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Photo illustration by Glen Wexler

Dead Man Walking

On the verge of a revival last year, AOL suddenly imploded. The inside story of a journey to nowhere.

In May 2007, nearly six months after he was hired, AOL chief executive Randy Falco gathered his employees together for an "all hands" meeting at the company's Dulles, Virginia, headquarters. Until then, Falco had remained a mystery to much of his team, often holed up at the New York offices of Time Warner, AOL's parent. He had spent 31 years at NBC, rising to the top as the network was sinking to fourth place. Many in Virginia wondered why the board had chosen this old-media type. There were rumors he barely used email. The meeting took place at Seriff Auditorium, AOL's largest. It was the nerve center from which the company's brain trust had hooked America on the Internet, a triumph that changed the world and threw off fabulous lucre. Falco, 54, a large man with pale skin and silver hair, was dressed strategically in a casual sports coat and an open-collared shirt. His executive team sat in the front. As he delivered his remarks, bathed in cool PowerPoint light, his halting image was Webcast to employees in their cubicles across the sprawling white-brick-and-glass campus.

The event was intended to rally the troops. Falco's handlers had rotated the seats in the auditorium 90 degrees, a gesture signifying change. New chief operating officer Ron Grant -- who had been plucked from the staff of Time Warner's then-president Jeff Bewkes -- led off with an attempted joke about the seating arrangement: "I don't think there was a single good decision made in this room, so I'm glad we switched it." Falco also tried humor. A line about his head of technology fell flat, giving engineers the impression he hadn't yet learned the man's name. Later, Falco directed some of the blame for AOL's downsizing on the victims themselves. "Smart companies don't lay off excellent people," he said.

Many were put off by the remarks. "Falco and Grant seemed tone deaf," as one longtime employee puts it. "They didn't understand what they should be saying to get us on board." It was as if the new bosses couldn't appreciate the loss of dignity AOL had suffered since the disastrous merger with Time Warner in 2000. The company had endured lawsuits and federal sanctions, and had shed two-thirds of its employees. Annual revenue had withered from $9.1 billion to $5.2 billion, and subscribers from 27 million to 10 million. To emerge from the morass, AOL needed charismatic leadership with a strong vision. Instead, its overlord from Gotham sent down Smithers and Mr. Burns, as employees took to calling Grant and Falco.

Worse still, there had recently been a rush of genuine hope. Less than a year earlier, Falco's predecessor, Jonathan F. Miller, had persuaded Time Warner to tear down the walls around AOL's proprietary content, opening it up as a free, ad-supported business similar to Yahoo. AOL went on to deliver 46% ad-revenue growth that quarter and 49% the next. After years of floundering, AOL suddenly seemed to be back on track. Optimism on Wall Street helped drive Time Warner's long-stagnant stock price up 40% in six months. Yet in the middle of this rally, Miller was abruptly fired in favor of Falco. Morale plummeted. For inspiration, employees got bad jokes, PowerPoint slides, and rotated seats.

Within weeks of Falco's presentation, AOL closed the quarter that would end its brief renaissance. Ad growth had slowed by nearly two-thirds. In the fall, 20% of the workforce was laid off. Time Warner's stock slid below $15, its lowest level since 2003. When Microsoft issued a $45 billion offer for AOL rival Yahoo, Time Warner's shares barely budged. "As we exit 2007," wrote Citi equity analyst Jason Bazinet in November, "it's fairly clear that the AOL turnaround isn't going to materialize to the extent we hoped."

The question is: Why? Eight years removed from the Time Warner merger and more than four years after AOL was expunged from the public company's official name -- an eternity in our evolving Internet age -- AOL has been unable to find a way to innovate out of its troubled past. Yes, AOL has been plagued by internecine battles with its corporate parent and by a dial-up subscription-revenue model that could not possibly survive in the modern era. But it has also failed to exploit a wealth of formidable assets, including a ubiquitous brand, millions of regular users, the Web's dominant instant-messaging service, the iconic MapQuest and Moviefone, the most popular finance site, a top celebrity-gossip site in TMZ, an innovative video search engine in Truveo, and deep television and music offerings.

Neither Time Warner's now-CEO Bewkes nor Falco or Grant would agree to speak with us. But in extensive interviews with dozens of current and former AOL insiders (many of whom would speak only on background), what emerges is a tale of failure on multiple fronts: short-term thinking, bad technology, bungled product development, a dramatic miscalculation of what drives page views on its own site, and a risk-averse culture more prone to imitation than innovation. "Pretty much everything we worked on," says a former AOL manager, "executives pointed to someone else's product and said, 'We want that.'"

At the simplest level, AOL's troubles in the past couple of years are the story of a business without a vision and therefore without guiding principles to clarify which risks are worth taking -- and which are worth sticking to. Back in its heyday, AOL's mission statement hung on a plaque in the lobby in Dulles, in shiny silver lettering that read, to build a global medium as central to people's lives as the telephone or television... and even more valuable. By 2000, that vision had been accomplished, and no next-stage aspiration had risen to replace it. AOL did finally convene a committee to write a new mission statement in 2006. They came up with this gem: "To serve the world's most engaged community." It is a creed that could just as well suit a Hardee's.

To understand, in a quick snapshot, AOL's interconnected shortcomings, there is no better example than the company's social-networking efforts. Way back in the 1990s, when Facebook founder Mark Zuckerberg was still in junior high, AOL pioneered the field. It created platforms for community interaction, and its Member Directory featured profiles similar to what MySpace would eventually offer. It invented buddy lists to let users know whether their friends were online. "There's very little that MySpace and Facebook have that AOL didn't have a version of 10 years ago," says Joe Dzikiewicz, a former AOL systems architect.

But as time passed, AOL let that leadership slip away, and it wasn't until 2005, after watching News Corp. snap up MySpace, that AOL moved in earnest to capitalize on its legacy. That fall the company hastily conceived AIM Pages, a social-networking site designed to exploit the huge user base of AIM (formerly AOL Instant Messenger). Employees seized the opportunity like furloughed prisoners at a brothel. "Everyone wanted a piece of it," says a former manager who was at the center of the storm.

"People were like, 'This is going to make careers.' We thought it would save the company." According to initial projections, the service would be half the size of MySpace in just six months, says Kerry Parkins, a former VP.

There was a "me too" aspect to AIM Pages. Before it had a name, employees called it "AIMSpace," and used MySpace as a template. AOL was eager for AIM Pages to produce revenue quickly, though its business department couldn't decide how to monetize it. They rushed headlong into false starts, developing lame features such as advertiser-friendly "affinity networks" for people who were crazy about Cadillacs or Mountain Dew. Programmers had to grind away on elaborate schemes, only to see them abandoned later. "The direction on the product changed constantly," says one product manager.

The launch, in May of 2006, was catastrophic, AOL's version of Britney Spears's tottering comeback at the MTV Video Music Awards. Larded with JavaScript and riding on seven preexisting AOL systems, it was slow and buggy. The influential blog TechCrunch panned it, questioning what value it added in the already-crowded social-networking sector. "As soon as it bombed, no one wanted anything to do with it," says a product manager. Six months in, AOL replaced AIM Pages with a simpler version called AIM Profiles. This time, the objective was to copy Facebook, engineers say. When that didn't fly, it was merged with the old Member Directory. It now attracts about 170,000 page views a day, according to comScore; Facebook's figure is 1.2 billion.

AIM Pages' creators are irked that the company never promoted the product. When MySpace launched, its founders stoked viral interest by recruiting L.A. bands, which then brought their fans. AOL was still rooted in the mentality of publicizing something on the welcome screen, which in the 1990s would generate millions of visits. Executives expected AIM Pages to rise from the crib and dance on its own: "My take on Web products is that if they're good, the world will discover them," says a former executive. "AIM Pages didn't make sense for us. It was just too late."

"I used to ask,'What does AOL want to be when it grows up?'" That question, from former senior vice president of technology Sree Kotay, has hardly gone unexplored. AOL held several meetings from 2004 to 2006 at the swank Lansdowne Resort in Virginia, in part to tackle the topic. "There were a lot of epiphanies and arguments," Kotay says. "At one off-site, someone said, 'We ought to get rid of 60% of the senior executives. It doesn't matter whose voice is heard, just as long as someone's is.'"

The voice in charge during those years was Jon Miller's. He came aboard as CEO in mid-2002, a Harvard Business School grad and former top executive at Barry Diller's USA Interactive who had also worked at Nickelodeon and Boston's WGBH. The corporate culture he inherited was sick and wheezing. The accounting system, for instance, was snarled by thousands of arcane codes, each corresponding to a different "special offer" for Internet access. There were so many billing systems that the company launched an investigation just to identify them all. Meanwhile, the general ledger recognized only two forms of revenue: subscription and "other."

In AOL's organizational structure, known as "the Matrix," employees were assigned to centralized departments according to function. When a new project began, managers would assemble a team from those areas. Given the hierarchical hurdles, decision making took forever. "Somewhere between four and eight departments needed to cooperate before a product would reach a consumer," says Bill Wilson, EVP of programming. Adds David Corboy, a vice president in the technologies group: "Everything was decided by committee, so there was no real neck to choke when something went wrong." There were constant reorganizations; some people couldn't identify their own bosses. In the halls at Dulles, employees would joke: "So, who are you working for today?" The opacity gave rise to a career track known as "rest and vest," where people would hide out until their incentive pay matured. "AOL lacked a risk-taking environment," says one exile. "It was about self-preservation."

To make matters worse, Miller faced an unenviable business dilemma: What was good for AOL's future was bad for its present, and vice versa. While dial-up Internet service was doomed, it was also the company's most significant source of revenue. Major budgets were dedicated to updating AOL's software suite, loading it onto discs, and carpet bombing the country with them. As late as 2003, "The mind-set was, every dollar we have, we're going to invest in mailing a disc," says one former senior executive.

Some believed that AOL's best option was to compete on the open Web as an ad-supported business. But that strategy would crush existing cash flow. AOL knew that many of its customers paid their monthly fees only to keep their email addresses, and that offering mail for free would cost millions of subscribers. The company estimated it would take 10 free customers to generate enough ad revenue to match one dial-up subscription.

Then there were the technology challenges. AOL's sites were written in a proprietary code, Rainman, that was incompatible with standard browsers and search engines. Ad servers couldn't read it either -- one reason ad revenues slumped from $2.6 billion in 2001 to $781 million in 2003. The company would have to invest a fortune in tech upgrades just to get to the starting gate.

Miller also had to manage a hostile corporate parent. If AOL had been independent, he might have had the freedom to use its still-enormous subscription revenue to invest in acquisitions. Colleagues say he had his eyes on YouTube and MySpace, among others. But Time Warner's board, already burned by a historic $99 billion write-down from the 2000 merger, had little stomach for new-economy startups, especially ones that hadn't yet turned a profit. Although he bore no blame for AOL's sins of the past, "Miller had the problem of being only one degree removed from the team that Time Warner hated," explains a former executive. "He could have been Einstein and Gandhi combined, and the corporate immune system would still reject him."

Not that Miller was blameless. In April 2005, he launched AOL Internet Phone, an entirely new product that he spent millions developing. To recoup costs, the monthly fee was set at almost double what competitor Vonage charged. "The rationale they told each other internally was that, 'Oh, well, we have all these extra features customers want,'" says a former executive. "In fact, people didn't want features. They wanted a phone, cheaper." And because of tangled billing systems, at first only AOL's ISP customers could subscribe to Internet Phone. This was no small glitch: Internet Phone ran on broadband only. So AOL's dial-up subscribers would need a separate high-speed connection to make it work. As if that weren't farcical enough, sources say that just before the launch the company's board refused to let the service compete in cities where Time Warner Cable was offering its own VOIP service. In the end, Internet Phone had a mere 2,000 subscribers when it was canceled in October 2006.

Because Wall Streetviewed AOL as Time Warner's most potent growth engine, Miller was ordered to boost net earnings, even though revenues were shrinking from canceled dial-up subscriptions. He had no choice but to cut thousands of jobs, while Time Warner used AOL as a cash cow, sucking out more than $6 billion between 2003 and 2007. Miller nearly tripled operating income, to $1.9 billion, while revenues fell by 8%.

On Miller's watch, one unquestioned home run was the 2004 purchase of Advertising.com, a leader in placing ads on millions of independent Web sites across the Internet. AOL's ad revenue rose steadily from $781 million in 2003 to $1.3 billion by 2006. That set the stage for Miller's next coup: In August 2006, AOL finally moved to offer all of its Web content for free. That hastened the dial-up customer exodus, costing at least $1.5 billion dollars in annual subscriber revenue, but it also signaled to investors a brash confidence about AOL's future prospects. When Miller reported astronomical ad growth -- 46% in the third quarter of 2006 -- Wall Street became a believer too. Time Warner's shares shot from $16 to $23 in six months, adding some $20 billion to the conglomerate's value.

Miller's reward for this achievement was a pink slip. In early fall, Miller had met Randy Falco for a drink at Bewkes's suggestion, with the implication that Falco might join Miller's management team. In mid-November, Miller learned from reporters calling for comment that Falco was replacing him. "Time Warner is a cutthroat environment," says a former executive. "Bewkes and Miller never got along. When Bewkes became president [in late 2005], he wanted one of his guys in there." Bewkes thought AOL needed someone with Falco's operations expertise to make the new ad strategy gel. (Falco had nicknamed himself "the Conductor" at NBC for his obsession with running the trains on time.) To AOL employees, it appeared that just as their business was finally rising from the mat its own parent threw a sucker punch.

To AOL employees, it appeared that just as their business was rising from the mat its own parent threw a sucker punch.

But there was another major blow to come. Even as a handful of executives followed Miller out the door, Falco had to prove that AOL's ad growth had been no fluke. And he was all smiles. Around the time of the Seriff all-hands meeting -- shortly before Time Warner's second-quarter 2007 results were released -- Falco even remarked publicly that ad growth was "doing what we had hoped, and a little better."

It now seems predestined, given AOL's tortured history of disappointment, that those assurances would prove false. The company's ad figures failed to meet expectations, rising just 16% that quarter, and the investor backlash was brutal. Worst of all, the shortfall was largely attributable to the new team's own moves.

Grant had grown increasingly concerned during the second quarter about AOL's search pages losing traffic. In November, search had posted 38.9 million visitors; by May, the figure was down to 35.2 million. Grant zeroed in on the multimedia character of AOL query results: If you searched for "Radiohead," for instance, you would get not just text articles on the band but also images, video, and links to their songs. Grant saw this differentiation as a weakness -- it slowed load time, and the rich results meant that users were less likely to refine their searches, thus delivering below-average page views. He ordered a change to the page, making it look and operate exactly like Google's. Yet it turned out there were ways in which some users actually preferred the old format. It was certainly different, offering people a reason to go to AOL rather than Google. And the below-average page views could be seen as a sign that users were finding what they wanted the first time through. Also, according to former executives, the old search page actually produced more revenue per search than Google's.

In any case, changing the page backfired, badly. Search revenue fell to $156 million, from $232 million the previous quarter. As a result, AOL missed its revenue targets. "Management was blindsided by how disruptive the change to search was," says Pali Research analyst Richard Greenfield. "It's troubling that they didn't know what the impact of the search change would be. This raises serious concerns about their ability to run the business and turn it around."

Falco dismissed the search mishap as a "hiccup," and Time Warner executives defended the move as being good for traffic growth. But over the next six months, search users fled even more quickly than before. Monthly unique visitors were down to 30.6 million by November 2007, according to comScore. (Grant's tweak still remains in place.) In August, Falco had to retract his earlier assurance that he would continue to grow ad sales "faster than the industry." He ended the year with 18% ad growth, scoring only 10% in the fourth quarter, significantly lagging the online-ad market's 26.8% annual growth in 2007. As Jeff Bewkes ascended to CEO in January, AOL was once again playing its customary role as Time Warner's millstone.

In February, Bewkes took a baby step toward relieving that burden. In his inaugural earnings call as CEO, he said he was "working to separate" AOL's ISP and Web businesses. "This should significantly increase AOL's strategic options," he said, hinting at a sale of the ISP, or more. Wall Street applauded; share prices bumped up slightly.

Falco had unveiled a plan in September 2007 to move corporate headquarters to Manhattan and "realign the business" as a "global integrated advertising platform." A new division, called Platform A, would be built around the Advertising.com unit. During 2007, AOL invested $900 million in complementary companies, such as Quigo, Tacoda, and Adtech (see AOL's Greatest Hope). By bundling these companies, AOL plans to offer a one-stop shop to help major brands promote themselves on the Internet.

There is some wisdom to this move. Online advertising will double to $42 billion by 2011, according to eMarketer. Meanwhile, the Web is fragmenting: Old-school portals like AOL and Yahoo are losing traffic to millions of smaller, independently owned Web properties. So-called third-party networks, such as Advertising.com, work as matchmakers, placing ads on appropriate pages. Platform A is still small -- accounting for less than a fifth of AOL revenue -- but the company's strategy this time is finally sharp. It's conceding the search market to Google. Instead, it is going after the premium display-ad market, where big corporations feel comfortable building their brands on mainstream sites. This is hardly surprising, as it's the segment that most resembles Falco and Bewkes's home turf: television.

For the thousands of AOL employees who don't work in advertising, of course, the emphasis on Platform A is an ominous sign. "The Dulles campus, where the Web business is, realizes that it's a cost center," says a former executive. Internally, Falco and Grant have managed to boost productivity there by dismantling the Matrix and organizing employees in small teams similar to startups. But with ad revenue projected to be flat in 2008, layoffs are likely to continue. At best, "there's probably a good mediocre business in there somewhere," the executive concludes.

Whether or not Bewkes breaks up AOL, staggering on as an ad business without a strategic partner could eventually lead into a death spiral. If Microsoft were to succeed in swallowing Yahoo, AOL would lose two of its most obvious potential buyers. At IAC, Barry Diller told investors in February that although he was once interested in buying AOL, "I don't really feel the same way now" unless it "came down in price to something ridiculous." As an orphan, AOL's online-ad business would be left to fight for market share in a fiercely competitive sector, dominated by Google and a potential Microsoft-Yahoo tie-up. The only hope, perhaps, would be for the latter two companies to fare as badly together as AOL and Time Warner have.

David Case is a freelance writer in New York. He is not related to AOL founder Steve Case.

Photo illustration by Glen Wexler

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9 Comments

  • Kasey Marcum

    Very well written, David.

    I am surprised that the employees aren't fleeing at an alarming rate. It has been obvious for a while that AOL should just give it up. Not sure why one would continue to work in this kind of environment.

  • Desmond Haynes

    Interesting read http://techwatch.reviewk.com/2...
    ... building AOL into a major digital ad-sales firm.” The content push “is part of AOL’s bid to reinvent itself as an ad-supported Web company following its August 2006 decision to make its Internet-access service free. Visits to AOL’s Web sites slowed as a side-effect of that decision. … To draw visitors back, AOL redesigned sites in the news, sports and health categories. It also created a half-dozen new sites that don’t use the AOL name, such as a technology-focused site called Switched, a hip-hop site called BlackVoices, and a Web trend tracker called Urlesque.com, as well as Asylum. Dropping its name was an acknowledgement that the brand wasn’t hip enough for the consumers AOL was trying to attract.” AOL “also adopted some common tricks of the trade, such as making its sites appear higher in search-engine results....

  • Bill Later

    Enough already... Can someone just please shoot this company in the head? Elvis left the building when Pittman moved to NY in 2000 to take his ill-fated CEO in waiting spot at TW. There hasn't been any talent left in Dulles since. Idea: Number the employees and fire the odd-numbered ones (hell, ok, the even ones then). Then distribute all the savings to shareholders in a dividend. They deserve it after the stock's performance for the past 8 years.

  • James Belle

    perhaps they should have learned from Yahoo's mistake in hiring a guy from Hollywood to do a tech job! I don't think AOL is necessarily a dead man walking, they can still turn it around.

  • Mark Zorro

    I have not followed anything about AOL but I find the responses to this article as well as David Case's piece highly insightful. Normally I don't focus on corporate autopsies or ugly micro-details but I can learn much by digging into the piece because David Case has written comprehensive piece (with or without flagged sections by respondents) and the prose laced with meaningful numbers is brilliantly presented. It actually surprised me to read this level of detail here and I really am only going to significantly grow my learning if I continue to come across pieces that are incomprehensible to a dweeb thinker......M.

  • Anonymous still anonymous

    What a sad testimony to a fallen dynasty - one that others should take note of. AOL's problem was one of arrogance - pure and simple. The universe took care of this by installing a "tower of babel" that still exists today. The only thing left are employees who wistfully yearn for the "good old days".

  • Media Maven

    Turning around AOL was a task no one could accomplish, given the constant demands from the parent company to generate income growth to offset the performance of Time and other old media assets. That tactic forced the company to obsess about mechanisms to prop up the dial-up cash cow, even as the tectonic plates of technology were shifting underneath them. Did AOL, at some point over the last 5 years, have assets to exploit to shift to a new business model? Yes, but at no point could the transition to an ad and search model be supported without re-baselining the business, a journey that Dick Parsons, Jeff B, and others were unwilling to undertake. They have a major role in the accountability chain for the whole AOL journey.

    So, with these short-term earnings constraints, what did you get? A half-hearted transition, with the dial-up business still generating the majority of the earnings out of an aging and not very credit-worthy user base.

    I think that some of the moves (the purchase of advertising.com, userplane, weblogs, the formation of TMZ.com, and the shift to a more robust free portal to retain customer traffic, etc.) were all decent moves, given the performance and investment constraints imposed on AOL, but without a new wave of initiatives to keep the journey moving forward at speed, in 2007 you began to see the languishing advertising growth starting to occur. In my eyes, Bebo is the first real new move by Randy Falco and Ron Grant that isn't a derivative of the Jon Miller-crafted playbook (I would say their hubris in claiming some intellectual highground over Miller was bad form as leaders, but that's another topic), and that's how I will grade them as business strategists going forward. I wish AOL the best of luck, but with the TWX stock trading at new lows, even when rumors of AOL being purchased hitting the wires, I think the analysts (Jessica Reif Cohen et al) still bullish on the stock should have their tickets pulled - they have done their clients a huge disservice by keeping them in the stock as it fell from its $23 peak...

  • Bob Jones

    To be fair, S&B didn't know what they were getting into. While AOL was growing, there were still problems that needed to be dealt with. There continued to be a need for a vision about where and how AOL would play as a Web company - we can't expect S&B to have that vision as they were relative newbies. S&B and TW thought they could go in with purely execution in mind while riding the gravy train to growth. Big mistake. After spending the first 6 months learning about the company, the industry, and the problems they faced, S&B tried what they thought to be fast and prudent moves to solve the problems but it was 1 year too late and some of it backfired. Instead of treading new ground, AOL was back to playing catch up to the competition. This is the problem when office politics overrule logic and vision. And, in my opinion, is largely a result of the shark infested waters at TW.

  • Not Disclosed

    ///Then there were the technology challenges. AOL's sites were written in a proprietary code, Rainman, that was incompatible with standard browsers and search engines. Ad servers couldn't read it either -- one reason ad revenues slumped from $2.6 billion in 2001 to $781 million in 2003. The company would have to invest a fortune in tech upgrades just to get to the starting gate.///

    This is just pure BS. Which is perpetuates from an article to an article. The saddest part is that AOL execs believe that even today.

    There was nothing that prevented Rainman from generating the content that was quite compatible with "standard browsers and search engines". It was done and it is done even today. Take AOL France Welcome Screen as an example.

    Technical illiteracy of AOL execs made them trust snake oil salesmen. But that did not help either, did it?

    Let me ask you: why it was so important to make AOL "go after Yahoo"? Why not make a bunch of Web brands they had chase Yahoo and leave AOL Flasgship service alone? Netscape, AIM, ICQ, Winamp, Compuserve! Sure they could make a thriving web brand from at least one of those if there was a theoretical possibilith of thatthey, couldn't they? And they would not have to deal with that dreadful Rainman. why not just leave the AOL Sevice alone? The "New Coke" marketing lesson: don't mess with the products that work! I guess they did not teach that in Harvard business school.