AOL BUYS SOME TIME

By David S. Jackson/San Francisco

For standard bearers of the computer revolution, the techies who run America Online have a pretty shaky grasp of basic math. Let's see: you're the most successful online service in Internet history, with membership rolls shooting up in only three years from 500,000 to 7 million. You're about to launch a snazzy TV ad campaign built around a radical change in pricing policy: from stiff, pay-by-the-hour bills to unlimited all-you-can-eat access to the Internet for $19.95 a month. Yet you have added only a modest number of modems to the 200,000 you already need to service your teeming masses. On Dec. 1, you flick the switch on the new era.

The result? Half a million new subscribers in four weeks, twice the usage from your existing customers and countless unhappy people, such as Bill Blevins, a Springfield, Missouri, police dispatcher and AOL subscriber who spent four hours and hundreds of busy signals one afternoon last week before managing to log on. "It's got progressively worse," says a weary Blevins. "They're advertising something they can't provide."

Not anymore. Last week, after a multimedia convergence of bad publicity, customer complaints and threats of legal action from three dozen state attorneys general, America Online, the world's largest Internet and online-service provider, agreed to cancel its cool, Jetsons-themed television pitches for new subscribers while it augments its network to accommodate the 8 million members it already has. AOL is committed to spending $350 million over the next few months to add 150,000 modems. As part of the deal made with the attorneys general, the company also agreed to offer rebates of up to $39.90 for users who couldn't get what they were paying for.

And wouldn't you know it? AOL's phone lines were swamped once again, this time by users requesting refunds. Many of them were angry at being kept on hold for long periods, but state regulators pronounced themselves satisfied. Most analysts also seemed unconcerned. Said Lehman Brothers analyst Brian Oakes: "I think we've passed the peak of the problems with both the busy signals and the refund calls. There's always an initial wave."

Bob Pittman, president and CEO of AOL Networks, was quick to declare victory. "We did the right thing for the customer," he said. "We are not about computers and wires; we're about a relationship with our members."

Funny, that relationship almost came undone by a lack of computers and wires. For years the company flourished despite monthly fees of $9.95 for five hours online, plus $2.95 for each additional hour, which kept AOL's subscribers watching the clock. But the growing challenge from Internet- service providers like Netcom, AT&T and even Microsoft Network finally prompted AOL to lower its monthly fee to match the going rate of $19.95 for unlimited Internet access. For that amount, users would get not only the Internet but also AOL's own proprietary content, including games, scores of newspaper and magazine sites and special features like the popular Motley Fool investment forum.

The gamble paid off all too quickly: 500,000 new members signed up in December alone, and AOL officials were jubilant. "There's a time in the life of any product, whether it's the telephone, television or cable TV, when it goes from being a luxury to a necessity," an excited Pittman told colleagues. "We will look back on this point in history as the time when the mass market moved to the Internet."

They will also look back on it as the time the mass market crushed their company's physical plant like a bug. Although AOL had been adding modems since September in anticipation of its late-October pricing announcement, the growing surge of demand quickly ate up the added capacity. From September to January, the average number of minutes AOL users spent online per day would more than double, to 34, while the overall number of daily visits vaulted from 6 million to nearly 11 million. Explains AOL chairman Steve Case: "We expected we'd get a couple of hundred thousand new members every month, and that pace would get us to about 10 million customers by the end of this calendar year. So in December we were expecting about 200,000, and we got 500,000." And in mid-December the first lawsuit was filed, in Illinois.

On Jan. 16, Case, who himself had experienced log-on delays, threw gasoline on the fire by publicly appealing to members to "try to show some restraint" during the peak evening hours. But skeptical users began staying on even longer, reasoning that if they logged off, they wouldn't be able to get back on. The day Case's message went out, his mailbox crashed from all the E-mail he received. In one two-day period, he was hit with 17,000 messages.

As complaints mounted, attorneys general in 20 states warned of legal action if the company continued to charge customers for services it couldn't deliver. Lawyers from AOL met with the attorneys general in Chicago on Jan. 22. A week later, AOL announced its concessions. Says Case: "Someone turned on the TV in my office, and cnn was breaking in live to the press conference in Chicago with the attorneys general. They were treating it like it was a verdict in the O.J. Simpson trial."

As part of the agreement, AOL will make it easier for disgruntled users to quit the service. It will accept cancellations by fax and letter as well as over the phone.

From a business standpoint, having an ever-growing base of millions of customers clamoring to spend time on your service isn't exactly the most devastating problem an Internet company may face. It may also be an indication of how thoroughly your company has come to dominate this increasingly lucrative market.

Officials insist the company is on target to report its first profitable quarter by midyear, despite customer rebates that could total $20 million. "Is it going to take a bite out of their revenue?" asks Mark Mooradian, an analyst for Jupiter Communications. "Absolutely. Is it going to be devastating to them? I don't think so."

AOL enjoys a nearly 3 million-subscriber lead over CompuServe, its nearest competitor, and boasts a monthly revenue stream upwards of $140 million, a number that is a fantasy to the people who run your average Top 10 Websites. Although it could be spring before all the improvements are felt, most users will probably stick it out. AOL has improved its features over the years so that no other online service can match it for ease of use. AOL also has another advantage: changing an E-mail address is as inconvenient as changing a real one.

For years, the techier-than-thou digerati have been deriding AOL as "training wheels for the Internet" and predicting the imminent demise of the firm's proprietary-software model at the hands of the free-to-the-masses World Wide Web. But now that AOL has matched its Web rivals on price, the training wheels have come off. And AOL is not only still pedaling, but--its recent mishaps notwithstanding--it also currently runs the most lucrative toll booth on the information highway.