E-BUSINESS SPECIAL REPORT
The AOL Albatross

As it sputters and stutters through a thorny merger with Time Warner, financial woes, management upheaval and corporate scandal, America Online seems like an aimless teenager, awkwardly casting about for a purpose that will take it in a positive -- and profitable -- direction.

"Clearly, they've lost their focus," IDC analyst Jonathan Gaw told the E-Commerce Times. And AOL Time Warner (NYSE: AOL) has so many other problems that the AOL division has been temporarily lost in the shuffle.

For example, in recent months, the company has found itself the subject of a U.S. Securities & Exchange Commission (SEC) investigation into revenue misstatements, which resulted in the ouster of deal-maker David Colburn.

"The scandal stuff should not affect the way AOL Time Warner does business, but it does," Gaw said. "The SEC investigation shouldn't matter much to rank-and-file AOL employees, but it does."

Management Upheaval

In addition, the company has been in the throes of management upheaval, with former chief operating officer Bob Pittman replaced by Jon Miller, formerly head of a division at USA Interactive. Other AOL executives have also been ushered out or pushed aside in favor of Time Warner loyalists. Even AOL founder Steve Case, whose name is practically synonymous with the company, recently found himself in the hot seat at a board meeting, facing down a scowling Ted Turner, whose influence at AOL Time Warner cannot be denied.

But AOL is far from a sinking ship, Yankee Group analyst Mike Goodman told the E-Commerce Times. "It is far and away the largest ISP, and it generates an awful lot of cash," he said. "It's not like they are about to go under."

The real issue, according to Goodman, "is where they go from here." The company cannot afford to meander toward its future. Advertising is flat or declining, and the company's subscriber base of about 35 million is not growing as quickly as it once did. Since advertising and subscriptions are AOL's two main revenue streams, the company must find new ways to generate revenue.

Positive Signs

There are signs that the company is moving in a more positive direction. For example, the recent management shifts bring the company more in line with a Time Warner way of life. Contrary to initial expectations that AOL would serve as the engine of growth for the combined conglomerate, Time Warner properties have generated the bulk of revenue as the AOL division has floundered. Therefore, it seems sensible that Time Warner executives would want to assume more control.

"The bigger company is reasserting itself," Goodman said. "Whoever has the bigger bottom line should run [AOL Time Warner]."

Indeed, after years of plugging itself as the quintessential new media company, AOL is discovering, as other companies have, that "old media is cool again" -- particularly in the sense that old media knows how to make money.

Fine Line

But the challenges facing AOL are likely to grow more urgent. If advertising continues to stagnate and AOL's subscriber base grows more slowly than it did in the past, it must find new revenue streams. Toward that goal, the company has pledged to focus more on broadband, although it has yet to present a clear strategy for achieving critical mass in that area.

As the largest ISP, AOL has a huge customer base to exploit. But the company is still in a tenuous position because converting dial-up users to broadband means "converting customers from a higher-margin to a lower-margin" service, according to Gaw.

In addition, Goodman noted, AOL must be careful "not to alienate dial-up users" as it focuses more resources on broadband. But the company cannot afford to hesitate. If AOL does not convert dial-up users, then competitors like Yahoo! and MSN have made it clear that they will. Those two companies will have no qualms about poaching from AOL's dial-up base. "The worst thing that can happen to AOL is to lose those customers," he added.