Captive Audience: The Telecom Industry and Monopoly Power in the New Gilded Age (17 page)

One of the regulators’ biggest concerns was that AOL Time Warner would have an unfair advantage because it could block competing Internet service providers from using Time Warner's high-speed cable lines. The regulators hoped to condition approval of the merger on a requirement that Time Warner let AOL's ISP competitors reach AOL Time Warner customers directly. By making this a onetime condition, they could avoid stating that all cable broadband networks should be open. (The cable distributors’ “forced access” rhetoric had put that issue on the “too hard to deal with” pile for the Commission.) Three months before the deal was approved by the Federal Trade Commission (FTC) and the FCC, Time Warner announced an arrangement with EarthLink (then the second-largest ISP in the country after AOL) that would allow EarthLink to share its lines.
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The companies agreed to a consent decree with the FTC requirement that the combined company make deals with two additional competing ISPs within ninety days of making AOL available to Time Warner subscribers in large markets. They also had to agree not to disrupt the flow of content provided by other ISPs or interactive TV services piggybacking on the AOL Time
Warner network. Meanwhile, the FCC barred AOL Time Warner from launching advanced Instant Messaging (IM) services like streaming video because the merged media giant would “likely dominate” new, IM-based high-speed services.
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In hindsight, the regulatory angst seems overblown, because the new company was star-crossed from the beginning. By the time the merger was approved, in January 2001, AOL's stock had lost half its value, and the merged company was worth approximately $110 billion. Things unraveled quickly from there: a scandal involving misstated revenue and backdated contracts at AOL and the crash of the dot-com marketplace in 2001–2 sent the stock lower still. AOL Time Warner reported a loss of $99 billion in 2002 (the biggest corporate loss in U.S. history at the time, according to PBS), and Time Warner dropped “AOL” from its name in 2003. Employees had been required to invest in AOL Time Warner for their retirement savings, and then they saw the stock price sag. Longtime Time Warner employees bitterly resented losing their money because of AOL's accounting antics. Time Warner CEO Gerald Levin had not consulted most of the company before the AOL deal, and employees felt betrayed.
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What Steve Case could not have known until the deal was done was that Time Warner was more like a stable of competing vendors than a single company. Its divisions were used to independence, fighting for their own profits and not necessarily cooperating with the others. The company had already been through two gigantic and painful mergers (Time and Warner Communications in 1990 and Time Warner and Turner Broadcasting in 1996); the addition of the arrogant, dismissive, boots-on-the-desk dealers from AOL did not help it function more smoothly. The attitude of the AOL executives grated on the Time Warner employees, who could tell that their new bosses considered Time Warner hopelessly behind the times. Following the merger, legacy Time Warner CNN employees often did not return AOL employees’ phone calls. All of this jockeying hardly led to the promised synergies.
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And no one seemed to know what those synergies were. Ideas were thrown around: maybe AOL could be a platform for digital music sales, a repository of first-rate tunes available for download. (There was no iTunes at this point.) But being a platform would require the Time Warner
employees to work closely with the new AOL group, and that seemed unlikely. Jeff Bewkes, the rising star at Time Warner and head of HBO at the time of the AOL–Time Warner merger, said in an October 2009 interview:

AOL was a distribution company, and Time Warner was a content company, but their interests did not align in a way that would make the merger work. For Bewkes, vertical integration makes sense only if the combined company has a large and powerful market share either upstream (in content) or downstream (in distribution), and the integrated AOL Time Warner had neither. Even if AOL had made itself the first screen for users’ Internet access over Time Warner's cable-modem service, it would have guaranteed access to just 15 percent of Americans. Without regulations mandating common carriage for the rest of the cable-distribution landscape, AOL did not have the leverage to force the other carriers to deal with it.

At the same time, AOL remained primarily a highly profitable ISP business (both dial-up and, eventually, broadband) in a regulatory realm that did not require that cable distributors (except in the onetime merger condition imposed on Time Warner) allow competing ISPs to use their cables. (Recall that Comcast, confident that the shadow of common-carriage regulation would never fall on its operations, bought up AT&T Broadband's cable systems in December 2001—and cable-modem Internet access service was a big part of the deal's upside.)
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Yet ironically, the cash flows from
AOL's existing business were strong enough to keep it from making the transition to another business model. And because pure distribution and pure content companies typically appeal to different kinds of shareholders, AOL Time Warner's stock was neither fish nor fowl to many investors. Add in the combined company's lack of dominance in either content or distribution, the fact that the resentful employees of Time Warner resisted helping their new AOL bosses, and AOL's own slowness to develop a new strategy, and you had a recipe for inertia and, ultimately, failure.

It took almost a decade, though, for the AOL Time Warner leadership to realize its mistake. In late 2009 Levin admitted his responsibility for the failure to convince Time Warner divisions to execute on the grand vision he and Case had articulated: “I'm really very sorry about the pain and suffering and loss that was caused. I take responsibility. It wasn't Steve Case's fault. It was taking this magnificent concept and not being able to meld it into a missionary zeal. It was not a supermarket, it was a mall.” As Case put it, “vision without execution is hallucination.”
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Bewkes, installed as CEO of Time Warner in 2007, subsequently spun off the Time Warner Cable operations in March 2009—and AOL as well. From Bewkes's perspective, both the capital-intensive needs of the cable-distribution business and AOL's inability to settle on a new business model distracted from Time Warner's content operations. By the time AOL was finally separated from Time Warner, in December 2009, the company's stock had declined 77 percent since the merger—triple the decline in Standard & Poor's 500-stock index over the same period.
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The regulatory conditions so painstakingly imposed on the AOL–Time Warner merger are seen today as failures. In Gerald Levin's view, the company had a “tough time with the regulatory process. They imposed conditions that are basically chimeras—I mean they don't really exist.”
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EarthLink managed to thrive as an independent actor, enlisting 445,000 new customers because of the AOL–Time Warner agreement, even as it moved from dial-up to broadband. But after the merger went through, no other ISP was able to get terms from Time Warner that would allow it to compete successfully. From a competition point of view, then, the regulations were hardly a success. (Earthlink asked the regulators to
impose the same condition as part of the Comcast-NBCU merger to no avail.)

The FTC had done its best to open competition to ISPs and had hired a highly respected FCC engineer, Dale Hatfield, to oversee the ISP open-access (common-carriage) elements of the AOL–Time Warner deal.
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But the merged company's obligations were not precisely clear, and the FTC had not had adequate technical advice in setting up the requirements. AOL Time Warner was plainly uninterested in providing the kind of access to competitive ISPs at a sufficiently fundamental technical level to allow the competitor to add value through quicker or better service; the competitor was in essence relegated to reselling the service that AOL Time Warner offered, without differentiation. (When sharing telephone wires for DSL Internet access, by contrast, a company with access to the copper wire that also had better technology on its side could do things the incumbent could not. Common-carriage requirements initially imposed on the telephone companies had made the provision of high-speed Internet access a respectably competitive business.)

But the biggest problem for potential competitors was the price squeeze: there just wasn't enough of a margin to make it worthwhile to share the pipe. Fixing this issue would have required somehow allocating AOL Time Warner's costs on a fair basis among competitors—and that, in turn, would have required major staff attention from the FTC. No one seemed to have the stomach to impose such a regime. Finally, without the ability to differentiate its services technically or charge a lot less (given the nonexistent margins), the ISP would have to prove that its service was nonetheless somehow “better” for consumers. With more and more services provided by online applications, there was little an ISP could do to stand out from the crowd. Any condition short of requiring a separation between content and distribution (something the Nixon White House had wanted, John Malone had feared, and Disney had sought in the context of the AOL–Time Warner merger) seemed to doom the future of independent ISPs.

The conditions placed on AOL Time Warner's Instant Messaging services seemed especially fanciful. The FCC had felt that AOL's IM service, with its 100 percent market share at the time, would crush the competition once it was combined with Time Warner's cable lines and content; the
agency imagined a world in which IM would be the place for gaming and video, and AOL Time Warner would have an unmatchable subscription list and content library. So it required that AOL Time Warner not provide any new buddy-list video services for IM unless its subscription list were interoperable with that of another provider.
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This quickly proved overly restrictive. By 2003, AOL was rapidly losing market share in the IM market to Microsoft and Yahoo!, which both offered attractive services, and the company pleaded with the FCC to be relieved of the interoperability requirement. FCC chairman Michael Powell lifted the condition, remarking that he had never agreed with it in the first place.
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Just like Comcast and NBC Universal, AOL Time Warner had had online video in mind. On January 10, 2000, the day the merger was announced, Jim Ledbetter of the now-defunct
Industry Standard
magazine zeroed in on this goal: “One of the things the two companies talked today about is streaming video through your computer … [but] these kinds of applications … right now are very difficult to do at the access speeds that most consumers have to the Internet. Time Warner, with its Road Runner service, potentially has the ability to deliver that.”
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Arguably, AOL Time Warner was simply ahead of its time and short on some key assets that would have made the video story work out better: a stronger transition of AOL's dial-up customer base to broadband, and a stronger position in cable distribution from Time Warner, together with a willingness on Time Warner's part to tie its content fortunes to some exclusivity or priority over the AOL service. And management expertise.

Indeed, AOL had one thing at the time of the merger that has remained extraordinarily valuable in the world of online video: its reputation for simplicity. Steve Case, after all, had started by offering his service via Commodore 64s, cheap toylike devices with built-in modems, which would connect subscribers to an online bulletin board. At the time, very few people were online and very few PCs had modems installed. Simplicity was key: if you subscribed to AOL, you got access, content, and communications, all in one safe, walled-off area. AOL had hoped to use the Time Warner merger to bring that simplicity and ease of use to a faster-moving broadband world.

Today, similarly, Comcast–NBC Universal aims to make “online” experiences as accessible as possible—as long as consumers play by its rules.

The Comcast-NBCU deal suggests that Case was right but a decade too early. AOL's vision could work today in a way it was unable to ten years ago; many Americans are once again confused by the vast array of Internet options, particularly video. Limiting and protecting the online experience—making it predictable, branded, pleasant, and easy to access—might make it more appealing to more users.

The key to this walled-garden future is Comcast's embrace of TV Everywhere: allowing users to watch high-quality video from well-known programmers online as long as they are already “authenticated” subscribers to pay-TV service bundles. If you pay for HBO on your television, for example, you can watch HBO on your computer, or on a mobile device inside your house.

Like the pre–Time Warner AOL, TV Everywhere will be popular (because it is easy to use and it simplifies the search for satisfying online video) and successful (because only TV Everywhere will have the distribution leverage to keep licensing costs of popular high-quality content down for online viewing). As Case envisioned for AOL Time Warner, TV Everywhere will be able to take advantage of the libraries of content currently provided by the media conglomerates. Plus new stuff.