Attention Internet-Access Shoppers: the Era of Unlimited Monthly Service for $19.95 May

On-Line: Why the $19.95 Internet Fees May Not Last By Jared Sandberg and Thomas E. Weber

12/24/1996 The Wall Street Journal Page B1 (Copyright (c) 1996, Dow Jones & Company, Inc.) Attention Internet-access shoppers: The era of unlimited monthly service for $19.95 may come to an end in 1997. Less than a year after they introduced it, some Internet companies are finding the below-$20 price to be a costly sales gimmick. The flat rate that has users happily frittering away hours on-line -- producing an irksome traffic jam and endless busy signals -- is causing on-line firms to fritter away profits. Many experts say the economics of the Internet dictate this can't go on forever. Several major providers already have abandoned the $19.95 strategy. Last week, Netcom On-Line Communication Services Inc., with more than 500,000 customers, announced plans to scrap its $19.95-a-month unlimited service plan. CompuServe Corp. folded its WOW! unlimited-access service last month and vowed to stick with hourly charges for its main service. Earlier this year, PSINet sold Pipeline, a customer service that offered a similar access deal, only a year after acquiring it. Now Sprint Corp., which began offering its $19.95 Internet access service nationally last month, is considering instituting higher prices for heavy users and imposing pricing "tiers" for higher levels of service. That approach would resemble the cable-TV industry's practice of charging extra for a tier of additional channels. "The problem with this [flat-rate] pricing model over the next three or four years is that the use of the network itself is probably going to explode compared with where it is today," says Jim Dodd, Sprint's vice president of Internet access services. So far, such powerful providers as AT&T Corp. and America Online Inc. say they have no plans to drop $19.95 service. But some industry insiders predict that big providers will keep the flat-rate deals only until other rivals give up on the gimmick. "As the market consolidates, the more powerful players have enough market strength to raise prices -- and get away with it," says David Goodtree, an analyst at Forrester Research Inc. The $19.95 price plan swept the industry this past year, after AT&T in February began pitching the flat rate and also a year of free access to long-distance customers who wanted to go on-line for only five hours a month. Many rivals quickly matched the $19.95 rate -- even as they doubted they would be able to turn a profit. The flat rate "is inherently flawed," says Bill Gurley, analyst at Deutsche Morgan Grenfell. "You can't have a limited resource priced in an unlimited fashion." Why, then, did so many companies do it? "People are trying to get market share," says Barbara Dooley, executive director of the Commerical Internet Exchange, a trade association of access providers. But providing Internet access requires more than just modems and phone lines. Companies spend hundreds of millions of dollars on advertising and disk giveaways to sign up subscribers, and they pay hefty sums to shore up their infrastructure and employ customer-support staff for befuddled users. And costs may be rising in the future. Telephone companies are searching for ways to increase the fees they charge Internet access providers for using their phone lines. The Baby Bells are lobbying hard to win new "access fees" from Internet firms, much like the fees they charge long-distance companies for routing calls to local Baby Bell customers. Certainly, access costs vary widely by size of customer base and other factors, but Mr. Goodtree of Forrester estimates that infrastructure cost alone can run 80 cents to $1.30 an hour per user. So a customer going on-line for more than 20 hours a month already has cut into an access provider's profit margin. Moreover, it costs Internet firms another $25 to $30 per hour to provide customer support services. An on-line rookie who spends an hour or two on the phone getting help costs the Internet access provider even more. For most on-line providers, that means the break-even point for a flat-rate user is about eight to 10 hours of usage per customer, says Michael J. Kleeman, vice president at Boston Consulting Group. After that, the firm loses money on the customer, he says. "Some of the providers that have offered $19.95 in the past did so before this industry collectively really understood the cost components of providing that service," says Stephen Von Rump, vice president at MCI Communications Corp. Yet MCI aims to offer its $19.95 package "as long as the competitive condition requires us to." But with more rivals pulling back, those conditions could change. "We can't find a way to become profitable at a flat priceand I'm not sure anybody can," says Denny Matteucci, president of interactive services at CompuServe, which is refocusing on small businesses. "We are just not going to spend our marketing dollars going after the mass consumer market, where they have price wars and no profits," he says. AOL, the nation's largest service with more than seven million users, embraced flat-rate pricing on Dec. 1. But AOL spent $130 million in its most recent quarter to add 355,000 new domestic subscribers, or about $366 a head. At less than $20 a month per newcomer, it will take AOL 18 months to recoup the cost of signing up these customers -- if they all stick with AOL that long. And that doesn't include network costs and the payroll for 3,800 customer-support people. Partly for those reasons, AOL isn't expected to become profitable overall until June. AOL concedes that it will have to raise other revenue from selling on-line ads and from on-line shopping. The $19.95 fee "probably doesn't make sense for a lot of players in this business," says Robert Pittman, president and chief executive of AOL Networks. Mr. Pittman says AOL can shoulder the flat fee because, among other reasons, the company's incremental infrastructure costs are only 25 cents an hour, far less than the industry average. AOL also can spread costs over its seven million members, more than twice the customer base of its next largest competitor. Not everyone is convinced. "I wonder how they can make money," says Tom Evslin, who heads AT&T's WorldNet service, which has 525,000 subscribers. AT&T, by contrast, sees other benefits: its long-distance business benefits from co-marketing with the Internet business. Of course, prices won't jump overnight, and Internet firms may try to disguise increases by "unbundling" such items as help-line support and high-speed connections. David Garrison, Netcom's chief executive, likens such choices to picking between Federal Express Corp. and the U.S. Postal Service to send an important document. "When you think it absolutely, positively has to be there, you use FedEx. And you're willing to pay for it," he says. Journal Link: To join an on-line discussion about Internet-access charges, see The Wall Street Journal Interactive Edition at http://wsj.com