The company responsible for introducing millions of people to the Internet is poised to undergo a transformation that would likely accelerate its decline as a gatekeeper of access to the information superhighway.
Time Warner Inc.'s board is expected to review on Thursday a proposal for its AOL LLC online unit to free up even more services, likely including the vaunted AOL.com e-mail accounts, in hopes of boosting advertising.
The strategy is risky: Millions of customers would likely drop their paid subscriptions, and AOL would lose hundreds of millions of dollars a year, perhaps even a billion or more, for the promise of an advertising payoff some time in the future.
But AOL has little choice. Its subscription business will keep eroding regardless. Internet advertising, meanwhile, is booming industrywide, and opportunities abound with ad-supported online video, where AOL is strong.
"It's a risky game they're playing, but it would be riskier not to play," said David Hallerman, a senior analyst with research company eMarketer Inc.
AOL got its start in 1985 as a provider of a proprietary online service, then known as Q-Link. Though it gradually allowed users to venture off to the public Internet, AOL tried its best to keep users within its walled gardens filled with exclusive articles, chat rooms and other features.
Millions of Americans got their first taste of e-mail, the Web and instant messaging through discs that continually arrived in mailboxes unsolicited.
To many users, AOL was the Internet.
But most people connected then via telephone dial-up modems.
As Americans turned to cable and phone companies for high-speed service, they saw less need to pay AOL simply for the exclusive content, even as the company offered discounts for those who didn't need unlimited dial-up access — currently $11 off the $26 monthly fee.
After peaking in September 2002 with 26.7 million U.S. customers, AOL's subscription base plummeted 30 percent, to 18.6 million in March.
Fewer Americans want dial-up
It's still the largest Internet service provider, but AOL faces the reality that fewer and fewer Americans want dial-up. Roughly two-thirds of AOL's subscribers are on dial-up plans, while nearly two-thirds of U.S. Internet users have broadband at home.
Over the past year and a half, AOL has aggressively moved most of its content — news, music videos, chat rooms — to free, ad-supported Web sites. Last year, ad revenues grew 33 percent, even as subscription revenues declined by 10 percent.
However, the company kept AOL.com e-mail a premium offering, giving free accounts only with less-desirable AIM.com addresses. Many subscribers hung on, but over time found the free offerings from Yahoo Inc., Microsoft Corp. and Google Inc. too sweet to resist.
AOL's proprietary software for checking e-mail, among other things, became even less of a draw as its rivals made their Web-based tools richer and easier to use.
"Just about everything AOL offers, you can get free from Google, Microsoft or somewhere else," said Dave Burstein, editor of the industry newsletter DSL Prime. "How long are people going to pay for that?"
Free e-mail is particularly important because the service is used often and regularly. As users check e-mail on an ad-supported Web page, Hallerman said, they may stumble upon a video or other content, boosting AOL's ad opportunities.
Keeping users on the paid service merely risks sacrificing those opportunities forever, said Jeff Lanctot, general manager of aQuantive Inc.'s Avenue A/Razorfish, an online advertising agency that places some ads on AOL sites.
"AOL is recognizing that over time, a larger and larger customer segment will in fact leave the (AOL) nest and like what they find" elsewhere, Lanctot said.
Two years ago, Bryan Chin, 27, discovered Google's Gmail, a free e-mail service he found easier to use. He kept his AOL account because not everyone has his new address yet, but he doesn't believe he'll ever switch back even if AOL is entirely free.
"If it has all the same features that I am still using AOL for, I don't know why I would still use AOL," said Chin, an entertainment writer in New York.
Company hopes to prevent further defections
The thinking behind AOL's latest strategy proposal is to prevent further defections and keep users within the AOL family whether they are a paid subscriber or not.
It's not clear what else might become free. It's possible AOL would charge separately for parental control and security software, so users wouldn't need the entire subscription package simply for those programs.
AOL officials would not comment for this story.
Investors, who have seen Time Warner stock prices hovering near its 52-week low, eagerly await details, which Time Warner plans to issue Aug. 2.
"The market's highly suspect," said Scott Benesch, head of stock research at the investment firm U.S. Trust. "We're not sure that you're able to reduce costs at the same rate, if not faster, than revenues decline in the dial-up (subscription) business."
Subscriptions still account for about 80 percent of AOL's revenues. The unit is profitable and contributed to 19 percent of Time Warner's revenues last year. Still, that's down from 24 percent in 2002.
Despite his doubts, Benesch acknowledged the latest proposal is something AOL should have considered even sooner.
If adopted, the new plan likely would result in a curtailment of subscriber retention efforts, which have been criticized for being too aggressive. It also could mean fewer television ads encouraging people to sign up — and perhaps an end to those promotional disks.
Layoffs would be likely, on top of the thousands already let go in recent years, including about 1,300 customer-service personnel given pink slips in May.
Allen Weiner, a Gartner research analyst, said AOL could benefit from focusing on one rather than two potentially competing businesses. Although Yahoo and AOL have bought several startups recently, Weiner said Yahoo has been quicker and nimbler at integrating their technologies.
The number of unique U.S. visitors to AOL sites has remained steady, while its three chief rivals all saw gains in June, according to Nielsen/NetRatings. And comScore Media Metrix found that in June, pages viewed at the main AOL sites — by subscribers and free users — dropped 44 percent, while Yahoo increased 23 percent.
AOL officials have said they've been trying to shore up the basic Web portal offerings, having had a late start, to put the company in a position to make gains with emerging features like online video.
Although it faces stiff competition from the major portals and startups like YouTube Inc., AOL can potentially tap the archives of other Time Warner units, as it already has with old Warner Bros. TV shows.
AOL also can take advantage of Google's recent $1 billion investment. As part of the deal, Google would help ensure that AOL's video and other hard-to-index materials find their way into Google's search results, though it won't give AOL preferential treatment.
"The real value to AOL in the future — if it has a value — is as an advertising and marketing platform," said Morris Mark, managing partner of Mark Asset Management LLC, a Time Warner shareholder. "Google did not make a 5 percent investment in the company out of charity."