Free access ISPs aren't becoming extinct - they're evolving Based on the hand wringing during the past few months since several free access ISPs dropped off the landscape, many might guess that the species is going the way of the hairy-nosed wombat. It's not extinct yet, but the obit writers are pounding furiously at their keyboards.
However, upon taking a closer look, it seems clear that what is happening in the free ISP space is exactly what has happened in thousands of industries and marketplaces before it: an evolutionary shakeout.
The strong are getting stronger, the weak are going away, and those that are surviving are doing so in part because they started with a better business plan and learned to adapt to their environment. The difference between the evolutionary path taken by the free ISP marketplace and that of other marketplaces is that the shakeout seems to be occurring at an accelerated clip.
To be sure, with Spinway, 1stUp and OneRamp going out of business at roughly the same time, and Freewwweb and WorldSpy being gobbled up by a bigger, stronger competitor in Juno Online Services, it is obvious that mistakes were made by many in assessing the free ISP market potential.
What's less clear is what those mistakes were. Some, such as Emily Meehan, an analyst with The Yankee Group, believe that the concept of free Internet access was flawed at best and a huge miscalculation at worst.
"The ISP business is a very low margin business to begin with, so once you take out the subscriber fees, it becomes even harder to make ends meet," she said. "The hope was that advertising revenues would support it."
Daryl Schoolar, industry analyst of ISP strategies for Cahners In-Stat, agreed. "A year ago, people were a lot more optimistic about what the Internet would do," he said. "The bottom line is that people just aren't buying as much as anticipated, so advertisers stopped spending money. When the ISPs run out of money, they go away."
While he concurred with Schoolar's assessment that the advertising market has gone soft, NetZero Chairman and CEO Mark Goldston bristled at the notion that a free ISP cannot support itself solely by advertising revenues.
"Is the Internet advertising market or the advertising market in general a tough place right now? Absolutely," he said. "But starting in the June 2000 quarter, NetZero has... generated more revenue on ad sales than we have spent on telecommunications costs. The notion, then, that ad-supported businesses cannot generate enough revenue to cover costs is absolutely wrong."
Goldston also disputed the contention that surfers looking for a freebie represent an undesirable demographic. He pointed to a study conducted by @Plan for NetZero that indicated NetZero subscribers are 88% more likely than the average Internet user to purchase home electronics online, 45% more likely to purchase mutual funds and 64% more likely to purchase computer software.
"These are not poor shoppers but smart shoppers," said Rusty Taragan, senior vice president and general manager of NetZero's CyberTarget research division. "They say, `Why spend money when you don't have to?'"
In addition, Goldston questioned the business model some of the now-defunct free ISPs employed. "Most of them developed a private-label model," he said. "They didn't know how to go about building a brand of their own, so they went to a Kmart or a Subway and tried to trade off their brand. What they failed to realize is that people don't go to Subway for Internet access - they go there for sandwiches."
An unfortunate adjunct dilemma for the brand-phobic free ISPs is they shared up to 70% of their operating revenues with their branded partners while managing 100% of the costs.
"If you're questioning the NetZero model, then how could you think these models were even passable?" Goldston asked.
Ergo, the free ISPs that are currently surviving - NetZero, Juno and Excite@Home's FreeLane among them - appear to have one important characteristic in common: They're branded entities. But that's where the similarities seem to end. While NetZero is solely supported by advertising dollars, strong parents using the free access component as a marketing tool back Juno and FreeLane. The hope is to first attract customers with the freebie, then up-sell them on features and services they will want later - such as broadband - when they are no longer Web neophytes.
It's similar to the strategy General Motors has used successfully for decades: Sell customers an entry-level Chevy and hope they trade up to a Buick or Cadillac later.
All three of these surviving ISPs share one particularly vexing problem, albeit to different degrees: A very small component of their free subscribers are accounting for a disproportionately large share of the telecom costs associated with providing the service.
"We did an analysis and found that of the 7 million-plus subscribers we have, roughly 5% accounted for 53% of our telecommunications costs," Goldston said.
"We determined that these people were probably professional users, small offices or home office people. And we said that's not going to fly. We developed this company to serve the recreational consumer, not to serve people who are operating a business at our expense."
To solve the problem, NetZero established a threshold of 40 free hours per month for each subscriber. To exceed the 40-hour limit, customers must agree to pay a fee of $9.95, which gives them unlimited access for the remainder of the month. Customers who balk at paying the fee can forget about logging onto NetZero until the next month begins.
Juno is addressing this challenge differently than NetZero. Rather than setting an hourly threshold, Juno chose to limit access by categorizing subscribers according to usage patterns. Those categorized as abusers find it more difficult to log onto the service as the company gives billable customers and its non-abuser free subscribers priority. Abusers also find it more difficult to stay on.
For its part, FreeLane - which is just a year old - is taking more of a wait-and-see approach. However, it's likely it will reach a similar conclusion.
"In the new world order, we are certainly assuming more financial risk in terms of continuing this program," said Juliana Scalise, general manager of Excite@Home's FreeLane. "In all likelihood we, too, will have more stringent parameters around usage."
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