Internet Outsider

The Great Advertising Share Shift: Google Sucks Life Out Of Old Media

[From Silicon Alley Insider] Everyone talks about advertising dollars shifting online, but when you're fighting all day in the trenches it's tough to get a handle on what this really means.  Here's what it means:

US advertising revenue at 4 big online media companies--Google (GOOG), Yahoo (YHOO), AOL (TWX), and MSN (MSFT)--grew by $1.3 billion in Q2, or 42%. 

US advertising revenue at 15 big television, newspaper, magazine, radio, and outdoor companies (Time Warner, Viacom, CBS, etc.) shrank by $280 million in Q2, or 3%.

Put differently, U.S. advertising revenue at all 19 companies increased 8% year over year in Q2, to $13.8 billion ($55 billion annualized).  The online portion of this pie grew from $3 billion to $4.2 billion (23% share to 30% share).  The offline portion, meanwhile, shrank from $9.9 billion to $9.6 billion (77% share to 70% share).  The online companies, in other words, picked up 7 percentage points of market share in a single year.

Other fun facts:

Within our company set, the only traditional media business that grew U.S. advertising year-over-year in Q2 was Outdoor (up 13%). Meanwhile:

• Television (cable and broadcast) shrank 1%, or $50 million
• Print (magazines and newspapers) shrank 5%, or $170 million
• Radio (terrestrial) shrank 7%, or $105 million

Obvious Conclusions

Traditional media executives--especially in the newspaper business--often blame their current woes on "the real estate market" or "cyclical weakness."   Economic weakness may be exaggerating the downturn, but it's not the real problem.  Whatever weakness is hitting the newspapers is also hitting Google.

Media power is not only shifting by medium (the handful of Internet companies are collectively valued more highly than most of their traditional media brethren combined), but by geography. Most "big media" companies are still headquartered in New York. Most media power, however, is now headquartered in California.

These trends are secular, not cyclical: TV networks, radio networks, and newspaper companies won't suddenly wake up one morning and find themselves back in charge.  Individual Internet companies may screw up (see Yahoo/AOL), but if they do, others will rise to take their place (Google).

Traditional media executives are doing a superb job of milking cash flow out of shrinking businesses, but you can't save your way to prosperity.  The smartest companies acknowledge this and are 1) returning cash flow to shareholders, 2) diversifying via M&A (as the Washington Post has done), and/or investing in or buying promising interactive businesses.

Details

We looked at US advertising revenue for 19 companies: Google, Yahoo, AOL, Microsoft, Time Warner, Viacom, CBS, News Corp., CBS Radio, Citadel, Disney, Entercom, Clear Channel, Clear Channel Outdoor, Time Inc., New York Times Company, McClatchy, Dow Jones, and Gannett.  We divided the companies into the following sectors: Online, Television, Print, Radio, and Outdoor.  Please see detailed data, analyses, and notes here.

AOL: A Mistake to Go Free? (NYT and DJ Take Note)

With everyone speculating about what will happen when TimesSelect (NYT) and Wall Street Journal Online (DJ) go free, it makes sense to check in on the last major wall-removal story: Time Warner's (TWX) AOL.  Was AOL's move a good one?  Or should it have hung on and watched its subscriber base slowly dribble away?

Answer: It was a good move.  AOL certainly sacrificed some near-term cash flow, but, critically, it has retained (or replaced) the lost subscribers in the form of unique users.  If AOL hadn't made it's email available for free, meanwhile, it likely would have lost most of these subs forever. Also, even as AOL's subscription revenue plummeted, the company has preserved its cash flow, which is far more important. 

What hasn't happened, which would have been nice, is that unique users and pageviews haven't swelled as the rest of the world learned that AOL is now free.  This said, they also haven't collapsed, which was a distinct possibility.  (Why? Because each AOL "subscriber" represents more than one unique user, as there are usually multiple users in the same household. Also, in the old days, AOL subscribers generated far more pageviews-per-user than average uniques, because of the frequency with which they checked email.  So the loss of each subscriber could theoretically have meant the loss of more than one unique and several multiples of average pageviews.)

Let's put some numbers on this...  (If you want to see the quarterly progression, percentage changes, and calculations, please check out this spreadsheet.  It's online, so just a quick click and no downloads or worries about nasty Excel viruses.)

Subs. Over the past year, AOL has shed 7 million subscribers, approximately 3 million more than it would have lost if it had maintained the status quo.   Importantly, the attrition rate has now returned to almost the pre-free rate (1 million a quarter), and the sub base is still a considerable 11 million.

Cash Flow. Thanks to big cost savings in marketing, sub retention, and network expenses, AOL managed to nearly preserve its pre-free subscriber cash flow.  (We estimate pre-free cash flow of about $400 million a quarter versus about $300 million now).  The company will continue to shed subscribers, and most of the big cost savings have already been booked, but subscription revenue should continue to throw off at least $200 million a quarter for several quarters.  (We estimate the subscription profitability by assuming an operating profit percentage of 35% for the company's ad revenue, calculating the operating profit from ads, and then backing into the operating profit from subs.  Please see the bottom of the spreadsheet).

Users.  Unique users have been relatively stable at about 110-115 million for the past year, despite the loss of 7 million subs.  This suggests the subs who quit the paid service are sticking around.

Pageviews.  Similarly, pageviews have stabilized and are now beginning to increase again (although most of the sharp gain in the last quarter was the result of a measurement-method change).  This, too, suggests that subs are sticking around.

Of all the companies considering going free--i.e., NYT and WSJ--AOL certainly had the most to lose.  And, for AOL, at least, pulling the wall down has turned out to be a good decision.

Search Share: Google Gains, Everyone Else Loses (Again)

Bob Peck of Bear Stearns offers a detailed analysis of Comscore's domestic search share numbers for April.  Search is by far the largest category of online advertising, and number of queries is the primary revenue driver.  So query share is crucial. 

Bob's full note is available at Searchblog.  Here are the key points:

• Google's share of US queries jumped another 140 basis points to nearly 50%, up 27% year over year.  This is a continued deceleration of the y/y growth rate, but it's still impressive--especially relative to the rest of the industry.

• Yahoo lost 70 basis points to 27% and grew only 6% year over year.  Yahoo is doing better than the other major players, but this ain't saying much.  It is important to note that Panama, even if wildly successful, won't help increase query share.

• MSN dropped 60 basis points to 10%.  Given how much time, effort, and money Microsoft has invested in search over the years, this is, in a word, pathetic. (But not surprising).  Importantly, the $6 billion Microsoft is spending on aQuantive won't help this trend.

• Ask Network was flat at about 5% and Ask.com was flat at a dismal 2%.  Search is not TV, and Ask's massive advertising push has had no effect on the site's market share.  There is no reason to expect this will ever change.

 

Implication of Flattening Keyword Prices

Jason Jones:  Fathom Online reports that year-over-year growth in U.S. keyword prices remains in mid-single digits.  This means that Google, Yahoo, et al, are losing a growth-driver and must grow their paid search businesses through international expansion, breadth of keyword buys, and market share gains.  The flattening of keyword prices explains both the tepid growth of all search players except Google, and the recent pick up in M&A interest in the branded-advertising business.

Where will advertisers shift their focus as ROI's begin to stabilize in the paid search business?  Probably to contextual & behavioral advertising.

          Price    q/q    y/y
1Q07    1.46    -3%   5%
4Q06    1.51    2%     6%
3Q06    1.48    17%   3%
2Q06    1.27    -9%   
1Q06    1.39    -3%   
4Q05    1.43    -1%   
3Q05    1.44 

Peter Hershberg of Reprise Media responds (Text adapted from comment below and from this Jan 2006 piece on Reprise's site): 

[FROM COMMENT]: The fact that people continue to reference Fathom's KPI is mind-blowing to me...  While it is *possible* that keyword prices are stabilizing, there's no way anyone outside of the search engines themselves know with any degree of certainty.  Along those lines, it's worth noting that in January of 2006, Fathom's KPI suggested that keyword prices for 2005 had fallen by 16%. Google's stock more than doubled over that time period...

[FROM JAN 2006]: Fathom's sample size of 500 keywords is not representative of the entire universe of advertising opportunities available on Google. There are literally millions of unique keywords being purchased in the search marketplace today. Furthermore, the KPI doesn't include either proper or brand names -- keywords that typically deliver significant volume at higher average CPC's. (In fairness to Fathom, they acknowledge this shortcoming in each of their reports. Whether or not the press picks up on it is another story...)

Second, and more importantly, Google's stock continues to rise because it's CPC's simply ARE NOT falling. And even if they were, there would be no way for Fathom, or anyone else, to know that was the case.

How can I be so sure? Because of Google's "Quality Score," a topic I've written about on several occasions in the past.

For anyone not familiar with this concept, Google defines Quality Score as "the basis for measuring the quality of your keyword and determining your minimum bid. Quality Score is determined by your keyword's clickthrough rate (CTR), relevance of your ad text, historical keyword performance, the quality of your ad's landing page, and other relevancy factors."

This essentially means that two (or more) advertisers could be required to bid completely different CPC's to occupy the same position against the same keyword. In other words, the advertiser with the "better" Quality Score might have to pay just $.10/click for the top position against the keyword "wireless accessories," while an advertiser that's been penalized for poor ad copy, a landing page that's light on content, or some other "violation" would be required to pay $.50/click for the same position.

      

Click Fraud Getting Worse, Especially on Content Networks

Click Forensics, a Texas-based company that tracks click fraud using detailed campaign data from more than 3,500 marketers, reported that industry-wide click fraud increased modestly in Q1 to its highest level ever: about 15% of all clicks, versus 14% in Q4 2006.

More ominously, click fraud on "content networks"--the third-party advertising solutions that support an ecosystem of thousands of small content companies--increased a more significant 3 points, to 22%, from 19% in Q4.  This trend is dangerous for small content providers in addition to search engines.  A continuation of this trend will soon result in more than a quarter of all content-network clicks being considered fraudulent, a level that could begin to cut significantly into the revenue of smaller content providers.

Also significant: Fraud on high-priced keywords--those over $2 a click--rose to 22% from 21% in Q4, confirming the theory that higher priced keywords are more susceptible to fraud than average- and low-priced keywords.

From the release:

“It appears that click fraud perpetrators are becoming more sophisticated even as search providers step up their efforts to fight click fraud,” said Tom Cuthbert, president and CEO of Click Forensics, Inc. “Click fraud seems to be following a similar path as other online fraud schemes such as spam and phishing - the problem is growing as fraudsters fine tune their methods.”

Video Piracy 2.0: Get Ready for Viewer Lawsuits

The Journal's Kevin Delaney details the latest frontier in online video piracy: Sites like www.YouTVpc.com that assemble links to your favorite movies and TV shows--which are hosted on third-party servers in, say, Malaysia. 

YouTVpc's proprietors don't upload the video content--they just find it and link to it.  Unlike YouTube, they also organize it in a user-friendly fashion: lists of shows by year and episode, etc.  The proprietors spend their evenings searching for videos and answering concerned emails from users saying "is this legal?" (Answer: Maybe, for now.)  They cover their costs with advertising and live off Jolt cola and kettle chips.

Implications:

• Merely "linking" to pirated video may not be illegal yet, but, presumably, after fierce lobbying and lawsuits by the MPAA, et al, it might be. (Although this would be a heroic and disturbing precedent--making lists of links illegal). 
• If such efforts fail, the MPAA, et al, will presumably follow the path blazed by the RIAA, et al, and start suing thousands of American consumers who watch pirated video.  The consumers' defense, presumably, will be, "But I didn't download it."  To which the MPAA, et al, will reply, "See you in court."  And the threat of hundreds-of-thousands-of-dollars-of-legal-fees later, most consumers will, sensibly, cave.

What is not likely to happen, but should, is that the MPAA and traditional video production companies should note that 1) successfully suing users hasn't saved the music companies, and 2) the world has changed forever and there is no way stuff the cat back in the bag.  In light of this, BigMediaVideo should pursue a parallel course:

1. Post all their old shows online on their own sites immediately and allow other sites to link to them.
2. Make clear that videos hosted on their sites are LEGAL to watch, whereas video at all other unapproved locations are ILLEGAL (and viewers may be sued, etc.)
3. Build the best-available online directories of online video (an area in which YouTube, for some reason, is failing), so as to establish a presence in video search.
4. Get better at embedding sponsorships, product placements, and, if necessary, short ads in the videos to generate as much revenue as possible.
5. Create subscriber plans in which paying users can get new videos instantly (thus offsetting any lost revenue from folks who prefer to watch TV on their PCs).
6. Share a modest referral fee with sites whose users link to and view the videos (thus encouraging affiliates to promote them.)
7. In short, EMBRACE change, instead of fighting it every step of the way.

Time Warner to Keep AOL, Sell Cable, and Buy...MSN?

Matthew Karnitschnig of the WSJ kicks off the morning with a Twilight Zone piece about how Time Warner may not dump AOL after all, but instead sell off cable and "double down" on the Internet by buying another big net company. 

Without commenting on the plausibility of this theory (except to say that it would be quite a change of heart), here are some thoughts:

• Oh, the irony!  The theory behind the strategy, apparently, is that cable will become increasingly commoditized and less relevant in a world with the Internet and Internet TV, etc.  It was, of course, exactly this sort of thinking that led to the "transformative" AOL-Time Warner merger in the first place.  Without concurring that cable will become less relevant (somebody has to plumb the pipes), this would lend credence to the idea that the AOL-Time Warner merger wasn't a colossal, bubble-headed strategic error, but just early. 

• The most sensible big-net-company acquisition/merger candidate is MSN.  A combined AOL-MSN would dominate online communications, and, together, would have the scale and clout that each company alone currently lacks.  The integration, management, and long-term growth strategies, of course, would be a nightmare.

• Assuming Time Warner isn't up for that challenge (and who could blame them), companies like Facebook, Bebo, Music Nation, and others fit into the company's entertainment DNA and would help offset/refresh the demographics of AOL's geriatric user base.  They also wouldn't require another bet-the-company roll of the dice.

AOL's having a 'meet the new AOL' event today, so maybe we'll get further details.

UPDATE

A reader suggests another sensible Time Warner acqusition candidate: Joost.  Any others?   (I personally think Joost would make sense but also be extremely risky, because 1) the site hasn't even launched yet, and 2) if/when Joost is owned by one of the big media companies, it will lose its status as a neutral "Switzerland" BigMedia solution.)

Google Swallows DoubleClick for a Mere $3B

What's $3.1 billion between friends?  Or, put differently, what's it worth to fix your display-advertising problem, corner the market for the "advertising operating system," and deliver a hammer-blow to an already prostrate Seattle-based competitor?  $3.1 billion?  Sure.  Only a few quarters of free cash flow.

So now Google controls a vast share of the market for graphical online advertising, too.  And has yet another display on its world-domination dashboard about who's doing what where.  For those with an eye on the really-long term, it's hard to see how this isn't good news.

For those with an eye on the near-term stock price, meanwhile, it's probably bad news: Lower margins, a big management challenge, a significant price tag, an admission on the largest scale to date that it sometimes makes sense to buy instead of build (no shame in that--just lower returns on capital), and so on.  But as Google made abundantly clear in its IPO prospectus, management (sensibly) isn't focused on the short term.

CBS Video Deals: Quincy Smith Being Smart Again

CBS's portfolio of video distribution deals shows that CBS Interactive's president, Quincy Smith, is still using his head. 

Quincy, you may remember, then at Allen & Co, was one of the investment bankers who sold YouTube to Google.  Before that, he was the IR man at Netscape and a Valley venture capitalist--so he knows smart Internet ideas when he sees them.  And CBS, you may remember, was one of the first major TV production firms to embrace (or at least experiment with) online video distribution through non-CBS properties.

CBS didn't participate in the DOA bigmediavideo YouTube killer occasionally known as NBCFoxTube (although it will reportedly distribute video through it).  It didn't alienate the entire digital industry by suing YouTube for $1 billion (instead, it did a small partnership).  And, now, intelligently, by doing distribution deals with anyone and everyone BUT YouTube, it is establishing precedent and leverage for the inevitable major YouTube negotiation.

According to Brooks Barnes in the WSJ, in its video deals, CBS is also retaining full control over the sale of advertising that will be shown in conjunction with its videos--a big sticking point for traditional media companies, who value their relationships with advertisers.  It is also demanding 90% of the advertising revenue, with only 10% going to the distribution partner.  For the distribution partners' sake, one hopes this is "net revenue", as the streaming costs alone will probably eat at least 10% of the top line.

Most importantly, CBS is doing everything it can to diversify its distribution channels, attract a loyal base of online users, and make its content ubiquitous--all of which will allow it to credibly maintain to the folks at YouTube that it--CBS--can take or leave a full-blown YouTube deal.  Whether this is in fact true is a different question, but CBS is doing everything it can to make it seem so. 

The quarterback behind these intelligent CBS machinations, I suspect, is Quincy Smith.  So give that man (and CBS) a hand!

UK Online Ads Pass Newspapers; U.S. Online Ad Spending to Triple?

According to IAB, online advertising spending in the UK in 2006 exceeded newspaper advertising spending.  This amazing fact received less attention in the U.S. than it should have.

One of the big mysteries of the past few years, for those who follow U.S. media, is how and why U.S. newspapers have been able to maintain as much share of the advertising market as they have.  Yes, business sucks for newspapers, but it doesn't suck as much as it should when one considers that the vast majority of the product is printed on wood pulp, shipped around the country in gas-guzzling trucks, and then tossed into recycling bins before it is even glanced at. 

According to Morgan Stanley figures for 2005, U.S. newspapers still generate about $49 billion in advertising revenue (including classifieds).  This compares to about $16 billion last year for Internet, $45 billion for broadcast television, and another $19 billion for cable TV.

Unless there is something structurally different about the UK market--please weigh in on this if you know--the UK statistic suggests that 1) the US online advertising market still has massive growth ahead of it, and 2) U.S. newspapers have not yet begun to feel the pain. 

Two scenarios jump to mind:  1) Online advertising triples over the next 5-10 years, to $50 billion, and/or 2) Online advertising doubles and newspapers advertising gets cut in half.  And then, of course, there's 3) Online advertising triples AND newspaper advertising gets cut in half.

UPDATE: Paul Durham weighs in:

There is something very different about the UK newspaper market - the number and importance of national newspapers. The IAB data shows internet advertising overtaking NATIONAL newspaper advertising. Regional newspapers is a separate category, and took £2.8 billion of ad revenue. So the internet still lags well behind total newspaper advertising in the UK.

Posted by: Paul Durman | April 03, 2007 at 11:15 AM

So, ignore some of what I said above.

Advertisers Fleeing TV, Radio for Internet, etc.

Emily Steel of the WSJ reported startling numbers from TNS Media Intelligence showing just how fast major advertisers are pulling money out of traditional media and throwing it into paid search, digital media, and other "unmeasured" advertising.  This trend has been underway for years, and the figures are backward-looking, but it's no wonder that traditional media conglomerates like Viacom are starting to panic:

In a sign of how major advertisers are shifting money out of traditional media, ad tracking firm TNS Media Intelligence reported that the nation's 50 biggest advertisers cut their spending on "measured" media such as TV, print and Internet display ads by 1.5% in 2006 -- though U.S. ad spending grew 4.1% overall.

While some of the decline may reflect overall cutbacks in ad spending by big marketers, it likely signals that big companies such as Procter & Gamble are reallocating some of their ad budgets to new Internet ad venues which aren't measured by TNS -- such as paid-search advertising, social networking and online video.

Not surprisingly, the report showed that growth in ad spending on traditional media, particularly newspapers and radio, continued to slow dramatically while spending on Internet display ads is accelerating. But it also highlighted a significant slowdown in ad growth among cable channels, after several years of robust increases.

Viacom Sues Google for $1 Billion. Big Whoop.

So Viacom took the predictable next step in the GooTube pissing match and sued Google for $1 billion.  Why is this irrelevant?

• Because if Google takes the next logical step and goes through the motions of fighting the lawsuit, the companies will be in court for years.  (During which time Viacom's content will become less relevant and YouTube's platform will become more powerful.)
• Because $1 billion in damages is absurd.  Viacom wants headlines--and is getting them.
• Because $1 billion is also chump change in this league.  (The injunction is potentially more problematic, but would likely just force YouTube to do what it will eventually have to do anyway--develop better ways of monitoring what is on the site). 
• Because the lawsuit is just another negotiating move and will disappear when the companies finally come to terms.

Why won't the Viacom lawsuit shut down YouTube the way the music companies shut down Napster?  First, because the resources Google can draw on to defend itself are about a million times as big as Napster's were.  Second, because Google already has plenty of real distribution agreements with other real media companies that will view the Viacom fusillade as a chance to gain online market share.  (These media companies are not likely to suddenly switch sides and team up with Viacom.)  Third, Viacom doesn't really give a damn how many people watch its content on YouTube--they just want to get paid what they view as a less-insulting amount for the use of that content. 

The bottom line: If/when Google finally makes a concession or two, Viacom will declare victory, and the lawsuit will disappear.  Then, a couple of years later, when every media company in the world has a distribution deal with Google and Viacom's content is even less of a percentage of total views than it already is, the deal will probably get renegotiated on more favorable (to Google) terms. 

Privacy Summary: Consumers Don't Care--If You Tell Them

The Open Data morning session ended with a general consensus that consumers would be surprised and outraged by the amount of online data that is being collected, stored, and sold--and that sooner or later some smart journalist will "discover" this secret and trigger a consumer firestorm.

Most attendees agreed that consumers are happy to trade privacy for convenience and that, ultimately, if they like the product, they'll say "whatever" about the data collection.  Most people also agreed, however, that to get to "whatever," consumers have to know that everything they do is tracked, analyzed, and sold--and that the last time anyone read a User License Agreement was 1972.  So the industry has to figure out some way to get the story to consumers before some journalist does.  Because the latter will lead to Congressional hearings, new bureaucracy, and higher legal, compliance, and PR bills...  And who wants that?

ISPs Are Selling Your Clickstreams!

At Open Data, David Cancel, the CTO of Compete, Inc., reveals that ISPs happily sell clickstream data--and that it's a big business.  They don't sell your name--just your clicks--but the clicks are tied to you as a specific user (User 1, User 2, etc.).

How much are your clicks worth?  An symposium member extrapolated from David's round numbers and estimated about 40 cents a month per user (per customer)--a number with which David appears to agree.

Someone points out that this is more information than was shared by AOL in the search-term brouhaha.  It's much more! David says.  Someone else observes that the benefits/drawbacks of this are in the eye of the beholder: for the ISPs it's awesome.  Someone else points out (see comments) that the credit card companies sell far more interesting data than this and no one gives a damn.

David steps down.  Thunderous applause.

Click Fraud Steady at 14%--Click Forensics

Click-fraud consulting firm Click Forensics estimates that industry-wide click fraud in Q4 was 14.2%, which is at the high end of levels measured earlier in the year (the quarters ranged from 13.7%-14.2%).  The firm also estimates that click fraud on content networks--the "affiliates" that advertisers are always complaining about--was significantly higher, at 19.2%.  Most importantly, click fraud was highest on expensive key words (over $2/click), at 21%.

Overall, these figures suggest that click fraud remains an annoying but controlled problem, one that most advertisers view as simply a cost of doing business .  The higher fraud on the content networks and high-priced keywords suggests that Google and Yahoo will have to devote more resources and/or refunds to remedying the problem.  This should ultimately have a modest negative impact on profitability. 

New AOL CEO: Be Afraid

For those who missed it, Time Warner stuck the final knife into the back of the old AOL last week, when AOL's interim CEO, Jonathan Miller, allegedly hand-picked by the outgoing Steve Case, was axed and replaced with a career TV/old media executive.  Miller wasn't an Internet expert, but he'd worked with Diller, who is (now), and he quickly illustrated that he was willing to learn.  And he did a good job, all things considered.  But now he's gone, and so is the final vestige of the original AOL, which once utterly dominated Internet-land--and, later, so mortified the old guard at Time Warner that they've spent the last five years trying to erase the nightmare.

In the short history of the Internet, few old media executives have quickly grasped the ways the new medium is different. Untold thousands, however, have charged into the fray, ready to teach the Internet kids how a real media business works, only to learn, the hard way, that the Internet really is different (not better, just different). 

So what can we expect from Randy Falco, the new head of AOL?  I won't rush to judgement, but the early signs aren't encouraging.  If today's AP summary and Falco quotes are anything close to reality, AOL is about to resume its rapid slide into oblivion:

The incoming head of AOL said Tuesday he left a 31-year career at NBC for the chance to transform the online business into a formidable rival to television and other traditional media, AP writes, suggesting that Falco has yet to notice that ONE Internet company, Google, has long been worth more than the entire television industry combined (and justifiably so). 

''I'm fascinated by the Internet space,'' Falco told The Associated Press. ''I see it as a very exciting environment to be in. It reminds me a lot about network television 30 years ago. It's a little bit like the Wild West. There aren't a lot of rules. That's what excites me about it.''

A "fascinating environment"?  Yes.  And I guess it's good that Falco's excited about his new job.  But given that the next six months will determine whether AOL lives for a decade or dies in a year, one hopes that Falco's gee-whiz attitude is quickly replaced by an understanding that the Internet's wild west days are long gone and that there are crystal-clear Internet rules--one of which is that if you're not No. 1, No. 2, or, at worst, No. 3, you're toast.  And AOL fans should pray, hard, that Falco doesn't follow in the footsteps of some of his transitioning brethren and spend his first six months on the job enthusing about a new commitment to "original programming" and "shows."

Dear Google Bulls: Yahoo Comments Still Suggest Market Problem

Yes, Yahoo has Yahoo-specific problems, one of which is competition.  Some comments on the conference call, however, provide further evidence that the slowdown in advertising revenue is not just Yahoo-specific. 

When asked for the second time about whether the weakness was confined to autos and financial services--and whether the weakness was continuing--Sue Decker said this (transcript courtesy of seekingalpha.com):

We did say that we had seen some weakness in September in those two categories. Those sectors were meant as examples. They are having some industry-specific issues in both cases. We have seen a couple of -- several of the various sectors showing some of that, but we think those are specific to those sectors, and we do think those will continue into Q4.

Translation: We are seeing weakness in more than the auto and financial sectors.  The weakness is continuing.

The quick response from Google bulls is that PPC advertising is different, that advertisers view PPC as a "cost of sales" instead of "marketing spend," and, therefore, that a slowdown in general advertising won't affect Google.  I continue to believe that this argument is wrong. 

If advertising spending slows, it will slow because of weakness in consumer demand (which leads to lower revenue and, therefore, less money to spend on advertising).  Although it is true that you have to spend money to make money, advertising is usually one of the first expenses to get cut in a slowdown.  PPC advertising may be the last form of advertising to get cut, but it will still get cut. 

Why?  Because if consumers go from spending $1.00 on financial services to $0.90 on financial services, the ROI for any advertiser trying to attract that spending will drop.  As ROIs drop, weaker advertisers will reduce spending, which, in the case of search, will eventually filter into either keyword pricing (fewer advertisers competiting for the same keywords) or fewer paid clicks (fewer consumers seeking financial services).  The impact will not necessarily be disastrous, and it will not necessarily be as severe as it is for less-ROI-driven advertising, but there will be an impact.

Thus, I reiterate my prediction: Some of the weakness affecting Yahoo appears to be market-related, and if it is market-related, it will eventually affect Google. 

Analyzing More Ad Market Data Points

Ross Levinsohn of Fox Interactive says that Fox is seeing no signs of an advertising slowdown (per Mediapost), a tidbit suggesting that Yahoo!'s problems may be, well, just Yahoo! problems.  Meanwhile, Lowe's preannounced modestly disappointing results and blamed them on the housing market, as did homebuilder Lennar.  Washington Mutual recently said that the inverted yield curve and rising interest rates have dampened mortgage origination (no surprise), and consumer home equity withdrawals are apparently down year over year.  And the American car companies continue to suck wind.

Put it all together, and Levinsohn's observation does not necessarily support the view that Yahoo!'s recent news is a Yahoo! problem instead of a market problem.  Fox is presumably less dependent on advertising from financial services companies than Yahoo is (specifically, mortgage companies), and, with a younger demographic, it is also presumably less dependent on ad spending tied to the housing market.

Will Yahoo!'s weakness continue?  Is it a market problem that will soon affect other companies, including Google?  Is it the first sign of a slowdown that will spread to other industries?  Still too early to tell.  I continue to think, however, that the Yahoo! news and other data points above are consistent with the start of a general market slowdown, one that will likely gather momemtum if housing prices continue to fall.  The recent drop in rates may help housing prices stabilize (or even rise modestly) in the next few months, but the downward trend will probably resume eventually.

Put differently, I still think the Yahoo! news is a canary in a coalmine--one that the market has, so far, largely ignored.

More on Drooping Ad Spending, Yahoo, Google

Smart debate in the comment section about whether yesterday's Yahoo news reflected a Yahoo issue or a market issue, as well as whether a general slowdown in online ad spending would affect Google.  My take is that it is almost certainly a market issue and that, eventually, it would/will almost certainly affect Google.

As several readers noted, the slowdown was attributed to two sectors, automotive and financial services.  Given what's happening to Ford, GM, and Chrysler, the first isn't a surprise.  Given what's happening to the housing market, the second isn't a surprise either, especially if "financial services" is really a synonym for "mortgage brokers."

A Bloomberg story today reports data from Nielsen that confirms some of the above, but also suggests the problem is worse at Yahoo than elsewhere:

Advertisers reduced the amount they spent on graphical image
ads in the U.S. by 6.3 percent to $163.6 million in the week
ending Sept. 10 after a 2.7 percent drop the previous week,
according to Nielsen//NetRatings...         

Demand for banner ads on Yahoo by financial services
companies fell 4.2 percent to $16.9 million in the week ending
Sept. 10 and 16 percent in the previous week, Nielsen said.
Outlays across the Web rose 2.2 percent for the week ending Sept.
10, after falling 10 percent a week earlier.

The story also notes that, at Yahoo, financial services accounts for an extraordinary amount of revenue.

     Financial services accounted for 33 percent of U.S. display
ad spending on Yahoo at the end of August, the highest of any
category, while automotive took 2.6 percent, according to
Nielsen.

The Bloomberg story focuses primarily on display advertising, and it is possible that, for now, search has been spared.  If the problem is the economy rather than Yahoo, however, as consumer demand falls off, search spending should drop, too.  Less consumer demand will likely translate into fewer clicks (less revenue) or a reduced conversion rate, which will put pressure on advertisers' ROIs (reducing the amount they can profitably pay for clicks).  It is also worth noting that, thanks to their high-ticket sales, both automotive and financial services have extremely high keyword prices, so any fall-off in advertiser spending or end user demand in these categories will have a far greater impact on revenue than on overall clicks.

Bottom line, I have never seen a general industry revenue slowdown that did not eventually affect the biggest player.  If that's what this is, therefore, the safe bet is to assume that Google will eventually be affected, possibly severely.

Yahoo Wilts. Prepare for Won't-Affect-Google Denials

Yahoo's Semel and Decker dropped the bomb this morning at a Goldman conference: Yahoo!'s Q3 is wilting.  Nothing serious yet--just revenue at the "low end of the range"--but still eerily similar to the early warnings from Yahoo 6 years ago, when Yahoo!'s Q3 started looking sluggish in mid-September and then weakened further by the day.  If memory serves, the company just made that quarter (Q3), but severely reduced guidance for Q4 and then bombed Q1.  And the rest of the economy wasn't far behind.

True, Yahoo's revenue is more diversified than in 2000, and there aren't a few hundred etailers about to start reneging on $30 million portal deals, but still: When the economy slows, advertising is one of the first expenses to go, and even the top dogs aren't immune.

Get ready, however.  In coming days, a parade of analysts will eloquently explain why the trends that are hobbling Yahoo! won't affect Google--Google's revenue is pay-per-click, Google is a "must buy" for advertisers, Google has a much stronger market position, etc.  Listen politely, but don't believe it. 

Google is now a $7 billion global business with one primary revenue stream: advertising.  Google may do better in a recession than, say, a television network, but that doesn't mean it will do well.  $7 billion is a significant chunk of not only online advertising but all advertising, and if all advertising slows (or, worse, shrinks), Google's revenue will, too.

Back in 2000, the theory was that, as the dotcom shakeout progressed, the dominant players would slow for a quarter or two but avoid most of the damage.  Yes, it's different now, in some ways, but one lesson from that period should be clear.  Even No.'s 1 and 2 drink from the same stream as everyone else.

Yahoo! Fizzles; Implications for Google, et al.

The good news, such as it was, was that Yahoo! managed to stretch and claw its way to its numbers.  The bad news was that it did this by slowing hiring and postponing advertising spending.  Why is this bad news?  Because when times get tough, advertising and hiring are usually the first expenses to go (suggesting that times are getting tough), and, more importantly, because Yahoo! lives on advertising spending. 

And then there was the stoppage in registered user growth (flat q-to-q) and the postponement of the new search-ad system.  Of these two downers, the ad-system is, in one sense, the less worrisome, as the delay should (let us pray) be temporary.  But one does begin to wonder whether Yahoo! will ever get its act together in this regard.

So what does this mean for Google?  Unfortunately, for the intermediate-term, it's mostly bad news. 

Yes, on Thursday, Google's relative performance should once again look (and be) amazing.  Yes, Google should gain some more share.  Yes, Google will once again demonstrate that what it does is far more difficult than it looks and that its leadership position is defensible.  Yes, Google will have the option of using its strong currency and cash flow to snap up companies, invest in R&D, and explore strategies that Yahoo can no longer afford (a long-term advantage).  But over the intermediate-term, the Yahoo! news is more ominous. 

A significant chunk of Google's growth is coming from market-share gains, and Google already has more than 50% of the world search market.  If Yahoo! and Microsoft continue to sputter (likely), Google will probably coast to 70%-80% of the world search market over the next year or two.  After that, however, there won't be much more share to gain.

Also, assuming any of Yahoo!'s issues are market-related--and, more broadly, assuming they are indicative of a slowdown in search or ad-spending--Google will not be able to dodge this bullet forever.  Given its dominance, it will survive unscathed for a quarter or two longer than most, but, eventually, in the event of a broader slowdown, it will feel the pain. 

The Trouble With AOL's Hail Mary Assumptions UPDATED

The WSJ has another excellent article detailing the projected financial impact of AOL's plan to eliminate subscription fees for users who already have online access.  (Time Warner has clearly decided to pursue an informal "comments welcome" period before the plan is voted on, perhaps so the Board doesn't approve it and then get laughed out of town). 

According to the article, AOL expects to remain profitable through a three-year transition period, but lose an estimated $2.7 billion in revenue and about $1 billion in operating profit.  To hit these numbers, the company will have to continue growing its advertising business 25%-30% per year AND crank up the advertising operating profit from 17% to 42%.  This latter assumption depends on the online advertising market and AOL's traffic remaining strong (neither of which is a given).

The company's biggest challenge, which the article does not mention, will be to ensure that subscribers who drop their subscriptions but continue to use the service generate as many pageviews as subscribers who keep the service.  Right now, the big flaw in AOL's portal model is that subscribers generate the vast majority of the company's pageviews (mostly through email usage).  If subscribers who quit the service generate fewer pageviews than they did as subscribers, then AOL will have lost two ways, and the free-subscription gambit will have failed. 

The article also does not explain another mysterious assumption of the plan: How AOL expects to boost the profit margin in its remaining subscription business from an estimated 38% today to some 53% in 2009.  Per the article, the subscription business currently generates $4.2 billion in revenue and $1.6 billlion in operating profit (38% margin).  In 2009, the article reports, the company expects revenue of $1.5 billion and operating profit of $800 million (53%).  Given that the main driver of increased subscription profitability--declines in the cost of telecom services--is flattening, how is the company going to increase the subscription operating profit so much while cutting its scale by almost two thirds?

AOL apparently expects the plan to knock its overall operating profit down into the "mid-single-digits."  Given the apparently heroic assumptions above, however, shareholders would probably be wise to brace for losses.  The company is probably still smart to pursue the plan, but shareholders are not likely to get off this easy.

UPDATE:

A perceptive reader pointed out that AOL has another big expense it can slash if it waves the white flag on the subscription business--marketing.  Assuming the company is still spending a big pot of money preaching to deaf ears, this would instantly boost the margins in the subscription business well above the 38% reported by the WSJ.  If the company is still spending, say, $1 billion, and is able to cut this number to zero (unlikely, given that the company will now have to establish a different brand identity, but for the sake of argument...), the profit margin in the subscription business would leap to 62%, which would make a 53% margin on a smaller business seem far more feasible.

AOL May Bet Company; Scary But Smart

  The WSJ reports that AOL is considering making online access to its service--including, importantly, email--free.  (AOL email users currently have to pay for one of the company's subscription plans, although much of the rest of the company's content is already free.)  Per the WSJ, this move would vaporize about one-quarter of the company's revenue, or $2 billion.  The company estimates that it would also result in the loss of 8 million paying subscribers.

This is a scary, but smart, move.  AOL is between a rock and a hard place.  If it does nothing, it dies slowly.  If it makes moves like the one described above, it deeply wounds itself but hopes that it will recover and have a long-term future.  Neither option is appealing.  But only one--the latter--gives the company a chance of being around for the next few decades.

If it chooses this route, of course, the company will have to do a lot more than cut and pray.  It will have to immediately retool its email system to make it competitive with other free options, such as Yahoo and Gmail.  It will have to build a clear portal identity--and target audience (presumably the MySpace and existing AOL-user crowd)--and win over a segment of the market that has not yet pitched camp at Yahoo, Google, and MySpace.  It will have to find something, anything, that it is better at than anyone else, (which will probably be communications-related).  And then, ultimately, it will have to combine with one of the dominant portals.

Will it be able to do all this?  The odds are probably less than one in three.  But even these odds are better than certain death. 

Another "Doh!" Award: Time Warner's Wayne Pace

At least one senior Time Warner manager probably has more on his mind than AOL.  According to the Post, an alleged New York high-end madam has fingered TW CFO Wayne Pace as her sugar-daddy.  The Post article is waaaaay short on detail (even the alleged madam isn't claiming she slept with Pace, and "helping" someone buy an apartment doesn't necessarily mean forking over suitcases full of cash), but one imagines that the scandal is rocking the Time Warner Center.

Time Warner has yet to respond, but it will have to soon.  Unless Pace can persuasively deny any and all of the alleged madam's intimations (a denial that will presumably have to include an explanation of the alleged "help"), he will soon be "pursuing other interests."

Until details emerge, it would be unfair to give the married Pace a Doh! Award for his own actions, if any.  But it is fair, I think, to give him one for being the subject of a Post story entitled "Doing Time."  For Wayne's sake, here's hoping there's a good explanation.

Look Out Yahoo: Google Now A 5-Trick Pony

Citigroup's Mark Mahaney has published a report analyzing the competitiveness of Google's non-search products, such as Finance, Gmail, Calendar, News, Froogle, Video, etc. The success of such products is obviously important for Google's long-term outlook, as they should help lock in users and diversify Google's usage patterns.  Eventually, they might even contribute revenue, although this is not a given.  Mark's key conclusions include:

• Several of Google's non-search products are "best-in-class" or at least "in-the-running."  More important, most are continuing to improve and gain traffic share.
• Most of these products have a much stronger competitive position (traffic share) internationally than they do in the U.S.  Put differently, Google's dominance is much greater internationally than it is here (a scary thought).

Mark suggests that the success of non-search products creates "option value" for Google that is not yet factored into the stock price.  My sense is that such products are to some extent factored into the stock price, although Mark's competitive analysis suggests that, on balance, the products are doing better than they are perceived to be.  The analysis suggests that no Microsoft or Yahoo product is safe and that it is way too early to pronounce, say, Gmail, dead simply because it has not yet caught up in user-share.  This conclusion alone should serve as a major kick in the posterior to Yahoo, especially: Not only did the company blow its lead in search; it is now losing market share to Google in almost every other critical vertical.

The one key point that Mark did not address is revenue.  None of Google's non-search products generate revenue.  If the theory is that Google will simply live forever on search revenue, then Google investors will have to get used to the fact that the company's ROI is only going to go one way: Down.  Shareholders will also have to live with the risk that, if anything happens to Google's search dominance--or to search advertising itself--the entire company will be screwed.

The most obvious way for Google to monetize its non-search products is display advertising (I continue to find the idea of inserting AdWords style PPC-ads in Calendar, Spreadsheet, etc. absurd).  One reason Google's products score well in Mark's comparison, however, is that they are un-cluttered and commercial-free, and adding display advertising might bring them more in-line with the competition.  I imagine that Google could add some display advertising--or at least sponsorship buttons--without sacrificing much utility, and I expect this is the way the company will eventually go.

The other option is subscriptions, an option that devotees of Google Spreadsheet, etc., often assume will be a lay-up.  I think subscriptions are a good idea, but they seem antithetical to Google's current philosophy, and, even if successful, they will take years to ramp into a meaningful revenue stream (witness Yahoo!'s revenue mix).  For the next few years, therefore, it would seem foolhardy to expect the company to flick a subscription switch and immediately pay for all of its non-search spending.

Bottom line, Mahaney's analysis suggests that Google is well on its way to becoming less of a one-trick pony. This is good news for Google fans and bad news for Yahoo.  (It's also bad news for Microsoft, but in my opinion, Microsoft has already lost the Internet game).

(Apologies...had to remove link to Mark's report.  If interested, contact Citigroup and beg.)

Time Warner Says Synergy Is BS. So Sell AOL.

According to the WSJ, Time Warner has abandoned all pretense of "synergy" between its various media divisions, the failed concept that was the sole justification for its merger with AOL.  Without synergy--cooperation between divisions to develop next-generation services in music, VOIP, VOD, DVRs, interactive TV, and a host of other applications that have since been launched elsewhere--the merger had no reason for being.  Worse, as the article makes clear, the lack of synergy actually gives the merger significant reason NOT to be: Instead of helping the combined company, the divisions just waste each other's time and piss each other off.

Jeff Bewkes (TW's president who, to his credit, was never a fan of the merger and now feels comfortable enough to call the synergy concept "bullshit" in the WSJ) is no fool, so it would probably be shortsighted to view yet another Time Warner strategy shift as an excuse to bash the company for the sins of the past.  Perhaps synergy is, in fact, bullshit--perhaps the merger was doomed from the moment it popped into Steve Case and Jerry Levin's bubble-addled heads.  If so, however, then why on earth won't Time Warner just throw in the towel and sell AOL?

As Goes the Housing Market, So Goes Advertising

Well, okay, that's a stretch, but the link between the prognosis for the housing market and the economy seems strong (as goes housing, so goes the economy), and when the economy stumbles, advertising is often the first expense to get cut.

In 2000, I shudder to recall, advertising-driven companies (on and offline) were the first to crater, and they were followed shortly thereafter by all manner of other industries, like dominoes.  Some will undoubtedly argue that, even if there is a recession, Google and Yahoo will be fine, because search and other forms of pay-per-event advertising have a crystal clear ROI.  These bulls will point to the success of GoTo (Overture/Yahoo Search) during the last recession as evidence: While the rest of the online world as we knew it was ending, GoTo grew like a weed. 

And to some extent, this is true.  Search should weather an economic storm better than other forms of advertising, because even penny-pinched advertisers will know where each search dollar is going.  But weathering the storm is different than being "fine", and some Google and Yahoo customers will cut back (if only because their customers are cutting back).  Also, when GoTo was powering through the last recession, search was a cute little $100 million business.  It is now approaching a $10 billion business, and, as such, is far more exposed to the vicissitudes of the economy at large. 

So as the housing market continues to weaken, do not make the mistake of thinking that this is an isolated micro-event that is irrelevant to the big boys of online advertising.  It isn't, and like the rest of us, Google and Yahoo will probably feel the pain.

AOL Spaces: Great Idea, Five Years Too Late

No, I haven't checked out the new AOL MySpace killer (AIM Pages), and, yes, I suspect this admission will prompt a dozen comment bombs railing about how analysts don't even bother to use the products of the companies they are analyzing.  So be it.  My prediction: Even if the AOL product is ten times as good as MySpace (whatever that means), it is going to bomb.

Why?

For the same reason that AOL instant messenger still dominates instant messaging: it's where the people are.  MySpace is about community, and MySpace has the community. Unless MySpace suddenly unplugs itself or sells out, the community isn't going anywhere.  (Yes, I know, the AOL product is built for AIM users, so there's a built-in community, but most AIM users who want MySpace-like features are probably already using MySpace).

True, for an AOL (and Time Warner) shareholder, this situation is agonizing.  AOL is about community, too--or was--and five years ago, AOL ruled the MySpace demographic.  All those people that today use iPods, MySpace, Skype, and craigslist?  Five years ago, they all used AOL.  Now, most of them wouldn't be caught dead using AOL.

Whose fault is this?  A combination of AOL's former management, who decamped to run Time Warner (and failed), and Time Warner's current management, who celebrated arrogant AOL's self-destruction right up until the moment they realized they, too, were going down with the AOL ship.  After finally waking up two years ago, they've made a few smart, bold moves, but only a few.  And, unfortunately, in the "space space," as well as in VOIP, portals, music, and a half-dozen other promising spaces, it's too little too late.

P.S.: I tried to find AIM Pages, after all, just to make sure I wasn't making an ass of myself.  I couldn't.  So perhaps the WSJ hallucinated.

P.P.S.: Given that MySpace is launching a Messenger product, there is probably a smart partnership or sale opportunity here.  Time Warner clearly doesn't want AOL.  There is clearly still value in AOL.  Perhaps Rupert would like AOL?  If nothing else, it would save MySpace the hassle of having to break into the IM market.

Disclosure: Yes, I still own the bag of rocks known as TWX.

So, How's adCenter?

As the WSJ describes, Microsoft's adCenter debuts this week, when it is opened to all advertisers instead of just the 6,000 in the pilot program.  adCenter is critical to MSN's future and critical to the industry's future, as it will determine whether the search industry will continue to be a duopoly or will move to a more normal structure dominated by a "big three." 

Advertisers want the service to succeed, so they will have options other than Google.  Microsoft needs the service to succeed, or any remaining chance it has to gain ground in the search business will be lost.  And whether or not the service succeeds is a critical question for Google, Yahoo, and both companies' shareholders. 

If it is true that Google generates 50% more revenue per query than Yahoo! (and more than 50% more than Microsoft), and if it is true that a major reason for this is Google's ad-selection algorithms, then a successful adCenter could have a meaningful impact on not only industry revenue share but Google and Yahoo's growth rates. 

Revenue to the search engines equates to spending by advertisers, so every dollar spent on Yahoo and Microsoft is a dollar that won't be spent on Google.  Microsoft generates less than 1/5th the search revenue of Google (probably much less).  Still, if adCenter can boost Microsoft's efficiency by, say, 100%, a circa-$1 billion business could become a circa $2 billion business, which would mean that Google's $7 billion business would grow $1 billion less than it might have otherwise.  Bottom line, even if Microsoft keeps sweeping out the cellar in the search wars, it can still play spoiler to the big dogs.

So, the key question is, how's adCenter?  The word one user I spoke with two weeks ago used was "chaos."  Anyone else have any impressions/experiences?

UPDATE:

IO Reader Victor aggressively challenges my logic above that search spending is a zero-sum game (see his comment).  His argument is that, as long as the ROI is there, advertisers will buy as much search as they can, so Microsoft can grow it's own revenue without affecting Google's growth trajectory.  I am not sure I agree that advertisers view search as a "cost of revenue" expense rather than a marketing expense, but I do think Victor has a point (to a point). 

If the ROI on Microsoft is much better than on Google (which is certainly possible in the early days of a successful adCenter adoption), I think you will see dollars flow to Microsoft at the expense of Google and Yahoo--i.e., the argument I made above.  As long as the ROI on Microsoft is the same or worse than on Google, and as long as the demand for good quality search inventory still exceeds the supply, Microsoft's growth should not come at Google's expense.

Yes to Yahoo-MSN, No to Microsoft-Buys-Yahoo

  After fumbling its opportunity to get in bed with AOL, Microsoft has one more way to gain the scale necessary to be a serious competitor to Google: Get in bed with Yahoo.  (I am extremely skeptical that the MSN-is-a-Microsoft-division strategy will ever work--a skepticism developed over 11 years of watching Microsoft make vow after vow only to peak in distant third place).

To be clear: Microsoft buying Yahoo would be a disaster--for both companies.  Yahoo would disappear inside the Microsoft beast, the talent would leave, the brand would get diluted, the focus would change, and the company would ultimately disintegrate.  MSN's biggest weakness has always been that it is merely a division, one designed to support the ongoing dominance of Microsoft's crown jewels (Windows/Office).  If Microsoft bought Yahoo, the latter, too, would become a subordinate division.

The smart play, described in today's WSJ's article, would be for Microsoft to give MSN to Yahoo! in exchange for a big equity stake in the combined company.  Yahoo-MSN (which should remain "Yahoo") would immediately have the combination of scale, media, and technology necessary to challenge the Google juggernaut, and if it was successful in doing so, Microsoft shareholders would benefit.  It is less clear that this move would be a positive for Yahoo, which means that Yahoo could probably extract a good price. 

Right now, given the egos involved (on display in the failed AOL negotiations), this seems a long-shot.  Microsoft has never experienced or admitted defeat on this scale, and selling the division would undoubtedly (and shortsightedly) be viewed as defeat.  Short of a Yahoo-MSN combo, Microsoft's other option, in my opinion, is to spin MSN out as a public company. 

AOL Ad Growth Solid, Bumps MSN to No. 4

AOL is still sucking wind (subscriber losses are accelerating), but its advertising growth is solid--up 26% year over year.  This compares to 79% for Google, 34% for Yahoo, and a pathetic 7% for MSN.  Those convinced that it is only a matter of time before MSN rules the world will no doubt find a way to explain why it is irrelevant that MSN has now lost its grip on "distant third place" in the web wars and is now No. 4 (by ad revenue).

According to TW CEO Parsons, AOL's ad growth was solid across all three categories: display, search, and Advertising.com.  AOL's big challenge, of course, is to stabilize the subscriber base.  Although AOL has an impressive amount of web traffic, advertising growth cannot continue at current rates if the subscriber base does not stabilize.  AOL's critical weakness is that each subscriber generates between 4x-10x the monthly pageviews as each web visitor (for more info, please see a Cherry Hill Research report from November, 2005, accessible at the bottom of this post).  This means that for every subscriber AOL loses--and it lost 835,000 in the last quarter--it must attract 4-10 times as many web visitors just to stay even (Cherry Hill Research estimates, see report above).  This will be challenging, to say the least.

Click Fraud Update: Arkansas, Armageddon, etc.

We've had much debate about click fraud on these pages, so I wanted to share some of the recent work we've done on the topic over at Cherry Hill Research.  I'll try not to bore you with updates on CHR, but when we publish something that is free to all and might be of interest, I'll post a link here.

Here are some of our current conclusions regarding click fraud:  (The full write-up at CHR is here.)

• The click-fraud concern is real, and the search engines must do a better job of addressing it.  This said, the problem is manageable and will not cripple the PPC industry.
• Increased awareness of click fraud (or, more accurately, the "invalid click" problem) will likely lead to increased spending on click-stream auditing by both search engines and advertisers.  This will modestly reduce ROIs for advertisers (and thus weigh on keyword prices) and modestly reduce profit margins for search engines.
• Google's settlement in Arkansas (if approved) will be a much bigger win for the company than we initially thought.  It will preclude all future class actions based on historical click-fraud claims, including a large one that has already been filed in California.
• The plaintiffs attorneys on the California class action, in fact, called the Arkansas settlement "the worst class action settlement in history" [from the perspective of the plaintiffs.]  From Google's perspective, therefore, the settlement might be described as the best in history.
• The settlement payouts are such that plaintiffs will receive not 'pennies on the dollar' but fractions of pennies, and they will receive them as rebates on future ad spending, not cash.  As far as legal exposure goes, therefore, Google CEO Eric Schmidt might have understated the case when he dismissed the click-fraud issue as "not material."  A more accurate assessment might have been "non-existent."
• The Arkansas settlement does not preclude future legal action for claims after the settlement date.
• Because Yahoo has not settled the Arkansas class action, the California case against Yahoo will continue.  Given the terms Google got, as well as the opportunity to settle all historical claims, Yahoo might be well-advised to settle in Arkansas immediately.

Our write-up at CHR includes links to several interviews on the topic, including Ben Edelman (Harvard spyware expert), Andrew Goodman (CEO of SEM firm), and a pissed-off advertiser.  We will be posting more interviews in the next few days. 

Hope you find the work interesting and/or helpful.  Look forward to hearing your thoughts.

Edelman on Click Fraud: Snarky, Real, and Hard to Control

Thanks to several Internet Outsider readers (and journalists) who pointed me toward Harvard PhD candidate Ben Edelman's recent work on spyware click-fraud at Yahoo!  Edelman articulates his research and findings in extraordinary detail, and provides screen shots, video, and packet logs as proof. 

As Edelman describes (see below), the click fraud he observes is different than the usual kind (competitors clicking on links, bogus AdSense sites, etc.).  This fraud is spyware-driven: PCs are infected with spyware that serves up Yahoo! ads and, in so doing, generates clicks.  Importantly, in these cases, the PC users do not actually click the ads--the spyware produces the clicks automatically.

Edelman's videos, packet logs, and cookie logs are enough to make even the most ad-hardened online user feel sick about what is going on inside his or her machine, and advertisers who pay real dollars for such activity will, at best, be infuriated. 

In one particularly sleazy instance, Edelman clicked on a text link within a New York Times story to find that the link had been inserted by a spyware program on his PC and launched an ad.  In other words, a NYT reader who thought he or she was clicking through to additional detail within an NYT story was actually clicking on a non-NYT advertisement.  The click, meanwhile, generated revenue for Yahoo! and the spyware vendor at the advertiser's (and the NYT's) expense. 

This kind of actiivity has got to go, and if Eliot Spitzer doesn't take care of it, someone else will.  In the meantime, along with other types of click fraud, it is artificially puffing up online ad revenue and market statistics.

Unfortunately, Edelman does not--and presumably cannot--say how widespread such activity is.  He also doesn't say whether Yahoo! already offers advertisers refunds on such behavior (although he implies that it is so hard to control that they probably don't).  So, once again, we are left to conclude that click fraud is real and is a problem--and left to wonder whether how big a real problem it is.

Edelman:

Many others have alleged click fraud at Yahoo. (1, 2, 3) But others generally infer click fraud based on otherwise-inexplicable entries in their web server log files -- traffic clearly coming from competitors, from countries where advertisers do no business, or from particular users in excessive volume (i.e. many clicks from a single user). In contrast, my proof of click fraud is direct: As documented and linked above, I have captured click fraud on video and in packet logs. Yahoo may argue about advertisers' inferences in other instances, i.e. disputing that advertisers have really found click fraud. But it's far harder to deny the click fraud shown in my examples.

In the examples I show above and previously, Yahoo's problem results from bad partners within its network. Yahoo syndicates ads to numerous partners, many of whom syndicate ads to others, some of whom then syndicate ads still further. The net effect is that Yahoo does not know who it's dealing with, and therefore cannot exercise meaningful supervision over how its ads are displayed. I consider this a bad idea -- bad business, bad for quality, bad for accountability. But Yahoo need not listen to me. Instead, consider instructions from New York Attorney General staff member Ken Dreifach: "Advertisers and marketers must be wary of fraud or deceptive practices committed by their affiliates, even [affiliates] that they have no working relationships with." (Quote from MediaPost, summarizing Dreifach's remarks.)...

The many bad partners in Yahoo's network make fraud particularly hard to block: When Yahoo terminates one fraudster, that fraudster's partners find another way to continue operations...

Analyzing Search Share Data

Third-hand search share data via Battelle, Bear Stearns, and Comscore shows that Google is still gaining U.S. share and everyone else is losing it (don't let that tiny blip up in Ask's share distract you--it's irrelevant).  A few thoughts:

Google is now at 42% of U.S. search, up from 36% a year ago.  In a market without monopoly characteristics, it is rare for a leader to have 50% of the market, but Google appears to be headed there.  The company's rate of share gain, therefore, can probably continue for a while.  Importantly, Google's rate of search query growth is decelerating rapidly, despite the share gain--from 38% in Q205 to 25% in Q405--although it appears to have recovered slightly in the first two months of this year.

Yahoo!'s continued share declines (31% to 28% Y/Y) are bad news.  Even as it falls farther behind Google, Yahoo! should still be gaining share from the likes of AOL, Ask, and MSN.  Worse, Yahoo!'s query growth has smashed into a wall: 42% growth in Q205 and -2% shrinkage in Q405.  Per CFO Sue Decker, Yahoo! has already given up on trying to be No. 1 in search.  With these numbers, however, even its scaled back goal--"maintain our current market share"--looks dreamy.

MSN's continued share declines (16% to 14% Y/Y) are really bad news.  Last week's post about the Microsoft re-org prompted many smart comments about how Microsoft has finally gotten it right and how Yahoo! and Google are now toast.  I realize that search isn't everything, but I would love to hear Microsoft optimists explain when, how, and why Microsoft's search share is going to stop declining and start growing and how big it is eventually going to get.  Because the actual numbers from the field suggest that MSN search is getting more irrelevant by the day.

Ask (6%, up 0.5%) and AOL (8%) are still--and in my opinion, will always be--fighting over scraps.  According to the "Rule of Three," most markets support three major generalists with an aggregate 70% share of the market and a handful of specialists with less than 5% each.  Companies with 5%-10% of the market are neither fish nor fowl, and fall into the "ditch."  The way out is usually to specialize, but Ask, at least, still has dreams of joining the generalist big boys.  For many reasons, this will likely be much easier said than done. 

Microsoft Doubles Down, Swallows MSN

For a few years, Microsoft has been standing at a fork in the road: Spin off its web and consumer businesses or integrate them deeply into the fabric of the company. The latest re-org suggests that, despite getting its head handed to it in the online business for the last 11 years, Microsoft has chosen the deep integration path once and for all.  Given what is at stake, this amounts to doubling down. 

Henceforth, MSN, et al, will be part of the "Online Businesses Group" which, itself, will be one of eight divisions within a massive Platforms and Services Group.  Yusuf Mehdi also seems to have finally been put out to pasture with the ceremonial title of chief advertising strategist, perhaps to make way for new blood.

As I've argued, I think this is the wrong route for Microsoft, at least if the company is serious about challenging Google in the search and advertising-driven web services business.  The more MSN is subsumed within the Microsoft whale, in my opinion, the more the web efforts will exist just to protect a dying Windows monopoly.  Integrating the Internet with Windows has done little to help Microsoft dominate the online business: Despite 11 years of effort, tens of billions in cash, a browser monopoly, a desktop monopoly, and thousands upon thousands of brilliant engineers, the best the company has ever been able to do is run a distant third.  I don't see anything in the latest re-org that begin to change this; instead, I think it will exacerbate it.

I also remain skeptical that a company that dominates the world of corporate IT (enterprise scale corporate software and productivity tools sold to Fortune 500 CTOs) can also dominate a media business, which is what search and portals services are and will remain.  The differences between the two businesses (and customer bases) are vast, and the conflicts will forever force compromise.

This isn't the end of Microsoft: the company's position in enterprise IT (and on some desktops) should be secure for decades.  It could, however, be the beginning of the end for MSN.

We Aren't Fa-mi-ly! TWC vs. AOL

After five years, Time Warner Cable has finally consented to allow its sister division, AOL, to be delivered over its cable pipes.  Of course, Time Warner Cable is not about to replace its own also-ran regional broadband service (Road Runner) with AOL's premiere national brand.  Yes, doing so would enable Time Warner shareholders to save gobs of money by eliminating software, data center, email, advertising, and customer service costs, but it would also mean that Time Warner Cable would actually have to embrace AOL as a partner instead of a competitor.  As Carl Icahn has observed, Time Warner divisions don't do that.

And then there's VOIP.  With its strength in online communications and 20 million pre-existing subscriber relationships, AOL is ideally positioned to compete effectively with Skype, Vonage, and others in the VOIP market.  Of course, this would mean also competing (sort of) with Time Warner Cable--and, at Time Warner, intra-divisional competition is only allowed if it's the old Time Warner divisions competing with AOL.  As Julia Angwin noted in a December WSJ story, AOL has yet to roll out its soft-phone VOIP offerings in Time Warner cable markets to avoid competing with Time Warner Cable's VOIP offering, thus depriving itself and its parent of the opportunity to gain a major soft-phone foothold in such markets. 

Never mind that this is the only period in history AOL will ever have a chance to break into the soft-phone market and never mind that Time Warner Cable doesn't have a soft-phone offering.  (Some) intra-divisional competition will not be tolerated!

At times, it seems the only one of Time Warner's 85,000 employees who is happy that AOL is still a division is CEO Dick Parsons.  Time Warner Cable management certainly isn't, Jeff Bewkes certainly isn't, and it's a safe bet that AOL management certainly isn't.  So here's hoping that at least one of Icahn's proposals finds its way toward becoming reality.

Disclosure: Unfortunately, I own TWX.

Lazard / Icahn Right About AOL

Financial archeologists will still be digging through The Lazard Report when the next ice-age begins, but the upshot is this: Bust Time Warner into four pieces, lever up, and buy back stock.  With regard to AOL, at least, this is a sound plan.  Not because Icahn and Lazard's platoon of analysts have discovered the secret to rebuilding the company--they haven't--but because AOL's imprisonment within Time Warner is a net negative.

As Lazard revels in pointing out, it didn't have to be this way.  The whole point of the AOL-Time Warner merger (aside from distracting investors from focusing on an imminent slowdown at both companies) was to make the conglomerate's various assets work together to form leading broadband music, movie, content and communications services.  Instead, Time Warner's offended senior managers exacted their revenge on AOL's condescending senior managers by snickering when AOL hit the wall and then refusing to have anything to do with the company.  Even today, Time Warner operates competitive and duplicative broadband services (AOL and Road Runner) and has become an also-ran in music, movies, and other online services that it should have dominated.  And although Time Warner management has recently shown some signs of waking up to this--and forcing cooperation--the company's longstanding culture of independent operating divisions seems to hold sway.  So cut AOL loose.

Thankfully, The Lazard Report said nothing about an idea Icahn floated a couple of weeks ago: Merging AOL with another second-tier portal.  One hopes this unfortunate brainstorm is gone for good.

MSN Falls Farther Behind

The press hype about a coming "war" between Google and MSN has mercifully abated in recent weeks, perhaps because it is becoming clearer that, far from being a credible Google challenger, MSN isn't even in the same league.

Last week, Microsoft reported MSN's December-quarter results, which were, in a word, weak.  Advertising revenue rose a dismal 12% year-over-year, continuing the deceleration trend of the last few quarters (by comparison, Yahoo!'s growth was 39% and a poor showing for Google will be in the 100% range).  Operating income dropped 55% to $58 million, as salesforce and developer headcount ramped.  Any indication that this investment will ever pay off will have to wait for another quarter.

The key to MSN's recovery (and relevance) is search, and search revenue was awful.  The company's display advertising revenue grew 20%, only half of Yahoo!'s growth rate but far better than MSN search, which apparently posted growth in the low single digits due to a 20% year-over-year drop in revenue per search.  The company attributed this trend to the adCenter ramp-up (Overture's revenue per keyword is presumably higher than adCenter's) and weak performance from third-party partner sites.

The one important bright spot--and, considering the rest of the division's performance, it's a head-scratcher--is that search query growth was in the "low to mid double digits" (presumable translation: 20%-45%).  This means that all is not lost.  If the company can get its act together and stabilize revenue-per-search, query growth alone should produce nice revenue growth.  Based on recent trends, however, this seems anything but a lay-up.

As argued here, MSN is, at best, competing with AOL for distant third place in the web wars.  The December quarter results--combined with AOL's recent partnership with Google and broadband distribution deals--suggest that MSN is even losing ground in this race.  Google, meanwhile, is so far ahead that it's not even visible over the horizon.

Bravo! More Signs of Intelligent Life at AOL

Well, it took five years, but AOL has finally plugged the Titanic-sized hole in the bottom of its hull.  This morning, the company announced multiple broadband deals that, together, should allow it to offer an AOL broadband solution to most of the million-odd subscribers who call up to quit each quarter.

The big problem with AOL's "portal strategy" has been that the vast majority of the people who use the portal are AOL subscribers, who are unknowingly dumped there when they click links and buttons within AOL.  When subscribers defect to broadband services, therefore, they take their portal pageviews with them.  Until now, AOL has had no credible solution to offer broadband-bound defectors; rather, it has simply had to beg and plead with them to keep the AOL service or, at least, their AOL email address, and occasionally come back for a visit.  Unfortunately, only about 1 in 4 broadband defectors have been doing this.

Now, however, the company should be able to offer the broadband defectors better broadband deals than they can get with their local cable or telco (most of the new plans are priced at $25.90, less than many AOL-less broadband offerings and only a couple of dollars more than AOL's all-you-can-eat dial-up plan).  If the company can smoothly integrate the conversion process, moreover, it should be able to allow subscribers to upgrade to broadband with much less hassle than it would take to leave the company. 

Bottom line, therefore, the broadband offerings should allow AOL to increase its "save rate" of defecting subscribers, and thus retain their precious eyeballs.  The new rate may encourage some of the lazy cash-cow $23.90 subs who wouldn't have converted to convert, thus resulting in a near-term cash flow hit (because AOL is likely only getting a few dollars of subscription revenue share from its broadband partners, as opposed to $10 or more of operating profit from the fat-margin dial-up subs).  By sacrificing some cash in the near-term, however, AOL is giving itself a better chance to survive over the long term--something that Time Warner shareholders should applaud.

(For more on AOL's key problems--and why this move is critical to fixing them--please see the Cherry Hill Research report linked to in this post.  Thanks to Forbes.com for the heads-up.  Disclosure: I've owned the lead balloon known now as TWX for the better part of a decade )

AOL: Talk About Underwhelming

After weeks of secret strategizing and planning about a bold new future for AOL--interrupted only by an occasional press release complaining about how crappy a job Time Warner management is doing--Carl Icahn and team have finally leaked word about how they're going to save the erstwhile colossus: By merging it with another second-rate portal. 

Details, it is said, will be released next week.  Excuse us if we don't wait on the edge of our seats.

AOL-Google Deal Even Better In Details

Thanks to leakage, trial-balloons, and market conditioning that would do the White House proud, there wasn't much news in the TimeWarner-AOL-Google press release.  If anything, though, the deal looks even better than previously described.

For example, Google agreed to "white label" its search technology for AOL so the AOL sales force will be able to sell search within the AOL properties.  This should not only invigorate the sales force, but allow the company to get a quick if modest bump in advertising revenue.  Per the New York Times, Google also agreed to give AOL $300 million in marketing credits (links within Google to AOL content), which should drive significant amounts of new traffic to AOL--and traffic of a different demographic than AOL's core user base (teenage girls).  The two companies will also link their messenger products, creating a powerful alliance against Microsoft and Yahoo! and allowing Google Talk to become slightly less irrelevant.

Although Google purists are bemoaning the company's lurch toward "evil" by helping a partner figure out how to game the search engine and by agreeing to plaster some of its pages with banner ads, Google shareholders should be applauding this move: Google's search business is amazing, but if disaster is to be forestalled, the company's future growth cannot and should not depend on search alone.  As for the $1 billion investment, this is relative chump change (two quarters of cash flow or 1/4 of the $4 billion Google raised a few months ago by selling a tiny percentage of itself), and Google now owns a piece of a company that can help it improve its weak communications and content capabilities while generating meaningful revenue on the side (a run-rate of $600 millionish).  And, who knows, it might even turn out to be a good investment.

The deal will not save AOL, so the backslapping in Dulles and New York shouldn't last too long.  The company still needs to find some way to migrate its fleeing dial-up subscribers to broadband plans (cable, DSL, wireless, or BPL--the subscriber's choice), and until it does this, it is screwed.  Still, the Google deal addresses one of the company's big problems (more web-only traffic to the portal), and, Carl Icahn notwithstanding, is a big step in the right direction.

Icahn is Wrong About AOL-Google

Time Warner gadfly Carl Icahn has peed all over the AOL-Google deal, worrying that it might prevent AOL from pursuing a more shareholder-friendly tie-up with the likes of Yahoo!, MSN, eBay, or IAC.  And, as always, he has yet again threatened to hold Time Warner board members personally responsible.

I'm all for dissident shareholders, and, until recently, I've been mostly all for Carl Icahn, but he is beginning to sound like Johnny One Note.  With this latest salvo, moreover, he's wrong.

Just a few days ago, Icahn was quoted as saying that he and Time Warner CEO Dick Parsons were just a couple of guys from Queens who knew nothing about the Internet.  Today, he's online expert enough to suggest that AOL (or at least AOL shareholders) would be better off with almost anyone else.  In support of this, he invokes a Goldman Sachs report arguing that the best AOL marriage would be with eBay or IAC.

Give Goldman credit for originality, but strapping AOL to eBay would be like hanging a concrete block around the neck of an eagle.  eBay has problems, but they wouldn't be fixed by adding a massive dying revenue base and thousands of employees in an entirely different business--and eBay's assets certainly wouldn't fix AOL's problems.  If well-executed, the Skype-AOL connection would be a good one, but the companies don't have to merge or exchange equity to strike a deal like that.

As for IAC, AOL might be "complementary" in the sense that IAC doesn't have any business that looks like it (although they have almost every other business).  But "complementary" in this sense would not save AOL from being the No. 3 or No. 4 player in a market that will likely only support three players at most.  The only way out of that trap is to switch businesses (easier said than done) or partner/merge with one of the other three.

What Icahn is really up in arms about is a potential loss of flexibility from the Google deal: Too tight a partnership, he worries, and Time Warner will lose the ability to pawn AOL off.  This view ignores a few critical points:

First, in its current state, AOL is dying.  Without a deal like the one with Google, which should turbocharge AOL's traffic (at least temporarily), the company will slowly bleed to death.  If Time Warner cowers in fear of Icahn and does nothing, therefore, the amount the hypothetical buyer will be willing to pay for it will likely decrease by the day.  If a deal like the one with Google can help turn the company around, however, then AOL's value will jump--something that will be recognized by the market, whether or not the company is sold.

Second, a deal with Google should deter no buyers except, perhaps, MSN and Yahoo!, and even these two could just buy out Google and insist on a renegotiation of the partnership terms (if they didn't like the deal, which seems unlikely).

Third, the Google deal will not harm Time Warner's ability to spin AOL off in an IPO, an event that should "unlock" at least as much value as a sale (although I'm not convinced that the market is wildly undervaluing AOL within Time Warner, contrary to the opinions of most observers).

Google-AOL Not Just Defensive

Lots of commentary over the weekend suggesting that Google's play for AOL was just a defensive move designed to keep its AOL revenue, keep AOL out of the hands of Microsoft, and keep Microsoft irrelevant in search.  Although the deal will almost certainly accomplish all of these (MSN will now be alone in a distant third), there are plenty of offensive reasons for Google to do the deal as well.

I listed a few in the previous post (complementary user-bases, access to AOL's strong communications platform, and access to AOL's portal expertise), and Battelle and others added a few more over the weekend.  Battelle's thought?  Google is just doing what AOL used to do in the good old days: invest in a company and, by means of the investment, make the company much more valuable--and then reap a huge windfall in a subsequent liquidity event.  Back in the late 1990s, AOL did this with dozens of dotcoms, and, as Battelle points out, Google has clearly been infusing companies with value for several years now.

The problem with the theory in this case is that Google's $1 billion won't save AOL--although the incremental traffic it will drive to the portal via preferred links within Google should be a big help.  Unless/until AOL reverses its traffic, revenue, and operating income declines, the idea that it's worth as much as, say, Yahoo!, by virtue of a bigger revenue base isn't very convincing.

I still think AOL can be saved.  I also think it's going to be hard to do it with the company still in the arms of Time Warner.  But a deep partnership with Google can only help--and certainly much more so than a half-assed JV with Microsoft.

Time Warner, AOL, Google Menage

On the verge of apparently doing a disastrous sales-force combo with MSN, Time Warner has reportedly pulled a positive AOL deal out of the hat.  According to the WSJ, Time Warner's new partner, Google, will fork over $1 billion for 5% of AOL and remain AOL's search partner, and AOL will get free links to its content embedded deep within Google's pages.

On its face, this seems a good deal for all three companies--and a bad one for Microsoft.

Time Warner gets another $1 billion in cash to pay down more of its debt, gets to crow that AOL is worth $20 billion (which is apparently 2x the value the Street places on it--although this may just be media analysts overestimating the value of Time Warner's other properties), and gets to flip shareholder gadfly Carl Icahn the bird.

AOL gets to avoid switching search horses and, thus, risking the possible disruption and poor performance that might have been expected from an untested system from Microsoft.  More importantly, it presumably gets boatloads of much-needed traffic to its portal from Google.

Google, meanwhile, gets to keep AOL as a search customer (approx. $400 million in revenue and $50 million in gross profit) in exchange for some chump change from its cash hoard.  It keeps its fingers deep within the AOL portal pie, which is a positive because, despite its indignant denials to the contrary, it's headed straight for portal-dom.  It gets to keep its brand in front of AOL's demographic (Internet newbies and teenage girls), which has little overlap with its own demographic (web-savvy professionals).  And, perhaps most importantly, it gets to own a piece of a company that is strong where it (Google) is weak: communications.  Properly exploited, AOL's IM and mail products could improve the outlook for Talk, gmail, etc.

The deal won't solve everything: If AOL is to survive, it still needs to figure out a way to toss of the strait jacket of Time Warner's other divisions and cut some broadband, DSL, and VOIP deals in a hurry.  But it's a step in the right direction.

And MSN, meanwhile, must now be feeling even more lonely and forlorn than before.  Time to cozy up to Yahoo.

Steve Case to Time Warner: Free AOL

The former CEO of AOL, Steve Case, broke his silence on the fate of the company yesterday, arguing in favor of a break-up of Time Warner and a stand-alone AOL (the latter idea being one that I've flogged in numerous posts here and here).  Although Case & Co. must take responsibility for pursuing a merger that, in hindsight, probably had little chance of success, much of the damage to AOL has occurred in the years since the humiliated AOL old guard has been pushed out of Time Warner.

Specifically, Time Warner's management's refusal to take the lead in forcing the company's competing divisions to cooperate instead of competing with one another (or, at the very least, to allow them to compete) has obliterated the whole reason for the merger and made AOL next to irrelevant in high-speed services, Internet telephony, music, and other industry segments that it could have dominated.  If AOL bleeds to death, it will be Time Warner's current management, not AOL's old one, that should be held accountable. 

Case also pisses on the idea of a joint venture or other half-measure as a fix, another sentiment I very much agree with.  Last week's floated idea of combining sales-forces with MSN was one of the worst yet.

AOL Leaking People, Too?

One executive departure does not an exodus make, no matter how much the media tries to make a trend out of it.  Still, the WSJ's implication that the recent leap of an AOL bigwig to the VC firm Mayfield is the result of AOL's poor prospects and Time Warner's endless dithering over the fate of its most infamous division does not seem far-fetched. 

As suggested here, one of the challenges AOL and MSN face, as they try to remain relevant in a world dominated by multi-billion-dollar, laser-focused pure-plays, is retaining their best people.  When such folks can go out and potentially make tens, hundreds, or thousands of millions of dollars from stock options at an inspiring Internet company hell-bent on changing the world, or tens of millions in cash at a VC firm funding dozens of such companies, what, exactly, is the motivation to toil away in relative obscurity for relative peanuts in one operating division of a massive global conglomerate focused on another business (old media, PC software)?   

Yes, all this will change if the world ends again.  But when, exactly, is that going to happen?  And how many more billionaires will be created in the meantime?  If AOL and MSN remain shackled to their parental behemoths the best their employees can hope for will be generous helpings from the annual bonus pool and pats on the head from senior managers whose real priorities are elsewhere.  If they parachute to the right start-up, however, or even to a promising established pure-play?  Well, let's just say it's a lot easier for a $100 market value to jump 10- or 100-fold than a $100 billion market value.  And you also get the added bonus of not having to deal with their requisite infighting, entitlement, denial, and politics of legacy businesses.   

AOL: Dead Man Waking

Another proactive move from AOL, this time a lead investment in--and distribution deal with--online-TV enabler Brightcove.  (Diller and Hearst are in there, too, and Diller will get a seat on the board). This is exactly the sort of thing AOL must do to attract web-only traffic to replace departing subscribers.  One hopes this recent flurry of AOL activity is not too little, too late, but it's nice to see that the deposed heavyweight champ has some fight left.  And hats off to Time Warner for (finally) getting out of the way.

From the press release...

Brightcove offers a complete Internet TV service for video publishers ranging from small independent producers to major media companies who want to build their businesses by distributing and monetizing their video programming through a variety of broadband channels including their own web properties, networks of web affiliates, and other consumer-facing Internet services.

As a result of the content distribution agreement with AOL, the largest investor in the Series B round, video publishers using Brightcove will have the option to syndicate their video content directly to AOL.com (http://www.aol.com), and the companies will market a co-branded version of the Brightcove service as the self-service platform for publishing video on AOL.com. Moreover, through the syndication to AOL, publishers will be able to generate revenue from the advertising and pay media sales of their content on AOL.com and other video gateways on the AOL network of web properties.

While Time Warner Negotiates, AOL Bleeds to Death

It seems to me that none of the rumored partnerships--AOL, Google, or Comcast--will be enough to save AOL.  In my opinion, what is needed is another bold, bet-the-company move, similar to the recent removal of the garden wall or the switch from per-hour to flat-rate pricing back in the mid-1990s.

What most observers miss is that the company cannot just be chopped in half and the subscription business left to die.  In addition to producing most of the operating profit, the subscription business produces most of the company's page views--and without them, there would be no "content" business.  As previously described, according to Time Warner, each "subscriber" amounts to about 2.5 users, and each of those users tends to generate about 2.5 times as many pageviews as the average non-affiliated web user.  Which means that, for each subscriber the company loses, it must attract about 5 new web users just to stay in place.  And subscriber losses are accelerating...

As a result, the company must find a way to stem the subscriber bleed, even if it means signing broadband distribution deals that only generate, say, $3 per subscriber per month (like Yahoo!).  Such a move would obviously wreck the company's cash flow in the near-term, which is why it is unlikely that parent Time Warner would ever pursue it.  But it is probably also the only kind of move that will save the company over the long-term. 

A merger with MSN or Google would help AOL, as would a distribution deal with Comcast.  But, in my opinion, none of these moves alone will save the company.

For those interested, we explored these issues in more detail in a recent Cherry Hill Research Report: The Outlook for AOL: The Accelerating Bleed and What Must Be Done to Stop It.  Disclosure: I own Time Warner and Microsoft stock. 

Download the_outlook_for_aol_chr_november_2005.pdf

AOL and Time Warner Finally Cooperate

It took five years, but AOL and Time Warner are finally doing what they should have done five minutes after the merger: working together.  Starting in January, AOL will make old Warner sitcoms available for free viewing online, with viewers having only to suffer through a fifteen-second commercial to stream them (details on MediaPost).

How many people will want to watch old sitcoms online?  Who knows.  Making some money from the shows, however, is better than making no money.  Owning and controlling the shows' point of online distribution, moreover, seems to preferable to letting someone else (Google) own and control it.  Most important, the deal demonstrates that AOL is focused on at least one of the two key strategies it must pursue if it is to survive.

Right now, AOL is bleeding to death.  Subscribers still generate most of the pageviews on AOL's web properties, and the company is losing subscribers at the rate of approximately 650,000 a quarter.  According to Time Warner, each subscriber represents about 2.5 unique users (in a household), and each subscriber unique user generates 2.5 times as many pageviews as the average web-only unique user.  So each time a subscriber quits, AOL loses the pageview equivalent of approximately 5 web-based users.  To staunch the bleed, therefore, AOL must do two things:

1) Find ways of retaining more subscribers.

2) Find ways to attract more people to the web site.

The Warner deal falls into the latter camp.