Dead Man Walking

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.