. The company said that it was merely using new sign-ups to offset cancellations, but did not provide numbers on whether that was true. One judge, in Seattle, Washington, actually barred AOL from recruiting new customers in the state until it made changes to the system.

In addition, there have been several class action lawsuits. One of them, filed in Los Angeles by four California residents, seeks damages of more than $100 million for what it claimed was racketeering, mail fraud and wire fraud with regard to its customer services and its stock. AOL has called the lawsuit frivolous.

It is, of course, impossible to determine whether AOL was truly surprised by the rising usage or whether it simply knew it had to change its rates--whatever the consequences. What is certain is that AOL and its competitors are walking a tightrope. Every ISP on the planet is grappling with three sometimes conflicting challenges: how to add subscribers, be profitable, and still have the resources to keep these subscribers happy.

Any ISP can succeed at one of these points, and many ISPs have succeeded at two of them. But as the largest ISP, AOL is provides a vivid example of just how difficult it is to score a perfect three.

Is bigger better? Gaining market share

It is an unproven, but widely assumed tenet of the Internet business that you either add to your customer base, or you die. In theory, at least, you should be able to double your subscriber base without doubling your expenses. Hence, the conventional wisdom is that a few big Internet service providers will eventually dominate the industry. That means you either attract more subscribers and grow, or risk being wiped out by a stronger competitor.

That's conventional wisdom. Unconventional wisdom has it that small ISPs, both in the U.S. and Japan, can survive. Bruce Hahne, an American in Japan who left Mitsubishi Electric to help start the ISP, Global OnLine Japan K.K, maintains that service, not size, will be the bottom line for survival. "Providing the hand-holding necessary to get the newbies up and running with their first Internet connection is tough, time-consuming, and not something that the big boys necessarily want to deal with," he wrote in an essay that has been circulating in e-mail. "After all, there are an awful lot of newbies out there, and sometimes they can be a real pain to teach. If you can maintain a strong reputation for personal service in your local area, and keep your overhead costs down [and meet demands for higher bandwidth], I think there's a future for you."

In any case, size is one thing AOL does not have to worry about. In just three years, the company grew from 50,000 subscribers to seven million--a remarkable feat. With its move to a flat fee, the company added a half a million additional subscribers in just four weeks and doubled the usage from their existing client base. Today, AOL has eight million subscribers, with its sights set on 10 million. Besides the above-mentioned upgrades, the company has broken ground on its third data center, doubling the amount square- footage dedicated to AOL host systems. The company also set its sights on Japan with a Japanese-language Internet service in partnership with the Nihon Keizai Shimbun newspaper and Mitsui and Co. (In Japan, its flat rate scheme will be conspicuously absent. Rates will be 980 yen for three hours of use, plus 480 yen for each additional hour.)

AOL's size has also allowed it to offer its customers more services and a friendlier interface than its smaller competitors--like chat rooms and specialized forums. AOL is challenged only by CompuServe and Microsoft Networks on this front. Other ISPs deliver you the Internet, and nothing more.

Finding a pricing scheme that will turn a profit

But stock prices are about speculating the future. In AOL's second fiscal quarter, the company had a loss of $154.8 million. Even when you factor out one-time "restructuring " charges of $74.3, and another $24 million on credits and refunds related to its settlements with the attorneys general, AOL is still running at a loss.

"We're at eight million subscribers. We get a $20 subscription fee from each of them and we're just breaking even," AOL's network's president and chief operating officer, Bob Pittman, told the Associated Press. "What does that tell you about someone with half a million subscribers?"

AOL's pricing travails point to a larger problem for Internet service providers--how much online time can you give to subscribers and still make a profit? At this stage of the Internet game the answer appears to be this: Either you must redefine what "unlimited" time really means, or you must ask your subscribers to pony up more money, or you must use your subscriber base as a lure to attract more subscribers.

By the time AOL converted to its $19.95 monthly flat fee, that figure had already become the standard fee for Internet services in the U.S. after it was widely established by AT&T's Worldnet, and later by the Microsoft Network. But there is increasing suspicion in the industry that the $19.95 pricing scheme is not a sustainable model, but rather a loss leader to attract new customers. And some companies are experimenting with other pricing schemes in hopes of finding a better model.

While AOL seems committed to its flat fee, it has begun looking for ways to augment that fee through advertising revenues. Last March, for example, the company announced it would put ads in the chat rooms--the realtime discussion groups that are among the most popular parts of its service.

For the company, advertising is a largely untapped source of revenues: at present, only about four percent of its screens have it. And ironically, increase advertising will mean that AOL has come full circle. Once upon a time, AOL competitor Prodigy filled a substantial amount of the screen with advertisements but offered subscribers unlimited use. When that pricing model failed and Prodigy went to hourly rates, it lost many subscribers. CompuServe, too, had offered unlimited rates, not for Internet access, but at least for a core of standard services. And it, too, abandoned that plan and modeled its pricing scheme after AOL. So now we find AOL, which had put its ads on less than four percent of its screens, once again looking to generate revenues through advertising and in some ways recreate the very pricing schemes that Prodigy abandoned.

But there are some important differences. For one thing, bandwidth has increased so that the painful screen refreshes that Prodigy users experienced will be shorter. The ads in the chat room will cover about two and a half inches in the upper right hand corner of the screen, and will change every minute. Moreover, advertisers can show up to four different ads in a single space. Click on an ad and you go to the advertiser's Web site, or to a content area on AOL. For advertisers, this might well be a deal. Nearly 75 percent of AOL subscribers enter the chat rooms each day and spend about a million hours in discussion.

The real juggling act: keeping subscribers happy

At one point in its public relations debacle, AOL tried to put a happy face on the situation by expressing gratification that so many of its customers considered its service worthwhile. And there can be no question about that, except that it applies not just to AOL, but to Internet connectivity in general. In the United States, for many businesses, Internet connectivity has gone from a hobby to a lifeline--as critical to maintaining a connection with the outside world as the telephone is. And just as telephone subscribers expect to hear a dial tone every time they pick up the handset, Internet subscribers are increasingly expecting to be connected the first time and every time, and stay connected until they log off. With the advent of electronic commerce, those expectations have to do with cold cash. Electronic mail has become a way to correspond with customers, and Web sites are being used to sell products.

Thus, ISPs must not only figure out whether they can sustain a $19.95 flat fee, but whether they can attract more income by delivering better service. Think of airline service, in which most people settle for coach service while a few people fly first class. Many ISPs are at least considering offering premium Internet service for a premium price. And one ISP, Netcom, is actually giving it a try.

"The ISP industry continues to be challenged by the harsh economics that inevitably plague the $19.95 unlimited access, unlimited usage and quality business model," Netcom said in an online FAQ. Citing data from its own customer survey, the company is targeted at business customers--with a guaranteed 95 percent average network dial-up availability for a higher monthly flat fee--$24.95 and up. The company says that the higher fees will buy additional e-mail addresses, faster customer response, and, if you pay enough, 95 percent reliability.

And what about customers still traveling in coach? Netcom says that it currently delivers reliability in the mid-80 percent range, and believes that number will go up with the institution of what it calls a "Fair Use " policy. This policy goes after the three percent of its users that consume a disproportionate amount of time by staying online continuously. "During peak usage times, customers with extraordinarily high usage rates may be given lower priority access over the vast majority of customers," the company said in a press statement. "Netcom will work with its extremely heavy usage customers to find alternative Internet solutions that better meet their on-line needs." That's a polite way of saying that if you abuse the system, you may be asked to leave; it is a kind of limit on an otherwise "unlimited" online policy. Some other ISPs have achieved the same outcome by giving users a large number of monthly hours, then charging on a per-hour basis if that limit is surpassed.

And while most Internet customers will at least want to fly coach, a few may prefer to take the bus. For them, there are now cut-rate services that paint your screen with advertising, but offer a substantial discount for doing so. For example, Cyber FreeWay offers a one-time sign-on fee of $29.95 that is waived for the first month of use. Subscribers receive advertisements through a secondary on-screen window--viewed through Hyper Net--provided by Hyper Net USA, a wholly-owned subsidiary of the Tokyo-based Hyper Net Inc--which works with the user's own browser. The ads cover about an inch on the right side of the screen and changes about once every minute. Cyber FreeWay Web sites currently cover the San Francisco Bay Area, and the company has plans to take its service state- wide.

Another service, called Juno, provides e-mail service--again with advertisements. "Juno charges no monthly fees, no hourly fees, no membership fees, no per-message fees, and no fees of any other sort," says the company on its Web site. "Our sponsors pay, so you don't have to.

"And, unlike other online services, Juno's free offer doesn't go away after five hours or ten hours or sixty hours, and it isn't contingent on your buying anything. It's not a free trial. It's free, period."

What do you expect?

In the end, the dilemma facing all ISPs is balancing rising user expectations against the rising costs those expectations incur. Here again, a transportation analogy is very apt. Not that long ago, it would have been considered a miracle to fly from Tokyo to California. Now, jet travelers take that technological feat for granted and complain about long lines, cramped seats and bad airline food--while shopping for the best price they can get.

Similarly, when I first started experimenting with this medium, I took it for granted that I would not always be able to get through--that my e-mail might be delayed or a Web site might be unreachable. But that the end results were so miraculous, I would gladly put up with a few glitches

Now, a few years later, I--like everyone else--complain about slow downloads and busy signals. I want my Internet connection to be as reliable as the sun's rise in the morning, and I find myself shouting at the monitor when things go wrong. What was a miracle of technology is now a routine part of my working life--an extension of my senses, a link with my friends and business associates, an invaluable research tool, a source of information, and occasionally, enlightenment.

I *need* the Internet, or at least I think I do--but like everyone else, I don't want to pay any more for Internet connectivity than I have to. Call me a fickle customer--but there are millions more like me--and billions more waiting in the wings. In the long run, the game will go to those ISPs who deliver business quality service--not infallible, but reasonably good--at the lowest possible price.