America Online, Inc. Business Information, Profile, and History

Company Perspectives:

America Online's Vision: To build an interactive medium that improves the lives of people and benefits society as no other medium before it. America Online's Mission: To build a global medium as central to people's lives as the telephone or television ... and even more valuable.

History of America Online, Inc.

America Online, Inc. is the largest provider of branded information services that are delivered to customers' personal computers (PCs) over phone lines. The company's America Online service and CompuServe service, acquired in 1998, include a wide variety of electronic mail facilities, bulletin boards, conferences, and classes, as well as software, games, and online shopping. America Online's trademark has been easy-to-use, visually oriented services that make the online environment accessible and not intimidating to ordinary customers. America Online got its start in the mid-1980s as an adjunct offering for owners of one type of personal computer and expanded by branching out to other brands. In the 1990s, America Online's offerings were restructured and updated for more current operating systems, and, after the institution of an aggressive marketing drive, the company's customer base skyrocketed. Initially a niche-based product, America Online later expanded through agreements with a wide variety of computer manufacturers and media companies, considerably broadening its offerings and its reach.

Company Origins

America Online was founded by Stephen M. Case, a marketer who worked in the consumer division of PepsiCo Inc. In 1982, Case became intrigued by the possibilities of interacting with other personal computer owners through electronic telecommunications. At the time, there were small networks available for use, including the sharing of news and other data, but they were extremely difficult and cumbersome to use and, as a consequence, were mainly employed by computer buffs or other specialists in the field. Case reasoned that the demand for online computer communication would be much greater if it was easier for people to use.

In 1985, Case got an opportunity to put some of his ideas into practice when he formed Quantum Computer Services, Inc., in partnership with Commodore International, Ltd., a leading manufacturer of personal computers, and Control Video. Using $2 million in venture capital, Case created an exclusive online service for owners of Commodore computers. The deal worked well for both partners. Commodore had an added selling point for its products, and Quantum had a ready-made pool of customers for its service. Named "Q-Link," the service consisted of a few rudimentary bulletin boards, to which users gained access from their personal computers via a telephone modem.

Within two years, the Q-Link concept had proven its merit. Quantum's revenues had reached $9 million by 1987, and the company had started to turn a profit. With the Commodore Q-Link service as a model, Quantum then branched out to offer programs to owners of computers made by other companies. First, the company set up an alliance with the Tandy Corporation, which manufactured IBM-compatible computers. In November 1988, online services for owners of IBM-compatible PCs were introduced. Later, Quantum also began offering services to owners of Apple computers. This service began in September 1989, after a dispute with Apple about whether its name would include the designation "Apple." As personal computers became cheaper and more plentiful and as new, more powerful software and modems were developed, Quantum's subscriber base grew quickly and the company boomed.

In October 1989, Quantum introduced a new nationwide network for computer owners under the name "America Online." Two years later, the company changed its name to that of its main offering. At the same time, the company began to reorganize its operations, consolidating the services it offered to owners of different computers and focusing its efforts on the IBM-compatible and Macintosh market.

In addition, America Online undertook an ambitious marketing campaign to increase the number of its subscribers. Each customer who signed up for the America Online service was charged $7.95 a month for the first two hours spent on the network, and then ten cents a minute after that. In mid-1991, the company expanded its pool of possible subscribers when it introduced services for IBM-compatible computers using DOS operating systems.

Strategic Alliances in the Early 1990s

As part of its push to expand its subscriber base, America Online devised a number of creative ways to attract new users. In keeping with a policy of growth through strategic alliances, America Online entered into a joint venture with the Tribune Company, the owner of the Chicago Tribune, in an effort to ease its move into the Midwestern market. America Online created a news and information service designed especially for Chicago by making use of materials from the local daily paper. The product was a success, as thousands of Chicago residents began logging on to the service to exchange opinions on local politics, team sports, and other issues. In addition, America Online gained further capitalization from the deal, as the Tribune Company bought a 9.5 percent stake in the company for $5 million.

In another such arrangement, America Online teamed up with a group called SeniorNet, an organization formed to encourage senior citizens to use computers. With its 5,000 members, SeniorNet provided a new source of customers for America Online, which paid the group a premium for every new member who signed on. In return, America Online offered specialized programming to attract seniors, instituting special news and bulletin services covering topics of interest to them, such as healthcare.

Case described America Online's strategy as being focused on exploiting niches, such as those formed by the senior citizens group. Rather than trying to enroll the general population, as some larger network services did, America Online turned a profit catering to smaller special groups. "We see ourselves as a series of specialized magazines catering to specific interests," he told Business Week in 1992.

In May 1992, America Online capitalized on its history of solid growth when it sold stock to the public for the first time. The company's offering was greeted with enthusiasm, and its stock price rose sharply. At the end of June 1992, America Online reported its fifth annual profit in its last six years of operation. The company's revenues had reached $26.6 million, yielding profits of $3.5 million, a stark contrast to the persistent red ink generated by its larger competitors in the online services field. Continued growth and profitability appeared likely, as America Online's subscriber base grew rapidly, increasing by nearly 50 percent every 12 months.

At the end of 1992, America Online announced another important strategic alliance when Apple Computer Inc. signed a licensing and development agreement with America Online to use its technology in Apple's own future information services. The company was to earn $15 million from the agreement over five years. In addition, Apple contracted to pay for America Online's conversion of its technology for use on Apple machines. The two companies announced that they intended to improve the America Online technology and develop it into an industrywide standard for online information services. This joint venture lent weight and authority to America Online's efforts to expand its market share beyond the 10 percent it then held.

In January 1993, America Online expanded its offerings further, introducing an online service designed especially for the Windows operating system. As users of IBM-compatible computers moved in droves to the new, easier operating system, America Online saw an opportunity to convert them to its own graphically based online environment. The America Online Windows service featured the company's trademark high-quality graphics and ease of access and quickly became the most popular new product America Online had ever marketed.

America Online formed another corporate alliance when it reached an agreement with the Sprint Corporation, a long-distance telephone company, in April 1993. In return for discounts on the telephone usage that America Online needed to send its service out to users, America Online gave Sprint a large package of stock options.

Rebuffs Microsoft

By the spring of 1993, America Online's success had attracted the interest of another innovator in the computer industry, Paul G. Allen, a cofounder of Microsoft Corporation. When Allen's stock holdings in the company began to approach 25 percent of America Online's outstanding shares, the company's board of directors moved to prevent him from threatening America Online's independence by adopting a secret shareholders' rights plan that would go into effect if any one party's holdings in the company topped one quarter. In response, Allen filed documents with the Securities and Exchange Commission indicating his interest in acquiring America Online. He also stated that he might seek a seat on the company's board of directors and reported that he had refused to sign a statement proposed by America Online promising that he would not involve himself any further in the company's affairs.

Case and other America Online executives were concerned that any one overwhelming alliance would limit America Online's ability to maneuver and negotiate with other companies. "We've built this company by establishing strategic alliances with a wide range of companies, and we believe it's the best strategy for the company to remain independent," he told the Wall Street Journal. On May 11, 1993, Allen met with America Online executives and proposed that America Online and his other high-tech ventures work together to develop software for use in multimedia formats. This overture was initially rebuffed by America Online. Ultimately, Allen withdrew from his attempt to increase his involvement in America Online, as the two parties worked out an agreement to collaborate on some future endeavors.

The fruits of another America Online alliance were unveiled in June 1993, when Casio, Inc., and the Tandy Corporation, two computer manufacturers, introduced the "Zoomer," the first in a new generation of products called personal digital assistants. This device incorporated software developed by America Online to offer electronic communications, such as fax, electronic mail, and access to other online services. The company believed that devices of this sort would open the interactive services market to a much broader segment of the population. Consequently, it agreed to work with Apple on its hand-held Newton product and with Sharp on its Personal Digital Assistant.

Booming Subscriptions in 1993

By the end of June 1993, America Online's annual revenues topped $40 million, an increase of 50 percent over the previous year. In addition, the company's subscriber base surpassed 300,000, an increase of more than 60 percent. Not surprisingly, these gains made America Online the country's fastest-growing commercial online services company. By September, America Online's consumer base had grown even more, as an additional 50,000 customers logged on, pushing subscriber growth to 80 percent.

As America Online's subscriber base grew exponentially, the company began to move away from its early emphasis on niche marketing--the strategy that had provided its initial growth and profitability&mdashøward a stress on a broader array of services that would appeal to its new, broader selection of customers. As part of this effort, the company took a number of steps. It announced that it would offer access to the Internet, a consortium of smaller governmental and academic computer networks that was run as a cooperative. In this way, America Online hoped to tap into the popularity of the Internet, with over 10 million users in more than 50 different countries. The Internet was known as a difficult online environment to master, but America Online hoped to simplify its use by offering its customers access to the network through its own software.

In addition to its Internet venture, America Online also embarked upon a series of alliances with media companies. The service added features from the Knight-Ridder newspaper chain, Time, Omni, the Atlantic, and the New Republic, among other magazines, and from the cable network CNN. America Online also joined a branch of the Disney entertainment conglomerate called Disney Adventures.

Along with its expanded offerings, America Online instituted an aggressive marketing program to insure that its subscriber base would continue to grow at a healthy rate. The company started selling membership kits at bookstores and computer supply stores and also began to have starter disks bound into selected computer trade magazines. In addition, America Online continued to pre-install its software in many computers, making it particularly easy for new computer buyers to join the online community. Manufacturers incorporating America Online software into their products included IBM, Apple, Compaq, AST, Tandy, NEC, and Compudyne. Finally, in an effort to make its service appear more economical, America Online revised its pricing structure, lowering some costs. Although this move would have a negative impact on the company's revenues, America Online believed that this would be offset by the fact that more people would sign up and those who were already signed up would keep paying for the service longer.

By October 1993, America Online's campaign to increase its subscriber base and enhance its market share had pushed its number of users past 400,000, as its blistering pace of growth continued. The size of the company's customer core had more than doubled in the previous 12 months. In the same month the company reported that quarterly revenues had also doubled in the year before. In addition, the company's web of media linkages became more complex, as it brought online National Public Radio, the San Jose Mercury News, and a number of publications produced by Matra Hachette, the world's largest magazine company. In November 1993, America Online sponsored an "interactive event" with Christian evangelist Billy Graham. At a prearranged time, America Online users could send messages to Graham through their computer and receive general or, possibly, personal messages in return.

At the start of December 1993, America Online took another step to maintain its position on the cutting edge of information technology when it announced that it would participate in California with three other companies in delivering its interactive service to customers through a cable network, instead of through a telephone line hooked up to a modem. Cable delivery paved the way for fuller integration of video and sound into the multimedia mix of text and graphics already provided through personal computer-based services. In this way, America Online hoped to position itself to survive and thrive in a changing information services market and mitigate the danger that advances in technology would leave its offerings behind, or that huge information, communications, and computing behemoths, such as AT&T and Microsoft, would move into a revolutionized marketplace and squeeze smaller competitors such as America Online out of business. To this end, the company also announced plans to work with General Instrument, a manufacturer of cable television equipment, to develop services for interactive television.

In addition to these futuristic plans, America Online continued to strengthen its position by adding subscribers, whose number had passed the half-million mark by the end of 1993, and by adding media partners, including Rodale Press, a health and fitness magazine publisher, a reinvented online Saturday Review, and the New York Times. In the area of hardware alliances, America Online added Dell and US Robotics to the list of manufacturers that incorporated America Online products into their own.

By the end of January 1994, America Online's subscriber base had topped 600,000 members, and quarterly revenues had grown by 130 percent, as the company's customer base continued to skyrocket. "The unprecedented demand for America Online has caught us by surprise," Case announced in a company press release. "Our focus now is on expanding our infrastructure." As part of that process, America Online cemented its second agreement with a major television network when it added NBC Online to its offerings. In addition, at the end of January 1994, the company announced a further use of the network's interactive capabilities when it joined with Shopper's Express to provide a grocery and pharmacy ordering and home delivery service.

The company's subscriber base grew rapidly throughout 1994, soon exceeding a million subscribers. The same year, American Online acquired Redgate Communications, a multimedia developer, and Booklink Technologies, an Internet browser software developer. Strategic alliances continued to play a prominent role in America Online's growth. To gain access to the European market, the company joined forces in 1995 with the media conglomerate Bertelsmann to offer online services. Within two years, the partnership had more than 800,000 subscribers in Europe. That same year, an alliance with Intuit, maker of the popular financial software Quicken, brought electronic banking services to America Online users.

Facing increased competition from direct Internet providers, America Online sought to add value to its Internet access. In 1995 the company bought WAIS and Medior, two Internet-related businesses, to help AOL subscribers publish their own Web pages. By 1996, however, America Online was still losing customers to direct Internet providers. To stem the tide of canceled subscriptions, America Online began providing Internet access for a flat rate.

Struggling with Rapid Growth in the Mid-1990s

New subscribers, however, more than made up for those lost to direct Internet providers. Aggressive marketing brought in hordes of new subscribers. A major marketing tactic employed by America Online was to send out millions of free trials of AOL on diskettes, bundled with products as various as magazines, boxes of cereal, and Blockbuster video rentals. By the end of 1995, America Online could boast 4.6 million members, more than quadruple its subscriber base from a year before. However, the marketing costs and the rapid expansion in infrastructure required by so many new subscribers ate every dime of profit. Although America Online had reported a few scattered profitable quarters, it could only do so by treating its marketing expenses as capital costs. Although not illegal, the practice was heavily criticized, and America Online changed its accounting methods in 1996. As a result, the company took a $385 million write-off that year.

Rapid growth had other drawbacks as well. In December 1996 America Online changed its subscription fees from a per-hour access charge to a flat monthly rate with unlimited access. The resulting boom in online usage by its subscribers not only left many customers unable to access the system, it also resulted in the system overloading and crashing several times. Facing lawsuits from several states, America Online was forced by regulators in 1997 to offer refunds. Despite the refunds, the debacle left customers, content providers, and advertisers all distrustful of the online service's reliability.

The company attacked the traffic problem by building up its infrastructure. To accommodate almost three million new subscribers in 1997, America Online had to invest $700 million in its access network and in customer service. Although the company cut back on marketing (reducing the cost of attracting a new subscriber from $375 in 1996 to $90 in 1998), the shift in funds was not enough. Cost-cutting, including employee layoffs, played a significant role, but generating revenue from advertisers and retailers was the real savior. America Online worked out lucrative deals with retailers who wanted access to AOL's subscribers. For example, Preview Travel paid $30 million to be the exclusive travel agent on AOL, and Barnes & Noble struck a similar deal for $40 million. Although advertising took off more slowly, it still proved an important source of income for America Online. The brokerage firms E*Trade and DLJdirect both paid almost $500,000 in 1998 for ad space on AOL's personal finance channel. Revenues from advertising and commerce were 93 percent higher in the last quarter of 1997 than they were in the same quarter in 1996.

As profitable quarters accumulated, America Online's stock rose in value, reaching $80 a share and then splitting two for one in 1998, the fifth time since 1994. The company still struggled with customer service problems, however. System outages and e-mail problems occurred occasionally, and some customers complained about the proliferation of pop-up advertisements and distracting banners.

America Online began an aggressive program of acquisitions in 1998. In February AOL acquired CompuServe's 2.6 million subscriber base, its content operations, and $175 million in cash through the sale of Compuserve's transmission network to telecommunications provider WorldCom. Because CompuServe focused on more sophisticated online users, including small businesses and professionals, America Online decided not to merge the service into its existing offerings. The company established separate divisions, AOL Interactive Services and CompuServe Interactive Services, which together controlled over 60 percent of the market. In June of the same year, the company purchased ICQ, the largest Internet chat service in the world.

But in November, America Online announced an agreement for its biggest purchase yet, and one that could transform the company into a serious rival of industry giant Microsoft. The $4.2 billion deal to buy Netscape Communications would give America Online the expertise of a highly influential Internet access provider and its respected software tools. In addition, America Online brought in Sun Microsystems, maker of high-end workstations and the programming language Java, as a supporter of the merger. Sun agreed to license the AOL/Netscape software for three years for $350 million, and AOL agreed to buy server computers from Sun worth $500 million. According to the Economist, the combination held a great deal of promise: "The strategy looks impeccable. AOL has shown a capacity for re-inventing itself that has dumbfounded rivals and skeptics alike. Sun is a genuine technology heavyweight; together, the two companies certainly have the ability to make more of Netscape's assets than Netscape could have done on its own. But it will not be easy."

Principal Subsidiaries: The Imagination Network; Redgate Communications Corp.; CompuServe Interactive Services, Inc.

Principal Divisions: AOL Interactive Services; AOL Studios; AOL International.