America Online's Rapid Rise

It's the Hottest Player in Dial-Up Computer Services, But Stiff Competition Looms

by Daniel Southerland

Monday, November 8, 1993

Paul and Roberta Chesney "met" on America Online's computer network and made friends through the electronic connection with many who later came to their wedding.

"We found our best man on-line," said Roberta, 48. She was working in Manhattan five years ago when she first began swapping messages with Paul, 45, in Northern Virginia. Today both work in the customer services department at America Online Inc.'s headquarters in Vienna.

"We've got 40 good, close friends on-line," Roberta said.

Matchmaking is not on its list of dial-up services, but America Online's other offerings -- combined with its attractive prices -- have made it the hottest player in the commercial on-line business. It provides news, weather reports, stock quotes, electronic mail and other services via a personal computer and modem.

America Online's subscriber base is growing more rapidly than its rivals', and the company's stock price has doubled since the beginning of the year. Analysts said that even with fewer resources, America Online, or AOL, has made its services easier to use than those of the principal competitor it has targeted, Prodigy Services Co. of White Plains, N.Y.

AOL, with 300 employees, has formed alliances with more than 30 other companies. It is "hipper, cooler, and faster on its feet" than its rivals, said Joshua M. Harris of the New York research firm Jupiter Communications. But AOL's rapid growth is creating some new problems, and its competition is likely to get tougher as early as next year, according to industry analysts. Users say AOL's system seems overloaded and its response to computer commands has become much slower in recent months. The company said it is rewriting its software to handle the increased load.

On another front, Prodigy is taking steps to halt some of its losses to AOL. It is expected to launch some new features in coming weeks.

Most important, perhaps, powerful companies such as Microsoft Corp. are expected eventually to enter the commercial on-line market. One possible result is that America Online could become the target of a takeover, said Gary Arlen, president of Arlen Communications, a research firm in Bethesda.

As Stephen M. Case, AOL's president and chief executive, has acknowledged, the on-line market has become "too big of an opportunity" for big companies to ignore.

Jupiter's Harris said in a recent report that today's on-line players are unlikely to maintain their dominance in coming years. By the end of the decade, the report said, AOL and Prodigy "will experience both declining market share and slower annual growth rates than their newer competitors."

Jupiter expects that major media or telecommunications companies, such as Tele-Communications Inc., Time Warner Inc. or AT&T, will seize the market through investments and "an ability to bring creative marketing to an increasing range of products and services."

"The race will be to provide interactive electronic services via 'information appliances,' such as intelligent cable converter boxes, hand-held remote devices and screen-based telephones," according to the Jupiter report. For now, however, Jupiter gives AOL high ratings.

"Typically, AOL sets industry trends (low flat-rate pricing, graphical user interface, marketing and promotional techniques) which are soon followed by CompuServe."

CompuServe Inc., in Columbus, Ohio, offers a broad range of information services and may have the largest number of on-line subscribers. It claims to have 1.5 million paying accounts. By most estimates, Prodigy is No. 2 and AOL is third.

America Online's strategy has been to focus on the personal computer market, because it has the highest growth potential over the next several years. But AOL also wants to establish an early lead in new markets, such as small, hand-held personal communications devices. And the company is expanding its media alliances.

For the short term, the strategy is working.

Last month, AOL said it had added 130,000 users over a six-month period for a total of 350,000, a 59 percent jump. Prodigy, which says it has more than a million households on-line, lost as many as 5 percent of its customers during the same period, according to some analysts.

This week, AOL is expected to announce that its subscriber count has reached more than 450,000.

While the industry as a whole has been growing at a rate of more than 25 percent a year, America Online has expanded at more than 100 percent annually in terms of both subscribers and revenue. AOL recently reported that it earned $1.03 million in its fiscal first quarter ended Sept. 30, an increase of 48 percent from $696,000 a year earlier.

AOL says its superior "interactivity" -- the capacity for subscribers to share ideas and information -- has caused some of Prodigy's defections. AOL offers a "real-time chat" capability, which allows subscribers to talk directly with each other instead of through a message board, that Prodigy does not possess.

But most analysts say Prodigy's losses stem primarily from AOL's lower prices. After Prodigy imposed a price increase on its heaviest users in July this year, AOL announced a price cut.

An AOL subscriber gets up to five hours of all AOL services for $9.95 a month, while each additional hour costs $3.50. Prodigy charges $14.95 for unlimited basic service, but has extra charges for additional services, such as use of a message board.

AOL recently launched newspaper ads urging Prodigy users to "jump to America Online." At the same time, AOL created a "Prodigy Refugees Forum," an on-line gathering place where former Prodigy fans can learn the basics of AOL's services.

Prodigy is owned by International Business Machines Corp. and Sears, Roebuck and Co. Like its giant owners, it has been slow to adapt to the marketplace. AOL and CompuServe, for example, were quick to introduce versions of their systems designed to work with Microsoft's popular Windows operating system. Prodigy has yet to announce a Windows version of its service.

But Prodigy may be poised for a comeback. Scott Kurnit, Prodigy's executive vice president for marketing and development, has negotiated alliances with more than 25 cable TV networks, expanding the on-line market to include cable television subscribers. AOL has indicated it wants to move in the same direction.

Analysts estimate that Prodigy will lose about $30 million this year, but the company aims to become profitable next year.

Rick Martin, a Chicago Corp. analyst who follows the on-line companies, expects Prodigy to launch an entirely new package of services well before Christmas. The company is scheduled make some announcements tomorrow. Steve Case, James V. Kimsey, AOL's chairman, and Marc Seriff, senior vice president, founded America Online in 1985 as Quantum Computer Services. Their aim was to combine easy access and affordable pricing.

According to the magazine Microtimes, AOL differentiated itself from its competitors in key areas: a wide range of alliances with partners, including computer companies, software vendors and print publishers, and heavy investment in making the software easy to use. "Its success has been driven by its openness to outside partnerships and some aggressive marketing," the magazine said.

Analysts say that one of the company's strengths has been Case's background in marketing. Case, 35, worked for a number of years as a marketer for PepsiCo Inc. and Procter & Gamble Co.

Making alliances the key to its growth, AOL turned its first profit within two years of its founding.

In 1991 the company linked up with Tribune Co.'s Chicago Tribune newspaper. It created a news and information service for Chicago, a model that it hopes to use in other cities.

Last year, AOL announced a major deal with Apple Computer Inc., in which Apple will use America Online's technology in future on-line information services that Apple will manage and sell.

In September AOL announced it is developing the ability for consumers to use the global Internet system, an information "highway" reaching an estimated 15 million subscribers and thousands of university, science and business networks.

America Online went public in March 1992, at $11.50 a share. On Friday, its stock closed at $61 a share.

Wheat First Securities Inc. of Richmond says the sharp rise in the stock price stems partly from AOL's growth prospects, takeover speculation and the market's current fascination with interactive media.

Of the four major companies that provide on-line computer services for consumers, AOL is the only one that is publicly owned and therefore open to takeover by an investor buying stock on the open market.

Last spring, Paul Allen, a billionaire investor who was one of the founders of Microsoft, indicated he might seek to acquire AOL. Allen raised his stake in the company from 13.5 percent to almost 25 percent.

But Kenneth T. Berents, director of research at Wheat First, said he thought it was "moderately unlikely" that Allen would acquire AOL. One reason: AOL's ability to enter into strategic alliances with major partners is predicated upon its independence.

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