Free ISP concept too good to be true
Some poetic justice lies in the news that free ISPs, once seen as a threat to America Online's market dominance, have instead taken AOL's place under the scrutiny of federal regulators.
Underscoring how far the once-ambitious free companies have fallen, the Federal Trade Commission this month warned consumers against taking free offers at face value, settling complaints against computer maker Gateway and one-time highflier Juno Online Services.
"These so-called free Internet access offers were anything but," said Jodie Bernstein, director of the FTC's Bureau of Consumer Protection. "Information about fees was hidden in the fine print."
The federal actions are just the latest indignity heaped on a business model that has suffered much in the past six months. A year ago, free Internet connections were offered by all the major portals and by smaller sites, and even free high-speed connections were coming to market.
Today, most of the companies offering free service have gone out of business, almost independently prompting the first-ever decline in the number of people on the Internet, according to one recent study. Companies that remain still have millions of subscribers but are working hard to persuade them to start paying for services.
The market has shown clearly that free services supported by advertising are not financially feasible, analysts say. While their services may be offered well into the future, they will be far more limited than at the peak of last year's mania for all things free.
"It'll still be the hook that gets people in the door," said Jupiter Research analyst Dylan Brooks. "But the days of free, unlimited service are a thing of the past."
Always a difficult business
At first glance, the sheer number of subscribers would seem to indicate that free ISPs are still in the game. NetZero, the largest of the companies, says it has more than 8.4 million registered users. In its last quarterly results, Juno reported more than 3 million active registrants on its free ISP services, despite a recent campaign to drive people to its paid products. Kmart's BlueLight.com says it has more than 2.6 million active dial-up subscribers.
However, those numbers have helped drive all but the most well-funded companies out of the business and continue to cloud the futures of NetZero, Juno and BlueLight. Providing access requires expensive physical infrastructure that gets even costlier as more people use the service: ISPs must pay for modems, servers and bandwidth from companies that own networks, such as Level 3 Communications or WorldCom.
The early idea of most free ISPs was to defray these expenses with advertising. To tap into the free connection, surfers would be required to keep a window about the size of a banner ad open on their computer screen at all times, showing a rotating stream of often distracting advertisements.
The early companies were well aware that customers seeking a free service weren't necessarily in the most desirable consumer category for potential advertisers. But they added enticements: Because they could track precisely where their subscribers were going online, this information could be used to target ads far more specifically than was the case for ordinary Web sites. A subscriber visiting AutoTrader.com, for example, would be more likely to pay attention to ads for car companies.
The most innovative companies also developed new advertising strategies, painting themselves as primarily advertising conduits as opposed to ISPs. NetZero offered its advertisers the ability to pre-empt their competitors, allowing Ford Motor to buy space on a subscriber's ad window whenever a surfer visited Chevrolet's Web site, for instance.
At the height of the idea's success, many began questioning whether industry leaders needed to react. Microsoft publicly toyed with the idea of free or discounted ISP service, and analysts asked whether AOL would be forced to lower its prices.
The giants stayed firm, though AOL's CompuServe and the Microsoft Network each pursued a parallel strategy of offering $400 rebates on computers for new subscribers, effectively subsidising newcomers' ISP fees for several years.
"One of the mistakes the industry made is somehow convincing itself that the Internet and the New Economy were not subject to the laws of business physics," America Online CEO Barry Schuler said. "We looked at the free ISP model upside down, left and right, and could never see how that could turn into a profitable business."
The plunging market for online advertising proved to be the companies' undoing. ISPs began falling by the wayside by the middle of last year. Independent companies including Freewwweb neared bankruptcy, and many sold themselves to Juno. CMGI's 1stUp.com, a wholesaler that provided service for AltaVista, Excite@Home, Lycos and others, was closed after executives cited "insurmountable" capital costs for the business. Spinway.com, which provided service for Yahoo and Kmart's BlueLight, was bought outright by BlueLight.
Competitors in the traditional ISP market are on a death watch, hoping the no-cost alternatives will disappear so they can step in with discounted alternatives or remind subscribers of their own relative stability.
"There is a place for the discounted ISP," EarthLink Executive Vice President Michael Lunsford said, but "the free alternatives have to disappear completely first."
