Putting a lid on broadband use By John Borland Staff Writer, CNET News.com http://news.com.com/2100-1034-5079624.html

Earlier this month, a Philadelphia Comcast broadband subscriber got a letter from his service provider, telling him he’d been using the Internet too much.

Keith, who asked to keep his full name private, said he’d subscribed to the service for four years and never had a complaint before. Now he was being labeled a network “abuser.”

Worse, he said, Comcast refused to tell him how much downloading was allowed under his contract. A customer service representative had told him there was no specific cap, he said, adding that he might avoid being suspended if he cut his bandwidth usage in half. But even then, the lack of a hard number gave Keith no guarantee.

What’s new: Cable Internet service subscribers are quietly capping the volume of downloading they allow their subscribers to do. So far, it’s only affecting the heaviest users.

Bottom line: As broadband providers strive for ever-speedier and economical service–and bandwidth-hogging features such as video on demand become more popular–these caps may become more common. And they may affect digital subscriber line (DSL) providers as well.

“I don’t mind restrictions, but how can Comcast expect users to stick to a limit when they don’t say what the limit is?” he said. “If they’re going to impose limits, that’s one thing, but at least tell us what they are.”

Keith isn’t alone in his newfound position under the Internet service provider (ISP) microscope. Other high-volume Comcast subscribers have been getting letters since late summer warning them of overuse. A few others have even had their service suspended after the first warning. Comcast spokeswoman Sarah Eder said that its new enforcement policy was barely two months old.

As Keith and other frustrated users found, the company’s warnings to subscribers were not triggered by any “predetermined bandwidth usage threshold,” Eder added. Only about 1 percent of subscribers received letters, which were based on having exceeded average usage patterns rather than a specific number, she said.

For now, this quiet imposition of usage caps affects only a tiny fraction of extraordinarily high-volume users. But it goes to the heart of the competitive decisions cable and telephone companies are making as they struggle for broadband dominance . Comcast in particular is working to provide ever-increasing download speeds , and as result it is struggling to contain busy file swappers and others who are putting stress on their networks.

It is not something the broadband providers are eager to talk about. Even as Comcast sends out letters to its customers targeting high-volume users, the company bristles at the notion that the policy is a cap.

It’s easy to see why: As cable and DSL companies race to bulk up on subscribers, companies tagged as “bandwidth cappers” could be at a disadvantage. The problem is particularly awkward for cable companies, which have tried to avoid a price war with the telephone companies by promising better quality of service.

“The industry is leery of explicit caps, because even people who don’t come anywhere near the caps feel like something is being taken away from them,” Jupiter Research analyst Joe Laszlo said. As consumers grow more used to broadband services and begin understanding what to expect from their connections, companies “can’t claim their service is unlimited if there is some kind of informal limit,” Laszlo added.

Hard caps and fuzzy ones Different ISPs are taking widely different approaches to this issue, although caps seem for now to be limited to the cable companies.

Cox Communications started phasing in hard usage limits in February, and now a majority of that company’s subscribers are limited to downloading 2 gigabytes a day–the equivalent of about two compressed feature-length movies or about 400 MP3 songs. AOL Time Warner’s Road Runner cable modem service has no caps yet, although sources say the idea is being discussed internally.

Comcast’s policy has proven most controversial. The company’s terms of service say only that users cannot “represent (in the sole judgment of Comcast) an unusually large burden on the network.” According to a spokeswoman, the company began sending notes about two months ago to the top 1 percent of the heaviest users–people who collectively use about 28 percent of the company’s bandwidth–telling them they were violating their terms of service.

Eder said there was no specific line crossed by these subscribers, but she added that some of those people were downloading the equivalent of 90 movies in a given month.

Comcast customer Keith, a British immigrant, said he used his cable modem service to watch the BBC, have video conversations and trade DVD-quality home movies with his family in the United Kingdom.

Comcast defended the policy of having the unstated–but still enforceable–limitation on bandwidth use, saying that any hard cap would have to change in any case as high-bandwidth applications such as video on demand became popular.

“The Internet is growing, and there are more broadband applications every day,” Eder said. “If we were to set an arbitrary number today, we could be changing it tomorrow.”

Both Cox and Comcast have a policy of sending warning letters to subscribers before suspending or terminating service. No subscriber would be affected without substantial warning, spokespeople from both companies said.

Some smaller cable companies are imposing much lower caps. Alaska’s GCI Cable , for instance, limits its subscribers to transferring just 5 gigabytes a month.

Telephone companies offering DSL service in the United States say they have no limits in place for their users, unlike Canadian, British or Australian counterparts that routinely cap their subscribers’ usage. Verizon Communications and SBC Communications, the largest DSL providers in the United States, both said their services remain unlimited.

“The customers buy the lines,” SBC spokesman Michael Coe said. “We make whatever bandwidth they need available to them.”

There’s a limit The caps are a small but crucial part in the latest round of skirmishing among broadband companies over price and features. Cable companies have had a lead in the consumer market for years, but they’re now nervously watching telephone companies’ DSL services–particularly co-branded offerings like the SBC Yahoo service–start to close the gap.

Both sides are trying to figure out how best to attract and then support the mainstream dial-up Internet audience, which is finally starting to come to broadband in droves.

DSL companies have brought deeply discounted prices into their arsenal. It’s now rare not to see a $29.95 per month offer from the likes of SBC or Verizon, and that’s helping bring subscribers in quickly. The cable companies, on the other hand, tout faster download speeds and Web surfing than the average DSL connection provides, and they are working to make their networks even faster.

Comcast, leading the way, has promised to double the average Net surfer’s top speeds, from 1.5 megabits per second to 3 megabits per second, and to get even faster in future years. Analysts say the drive to keep very high-volume users under control is necessary if the company is to reach this goal economically.

Most broadband subscribers use their service for some music or video downloading, to send and receive digital photos or for other high-bandwidth applications. But ISPs say that a tiny percentage of people are using an enormous percentage of their total bandwidth. According to Comcast, just 6 percent of subscribers use about 78 percent of the company’s bandwidth.

Cable networks are particularly susceptible to the dangers of this imbalanced usage, because all the homes in a given neighborhood share access to the same local network. One extremely high-volume user can therefore have a Net-slowing impact on his neighbors.

Nor are DSL companies exempt from this issue, despite their rhetorical distain for caps today. Even if their subscribers don’t share their local wires, DSL uploads and downloads do wind up merging into a shared network a little farther upstream, and so heavy users can wind up having a negative impact on others’ speeds.

For this reason, some analysts think that bandwidth usage caps will ultimately be a far more common part of the Net’s daily life, particularly at the lowest tiers of service.

“It’s partly just so the economics make sense,” Jupiter’s Laszlo said. “If you’ve got someone downloading 60 gigabytes a month and paying $29.95, it’s hard to make it work.”

Related News Broadband adoption skyrockets worldwide   September 16, 2003 http://news.com.com/2100-1034-5077230.html

Comcast: Faster downloads by year’s end   September 8, 2003 http://news.com.com/2100-1034-5072641.html

Survey: Users want DSL but can’t get it   August 6, 2003 http://news.com.com/2100-1023-5060701.html

Endless summer of DSL discounts   July 7, 2003 http://news.com.com/2100-1034-1023465.html

Get this story’s “Big Picture”

APPLE Songs in the Key of Steve Steve Jobs may have just created the first great legal online music service. That’s got the record biz singing his praises. FORTUNE Monday, April 28, 2003 By Devin Leonard

Steve Jobs loves music. But as with a lot of geeks in Silicon Valley, his musical tastes are a little retro. He worships Bob Dylan and is the kind of obsessive Beatles fan who can talk your ear off about why Ringo is an underappreciated drummer.

So Dr. Dre, the rap-music Midas whose proteges include Snoop Dogg and Eminem, is the last person you’d expect to see huddled with Jobs, for hours on end, at Apple headquarters in Cupertino, Calif. No, they weren’t discussing whether John or Paul was the more talented Beatle. Rather, Steve had invited Dr. Dre up from Los Angeles for a private demonstration of Apple’s latest product. After checking it out, Dre had this to say: “Man, somebody finally got it right.”

The product that wowed him was the iTunes Music Store, a new digital service for Mac users offering songs from all five major music companies–Universal, Warner, EMI, Sony, and BMG. Though Apple had yet to sell a single song by the time FORTUNE went to press, Jobs is already causing a stir in the record business. Forget about rumors that Apple is bidding for Vivendi’s Universal Music Group, the world’s largest record company. Jobs says he has absolutely no interest in buying a record company.

The real buzz in the music trade is that Steve has just created what is easily the most promising legal digital music service on the market. “I think it’s going to be amazing,” says Roger Ames, CEO of the Warner Music Group. Jobs, not surprisingly, is even more effusive. He claims his digital store will forever change not only how music is sold and distributed but also the way artists release and market songs and how they are bought and used by fans.

One thing’s for sure: If ever there was an industry in need of transformation, it’s the music business. U.S. music sales plunged 8.2% last year, largely because songs are being distributed free on the Internet through illicit file-sharing destinations like KaZaA. Unlike Napster, KaZaA and its brethren have no central servers, making them tougher for the industry to shut down. The majors have tried to come up with legal alternatives. But none of those ventures have taken off because they are too pricey and user-hostile.

The iTunes Music Store, by contrast, is as simple and straightforward as anything Jobs has ever produced. Apple users get to the store by clicking a button on the iTunes 4 jukebox, available for download when the service made its debut on April 28. You can listen to a 30-second preview of any song and then, with one click, buy a high-quality audio copy for 99 cents. There’s no monthly subscription fee, and consumers have virtually unfettered ownership of the music they download. Jobs is rolling out the iTunes store with previously unreleased material by artists including Bob Dylan, U2, Missy Elliott, and Sheryl Crow. There will be music from bands like the Eagles, who have never before allowed their songs to be sold by a legal digital music service. And Jobs is personally lobbying other big-name holdouts, like the Rolling Stones and the Beatles, to come aboard.

The iTunes Music Store may be just the thing to get Apple rocking again too. As everyone knows, it’s been a tough couple of years for the computer industry as well. Apple swung back into the black in the first quarter of 2003 after two quarterly losses, but its profits were only $14 million, compared with $40 million a year ago. And as popular as Apple’s iPod portable MP3 player may be, it contributed less than $25 million of Apple’s $1.48 billion in revenues last quarter. So Jobs is betting that by offering customers “Hotel California” for 99 cents, he can sell not just more iPods but more Macs too.

Apple’s competitors dismiss the iTunes Music Store as a niche product. How, they ask, can Apple have any impact on the music industry when its share of the global computer market is a minuscule 3%? “It’s a very positive thing for their community,” says Kevin Brangan, a marketing director at SonicBlue, which makes Rio MP3 players. “But their community is a very small percentage of the overall market.”

Jobs, however, isn’t targeting just Mac users. He plans to roll out a Windows version of iTunes by the end of the year. (Apple already sells a Windows-compatible version of the iPod, which accounts for about half of all units sold.) It is a dramatic departure for Steve, who has deliberately kept the Mac’s best features off the screens of the much larger Microsoft-dominated world.

Steve isn’t suggesting that his new service will lift the computer industry out of its funk. But he is 100% convinced that the Music Store will rejuvenate the ailing music business. “This will go down in history as a turning point for the music industry,” Jobs told FORTUNE. “This is landmark stuff. I can’t overestimate it!”

The idea that anybody from Silicon Valley can swoop in and save the music industry seems laughable at first. But by nearly every account, this is not just some Steve Jobs sales job. In fact, the Music Store is being copied by rivals even before it hits the market. The reason, as Dr. Dre noted, is that nobody has come up with a better plan to sell music online. So iTunes or something like it had better work. Otherwise, the music industry as we know it could soon disappear.

It’s a sunny afternoon in early April, and Jobs is rhapsodizing about his new music service at Apple headquarters. He is clad in the same outfit he dons nearly every morning so he doesn’t have to waste time choosing clothes: a black mock-turtleneck shirt, jeans, and New Balance sneakers. There’s been a slight change in his uniform, though. The 48-year-old Apple CEO now rolls up the cuffs of his jeans. (What would Dr. Dre think of that fashion statement?)

But Steve isn’t interested in talking about his new look on this day. (He later allowed that he just bought pants that were the wrong size.) He’s here to talk music. “It pained us to see the music companies and the technology companies basically threatening to take each other to court and all this other crazy stuff,” he explains. “So we thought that rather than sit around and throw stones, we’d actually do something about this.”

He was equally appalled by the music industry’s reluctance to satisfy the demand for Internet downloading that Napster had unleashed. Who could blame him? After bludgeoning Napster to death in court, record companies promised to launch paid services with the same limitless selection and ease of use.

They did just the opposite. Universal and Sony rolled out a joint venture called Pressplay. AOL Time Warner (the parent of both Warner and FORTUNE’s publisher), Bertelsmann (BMG’s owner), EMI, and RealNetworks launched MusicNet. But instead of trying to cooperate to attract customers, the two ventures competed to dominate the digital market. Pressplay wouldn’t license its songs to MusicNet, and MusicNet withheld its tunes from Pressplay.

The result: Neither service had enough songs to attract paying customers, who couldn’t care less which record company a particular song comes from. “It was strictly the greed and arrogance of the majors that screwed things up,” says Irving Azoff, who manages the Eagles and Christina Aguilera. “They wanted to control every step of the [Internet] distribution process.”

The record companies were also fearful about doing anything that might cannibalize CD sales. So they decided to “rent” people music through the Internet. You paid a monthly subscription fee for songs from MusicNet and Pressplay. But you could download MusicNet tunes onto only one computer, and they disappeared if you didn’t pay your bill. That may have protected the record companies from piracy, but it didn’t do much for consumers. Why fork over $10 a month for a subscription when you can’t do anything with your music but listen to it on your PC? Pressplay launched with CD burning but only for a limited number of songs.

At the end of last year, Pressplay and MusicNet licensed their catalogues to each other, ending their standoff. MusicNet also now permits subscribers to burn certain songs onto CDs. But MusicNet users still can’t download songs onto portable players. “These devices haven’t caught on yet,” insists MusicNet CEO Alan McGlade. Never mind that U.S. sales of portable MP3 players soared from 724,000 in 2001 to 1.6 million last year. Pressplay, for its part, lets subscribers download some songs onto devices, but only those that use Microsoft’s Windows Media software. That means no iPods.

Pressplay and MusicNet say it’s too early for anybody to dismiss them as failures, but it’s difficult to see them as anything else. The music industry has little to show for its investment–Sony and Universal are believed to have spent as much as $60 million so far on Pressplay. The two services don’t release their subscriber numbers, but Phil Leigh, an analyst at Raymond James, believes that together they have signed up only about 225,000 customers. “It was clear to me in my first 30 days on the job that Pressplay was a first effort and a work-in-progress,” says Andrew Lack, who took over as CEO of Sony Music Entertainment in February. “No one was saying, ‘This is it. We can’t sign up people fast enough.'”

Consequently, the five major record companies have had to slash costs in the face of declining sales. BMG laid off 1,400 people, EMI shed 1,800, and Sony Music recently announced it was reducing headcount by 1,000. Even with those cuts, average profit margins for the five majors have slipped to 5%, compared with 15% to 20% in the late 1980s when the CD came into vogue. “All the chickens are coming home to roost at the same time,” says media analyst Claire Enders. “This industry has never been faced with such cataclysmic conditions before. It has no roadmap on how to cope with them.”

The irony is that the music industry has always survived by introducing new formats–from the 78-rpm single to the 33-rpm vinyl LP album in the 1950s, to the cassette tape in the 1970s, to the compact disc, which sparked a rebirth of the industry in the 1980s. Now nearly everyone in the business admits that the only clear path to the future is to come up with a legal, online alternative to KaZaA and other illegal file-sharing services. This could be the mother of all format shifts, because it would largely eliminate manufacturing and distribution costs. But nobody in the music industry has been able to get there. “This new technology has swept by us,” laments Doug Morris, chairman of the Universal Music Group.

As long as people can get free music online, the music industry’s chances of recovery are dim. But stealing songs on the Internet isn’t as much fun as it used to be. For one thing, file-sharing services are teeming with viruses. The Recording Industry Association of America has also upped the ante with a new suit accusing four college students of operating piracy networks. That’s likely to put a damper on illicit computer activities in many dormitories. In addition, the record companies are planning to introduce new CDs with two sets of the same songs–one that can be played on your CD player and another that you can listen to on your computer but that can’t be uploaded onto KaZaA.

In a world where CDs can’t be shared on the Internet and music pirates are hauled into court, there may be huge demand for a legitimate digital music service. But it’s going to have to be one that’s a lot better than what the music industry has offered so far. Apple’s timing, in other words, could hardly have been better.

Jobs didn’t set out to be the music industry’s savior. He was such a latecomer to the digital music world that some observers wondered if he’d lost his knack for spotting trends long before his competitors. Heck, Apple didn’t even include CD burners as standard equipment on its computers until two years ago. But once Jobs focused on music, he was consumed by it. He saw people ripping CD tracks and loading them onto their hard drives. So in 2001 Apple introduced the iTunes jukebox software, which lets users make their own playlists or have the computer select songs randomly.

What else might Mac users wish to do with their MP3 files? Apple engineers were certain they’d want to load them into a pocket-sized portable player with a voluminous hard drive. So they created the iPod, a device that works seamlessly with iTunes. Apple has sold almost a million iPods, even though the least expensive one costs $300.

Then Steve had an epiphany: Wouldn’t it be awesome if people could buy high-quality audio tracks via the Internet and load them directly into iTunes instead of going to the store to buy CDs to rip? It dawned on him that Apple had all the pieces in place to start such a business. For one thing, the company already had the Apple Store, an online operation selling more than $1 billion a year in computers and software, most of which can be purchased with a single mouse-click. It also runs the Internet’s largest movie-trailer downloading site.

The only thing missing was music. Until recently it would have been impossible for a major tech company like Apple to license tunes from Warner, EMI, Universal, Sony, and BMG. Executives at those companies simply didn’t trust their peers in the technology world. Many felt–not without some justification–that PC makers promoted piracy because it helped sell computers.

Apple, however, straddles the worlds of technology and entertainment like no other software or hardware maker. Along with running Apple, Jobs is CEO of Pixar, the digital-animation studio whose movies include Toy Story and Monsters, Inc. He also has plenty of admirers in the music world. Some of Apple’s most zealous fans are rock stars who use Macs, both at home and in the recording studio. “Musicians have always adopted Macs,” says Trent Reznor of Nine Inch Nails fame. Jobs is enough of a rock star himself–is anybody in the technology world as cool?–that he’s been able to get U2’s Bono on the phone to discuss the iTunes Music Store. He’s personally demonstrated it to Mick Jagger.

The iPod, too, has become a fetish item among musicians and notoriously technophobic music company executives. “I’m addicted to mine,” says Interscope Geffen A&M records chairman Jimmy Iovine. It made sense to Iovine and a lot of other record-company big shots that if Apple could transform a geeky device like the portable MP3 player into a sexy product with mass-market appeal, it might be able to work similar wonders with online digital music sales. It’s probably no coincidence that the most vocal boosters of the Apple store are Universal and Warner, whose debt-ridden parents–Vivendi and AOL Time Warner, respectively–are under pressure from investors to get out of the music business entirely.

The record companies were still leery enough of Apple that they would agree only to one-year deals with Jobs. Nevertheless, he was able to persuade Universal, EMI, Sony, BMG, and Warner to stop fixating on their subscription models and take a radically different approach to selling digital music. People want to own music, not rent it, Jobs says. “Nobody ever went out and asked users, ‘Would you like to keep paying us every month for music that you thought you already bought?'” he scoffs. “The record companies got this crazy idea from some finance person looking at AOL, and then rubbing his hands together and saying, ‘I’d sure like to get some of that recurring subscription revenue.’ ” He adds: “Just watch. We’ll have more people using the iTunes Music Store in the first day than Pressplay or MusicNet have even signed up as subscribers–probably in the first hour.” We’ll let you know in a future issue if that bold prediction proves accurate.

Record-company executives aren’t ready to dump the subscription model–yet. “I’m not sure subscriptions are going to work,” says David Munns, CEO of North American Recorded Music for EMI. “A mixed model where you can rent some music and download what you really like could work. Let’s keep an open mind.” But what really grabs music executives about iTunes is its sheer simplicity. “It’s a lot easier to get people to migrate from physical CDs to buying individual songs online than it is to jump-start a subscription service,” says Warner’s Ames.

Apple is trying to make that transition as easy as possible. With the iTunes Music Store, you can browse titles by artist, song title, or genre. Songs will be encoded in a new format called AAC, which offers sound quality superior to MP3s–even those “ripped” at a very high data rate. That means each AAC file takes up a lot less disc space, so you’ll be able to squeeze better-quality music, and more of it, onto your computer and iPod. Moreover, each song will have a digital image of the album artwork from the CD on which the track was originally sold. Says Sony’s Lack: “I don’t think it was more than a 15-second decision in my mind [to license music to Apple] once Steve started talking.”

Apple has also come up with a copy-protection scheme that satisfies the music industry but won’t alienate paying customers. You can burn individual songs onto an unlimited number of CDs. You can download them onto as many iPods as you might own. In other words, the music is pretty much yours to do with as you please. Casual music pirates, however, won’t like it. The iTunes jukebox software will allow a specific playlist of songs or an album to be burned onto a CD ten times. You can burn more than that only if you manually change the order of the songs in the playlist.

And anybody who tries to upload iTunes Music Store songs onto KaZaA will be shocked. Each song is encrypted with a digital key so that it can be played only on three authorized computers, and that prevents songs from being transferred online. Even if you burn the AAC songs onto a CD that a conventional CD player can read and then re-rip them back into standard MP3 files, the sound quality is awful.

The iTunes Music Store will initially offer 200,000 tunes, paying the record companies an average of 65 cents for each track it sells. Ultimately Jobs hopes to offer millions of songs, including older music that hasn’t yet made it to CD. “This industry has been in such a funk,” sighs singer Sheryl Crow. “It really needs something like this to get it going again.”

If the iTunes Music Store or something like it takes off, that could change how new music is released, marketed, and promoted. Until recently the chief fear in the music industry about letting people buy individual songs via the Internet was that it would kill the album by enabling consumers to cherry-pick their favorite tracks. Music company executives now bravely say that a singles-based business might actually revive sales.

Steve is doing everything he can to stoke their optimism. “Nobody thinks of albums anymore, anyway,” he argues, perhaps a little too blithely. “People think of playlists and mixes. We’ll still sell albums as artists put them out, but for most consumers of popular music, we think they’ll more likely buy single tracks that they like. And then they’ll organize them into customized playlists in their computers and on their iPods.”

The reality is that initially, at least, the record companies will probably sell less music if they shift to an Internet-based singles business model. For years they have been able to get away with releasing albums with two or three potential hits bundled with ho-hum filler cuts. That has been wonderful for the industry, but it has made a generation of consumers who pay $18.99 for CDs very cynical. “People are sick and tired of that,” says singer-songwriter Seal. “That’s why people are stealing music.”

For some artists, the idea of a singles-driven business is anathema. “There’s a flow to a good album,” says Nine Inch Nails’ Reznor. “The songs support each other. That’s the way I like to make music.” But Crow says it would be a relief to put out singles instead of producing an entire album every time she wants to reach fans. “It would be nice to have a mechanism to release a song or two or three or four on their own,” she says.

A renewed emphasis on individual songs could well improve the quality of music and lead to a reordering of the entire industry. It won’t happen overnight, but the record companies had better get used to this new model. Now that Apple has gotten the music industry to support its pay-per-download store, nearly all of its Wintel PC-based rivals say they will augment their subscription businesses with similar offerings. “Steve’s pushing the ball forward here,” concedes Rob Glaser, CEO of RealNetworks, which owns nearly 40% of MusicNet and plans to purchase Listen.com’s well-regarded Rhapsody subscription service.

But Glaser insists that Apple is ignoring a significant part of the digital music market by offering just downloading. He says Rhapsody users spend 72% of their time listening to streaming music. Only 13% pay $1 to burn cuts onto CDs. “If you make a really cool playlist of 200 songs on Rhapsody, you pay only $9.95 a month,” he says. “If you use Apple, it’s $200. Maybe guys like Steve and me can afford that, but I’m trying to run a service for everyone else too.”

No matter what happens, Jobs will likely sell more Macs. But that’s not all he’s after with music. The Music Store is his latest effort to diversify Apple’s sources of revenue beyond Macs. With Apple’s share of the desktop computer market stuck at less than 5% in the U.S. and less than 3% worldwide for several years, the iPod is the most obvious new line of business, steering Apple onto the home turf of consumer-electronics giants like Sony and Matsushita. Now Apple makes almost as much operating profit on each iPod it sells as it does on each iMac, even though the iPod costs a fraction as much to manufacture. So it should come as no surprise that Jobs is releasing three new versions of the iPod in conjunction with the Music Store (for more on that, see Gifts for the Grad: Apple iPod.)

Jobs has been very shrewd about the way he moved the iPod into the PC universe. Anyone who has tried the iPod with both systems will tell you it’s a lot more fun to use if you plug it into a Mac running Apple’s OS X than into a Dell with Windows XP. “The Windows iPod sucks” is Seal’s appraisal. “But what they are really doing is trying to get people to wonder, ‘Hmm, should I switch over?'” Jobs is betting that the iTunes Music Store, like the iPod, could be just such a Trojan horse.

It’s not as easy as it sounds. How many Windows iPod owners know what they’re missing by not using OS X? Do any of them really care? Perhaps that’s why Jobs is rolling out iTunes for Windows too. In fact, Warner’s Roger Ames is trying to broker a deal in which AOL would adopt iTunes as its music-manage-ment software. “Steve was resistant at first,” Ames says. “But now I understand that he’s decided to go that way.” AOL has been trying to develop its own music store to go along with its subscription service but hasn’t figured out a billing system for individual tracks as Apple has. A deal with AOL would land the iTunes Music Store on the desktops of AOL’s 26 million subscribers. That could quickly make Apple the dominant seller of digital music on the Internet. AOL would neither confirm nor deny a possible deal.

A big play for Windows users would be a huge shift for a man who has largely created a product–the Mac–that exists in a walled garden cut off from the much vaster PC world. Clearly, Apple will benefit enormously if it boosts its share of the computer market by even 1%–such a gain would lift its revenues by nearly a third and increase profits even more. In the meantime, if the iTunes Music Store takes off–and computer users of all stripes start buying millions of songs online each month–that will translate into tens of millions of dollars in new revenues per month for Apple.

His adventures in the music business have led to other changes in Jobs’ thinking. During the photo shoot with Sheryl Crow for this article, he acknowledged to the singer that he had never really understood what rap music was all about. But while playing with a prototype of the iTunes Music Store on his Mac at home in recent weeks, he had started downloading some of Eminem’s tracks.

“You know, he really is a great poet,” Crow said.

To which Steve replied, “Yeah, he’s starting to kind of grow on me.”

Feedback: dleonard [at] fortunemail [dot] com

But AOL will go down in history as a Ponzi scheme that makes 80s Junk Bonds look like chicken feed. Actually, I found a good backgrounder on Ponzi schemes here: http://www.mark-knutson.com/thescheme.html

-Ian.

——- http://www.fortune.com/fortune/investing/articles/0,15114,443065,00.html

AOL TIME WARNER Why AOL’s Accounting Problems Keep Popping Up The online giant created ad ‘revenues’ out of thin air. Now, it’s got scandals! FORTUNE Monday, April 14, 2003 By Carol J. Loomis

When there’s bad corporate news to be disclosed, the wise say, “Get it out and get it over with.” But that message hasn’t visibly permeated AOL Time Warner (parent of FORTUNE’s publisher) when it comes to accounting problems. Since last July, when the Washington Post did a biting two-part article about unsavory behavior at AOL, the company’s online division, the news hasn’t stopped. First the SEC moved in to investigate, and then came the Justice Department. Next, in August, AOL Time Warner’s CEO, Richard Parsons, certified the company’s financial statements–except for $49 million in AOL “revenues” that the company said it had just discovered maybe shouldn’t have been claimed as such. By October, when a “review” of that matter and others had been completed, the $49 million of nonrevenues had ballooned to $190 million (for unenumerated sins, most attributed to AOL), which the company said it would expunge by restating eight quarters of its 2000-02 financial statements. In the restatements, of course, profits vanished along with the revenues.

Then, just as March ended, came the news that the company and the SEC were arguing over yet an additional $400 million of revenues that might not deserve the name. In short, the SEC is suggesting that the $190 million confession didn’t exhaust the bad stuff. Its investigation continues, as does the Justice Department’s. So AOL Time Warner has acknowledged that further restatements might become necessary.

There’s a stark explanation for this river of news, and it’s kin to an old saying: “To a man with a hammer, everything looks like a nail.” At the AOL division, the locus of the accounting troubles, the hammer was an insatiable desire to show growth in revenues–very particularly, in what AOL called “advertising and commerce”–and to book the Ebitda (earnings before interest, taxes, depreciation, and amortization) that tagged along. So to AOL every business deal, including the unlikeliest of candidates, looked like a way to get these revenues. AOL won an arbitration award that it negotiated into an advertising contract. A raft of dot-coms that AOL invested in round-tripped their money–and at least once, in the case of Homestore.com, apparently triangulated it–into advertising. Investing in a dot-com called PurchasePro, AOL bought warrants for $9 million, then marked up the investment to $27 million and booked the difference as revenues.

And in the latest revelation, AOL’s purchase of Bertelsmann’s half-interest in AOL Europe magically produced that $400 million in ad revenues that the SEC and AOL Time Warner are fighting over. Magically and invisibly, we might add. Outsiders never knew there was $400 million of advertising tied to the Bertelsmann deal until AOL Time Warner made that fact clear at the end of March.

So, yes, in Virginia, at AOL, there was an obsession to get advertising in the door. Consequently nobody there appears to have paid much attention to whether the business deals at issue were really producing ad “revenues” by any acceptable definition–or perhaps the insiders didn’t think outsiders would ever learn the details. Well, the outside world has now caught on, and so have a lot of plaintiffs lawyers. Besides tussling with Washington, AOL Time Warner is today the defendant in at least 40 shareholder suits, many of which sprang from the accounting legerdemain.

It is important to recognize that at AOL Time Warner, whose revenues last year were $42 billion, neither $190 million nor $400 million is a major figure. But in certain ways these tainted amounts (leaving aside other problems the regulators may still unearth) counted for a lot. That’s partly true because incremental advertising revenues at AOL don’t tend to be heavily burdened with costs. So these revenues generally cascade into profits. Specifically, AOL Time Warner has said that the $190 million in bogus revenues ($22 million of which went to company divisions other than AOL) produced $97 million of Ebitda and $46 million in net income. That net translated–until the restatements whisked it away–into a neat profit-to-revenues margin of 24%. As for the $400 million, what it produced in Ebitda and net income can’t be said, because the company has not disclosed that information.

The other reason that these incremental revenues mattered is that they helped AOL paint a deceptive picture of exactly what was happening in its advertising and commerce line of business. As 2000 began, bringing with it the amazing news that AOL and Time Warner were going to merge, this segment of operations was the bright hope for AOL. Its online subscription business, true, was significantly larger and still growing. It produced revenues in 2000 of $4.777 billion, against a reported, though now tainted, figure of $2.347 billion for advertising and commerce. But everyone expected that growth in subscriptions would eventually flatten out (which, in 2002, it did), and here was this advertising and commerce business whooshing up like crazy–roughly doubling every year, in fact.

We all know now that the Internet bubble burst in March 2000, but at the time that fact was not obvious. And at AOL, for sure, the announced ambitions for advertising and commerce were then still extraordinary. At a joint meeting of the AOL and Time Warner boards in July 2000, Robert Pittman, the highly confident chief operating officer of AOL (who is now gone from the company), said that by the year 2005, he expected this line of business to produce $7 billion in revenues!

In your dreams–including the ones that began exploding in 2001. That year’s picture was helped out by $88 million in revenues that AOL Time Warner now says were “inappropriately recognized” and by $122 million in contested Bertelsmann revenues. Even so, the advertising and commerce line grew that year only to $2.673 billion, a tepid rise of 14%. And in 2002 the trend rolled over abjectly–like a worn-out dog–and revenues fell by a huge 40%, to $1.606 billion. The amount would have been significantly lower still had it not included $6 million of inappropriately booked revenues and $274 million from the Bertelsmann deal. In any case, the punishing experience of 2002 proved the idiocy and uselessness of all the contortions that AOL had put itself through in its advertising business: It was trying to get from a place it never was to a place it never could be.

During all the accounting events that led up to the $190 million restatement, including those that took place after the consummation of the merger in early 2001, AOL people were in charge of what was happening at AOL. Steve Case was the boss; Bob Pittman was originally No. 2 and later was the AOL Time Warner executive who had responsibility for AOL; Michael Kelly was the hard-charging chief financial officer (first of AOL, then for a time of AOL Time Warner); and a man named David Colburn –fired last August–ran the business affairs department that negotiated many of the smelly deals. In the meantime, the old Time Warner executives–Gerald Levin, who became CEO of AOL Time Warner, and Richard Parsons, now CEO–were in New York City, sort of listening in. What they knew about the happenings at AOL is unclear.

But the $400 million deal done with Bertelsmann, the big German media company, is different from the $190 million in that it spanned a regime change, in which the AOL forces lost power and Time Warner gained it. So people like Levin and Parsons were on the Bertelsmann case at certain key moments. The deal’s strangeness therefore deserves special attention.

When AOL and Time Warner announced in January 2000 that they would merge, Bertelsmann and AOL had a skein of connections. Steve Case and Bertelsmann’s CEO, Thomas Middelhoff, were good friends; Middelhoff was on AOL’s board; Bertelsmann was a significant holder of AOL stock (though it had also been a significant seller in the late ’90s, reaping glorious profits at per-share prices ranging up to around $95); and the two companies jointly owned AOL Europe. After the merger announcement some of these things had to go, for the simple reason that Bertelsmann and Time Warner were competitive media giants and couldn’t be in bed together.

So Middelhoff resigned from AOL’s board. And then in March 2000 the two companies said they had agreed on a complex put-and-call deal by which AOL would potentially buy out Bertelsmann’s 49.5% interest in AOL Europe. This business was then, and is now, a losing operation. But the price negotiated by the CFO of AOL, Kelly, was a product of Internet frenzy and was to be a monster $6.75 billion (or under certain circumstances even more). One major investor in AOL Time Warner recently called that deal the “killer” for the merger, though it is probably wishful thinking on his part to believe that this one transaction could have made the difference in a coupling so fated to fail.

If a minimum price of $6.75 billion was set, the exact timing and terms were not. Most important, AOL Time Warner had the right to pay in cash, stock, or a combination. There was also a delay factor built into the deal, specifying that payment would not begin, at the earliest, until 2002.

By March 2001, though, with the merger completed, AOL’s Kelly and Bertelsmann were down to hard negotiations about just what kind of payment–cash or stock–would be made. Looking at AOL’s tumbling shares, then fluctuating around $40, Bertelsmann naturally wanted cash. You might think that AOL would want the opposite, since it was loaded with more than $20 billion in debt and sure to need more if it paid cash. But what AOL really cared about, above all things, was a quid pro quo. AOL offered cash if “in exchange” (words used in AOL’s recent disclosures about the deal) Bertelsmann would sign up for ads.

And in the end a kind of compromise was reached: AOL Time Warner would pay at least $2.45 billion in cash (with the form of payment for the remainder of the $6.75 billion to be settled later), and Bertelsmann would buy $125 million in ads. When the $2.45 billion arrangement was announced in AOL Time Warner’s first-quarter 10-Q filing with the SEC, nothing was said about a $125 million advertising deal tied to it.

Bertelsmann’s ads, for such things as music products and book clubs, began to run on AOL, in most cases dwarfing the amounts being spent in those categories by other advertisers. But one former Bertelsmann executive remembers behind-the-scenes dissension at his company about the deal. He, for one, saw no use in advertising on AOL but was forced to go out and do it. Fortunately for his bottom line, he says, headquarters absorbed the cost of the advertising on its books rather than allocating it down to the operating divisions.

By the end of 2001, most of Bertelsmann’s $125 million had been spent, and AOL and Bertelsmann were back to negotiating the next tranche of payment. Mike Kelly (who declined to talk to us) had at that point been moved out of the CFO’s job, becoming the operating head of AOL. But the word at AOL Time Warner’s offices in New York City is that he continued to be the negotiator on the Bertelsmann deal. And certainly the style of what developed looked familiar: This time AOL agreed that in 2002 it would pay the entire $6.75 billion in cash, and in exchange, Bertelsmann would buy $275 million more of advertising on AOL (almost all of which ran in 2002).

So, to sum up: To get cash, Bertelsmann was willing, in effect, to cut $400 million from the purchase price (and maybe more; who knows?). AOL could have accepted that cut straight out, reducing the price it had to pay to $6.35 billion–and thereby netting a crisp, clean saving of $400 million. Instead, it opted to get that much in advertising, which though it may not have carried much in costs, certainly carried some. So AOL Time Warner did not, in that arrangement, garner a full $400 million. It’s totally weird–unless you know that the only reason for doing things that way was to capture advertising and commerce revenues.

We come now to the role of Time Warner executives in all this. By late 2001 there had been a regime change, in which the Time Warner crew had taken power from AOL. Jerry Levin was retiring in May 2002 but had designated Dick Parsons, not Bob Pittman, as his successor. A new CFO, Wayne Pace, formerly at Turner Broadcasting, had been installed in November 2001 and had been widely accepted as an upright, tell-it-like-is executive. And this new team was stepping up to the job of reporting the company’s results.

So in the spring comes 10-K time, in which the company must file its annual report with the SEC. The Bertelsmann deal got a lot of ink in that 10-K: The company, the filing said, would pay $6.75 billion in 2002 and was borrowing to raise the cash needed. But was there any mention that the $6.75 billion was offset by a $400 million advertising deal? Absolutely not.

FORTUNE sought to ask AOL Time Warner management about this omission, as well as many other points having to do with the accounting problems. But management, pleading the Washington investigations, wouldn’t talk on the record, and this writer wouldn’t talk off the record. Company executives merely repeated what they had said before: “As we stated in our Form 10-K, the company and its auditors continue to believe that the Bertelsmann transactions have been accounted for correctly. But, as we disclosed, we are engaged in ongoing discussions with the SEC staff to consider their views and any additional information they may have as part of the company’s continuing efforts to cooperate with the SEC’s investigation.”

Because AOL Time Warner wouldn’t tell us why it had omitted the $400 million advertising deals from its SEC filings, we can only speculate about the reasons. Maybe management and its auditor, Ernst & Young, honestly thought there was no need to mention the advertising. Then again, maybe they recalled what had happened in the first-quarter 10-Q–no reference to the first advertising agreement–and thought it would be controversially inconsistent to suddenly be making admissions about the Bertelsmann ad deals.

Although investors might think AOL Time Warner had a duty to disclose the advertising deals, the SEC’s declared problem with the Bertelsmann matter is not about disclosure but rather about the accounting for the advertising. As AOL Time Warner has described things, the SEC has a “preliminary view” that at least some portion of the $400 million should not have become revenues but instead should have been recorded as a reduction in the price that the company paid Bertelsmann.

Neither AOL Time Warner nor Ernst & Young agree with this argument. How could they, given that they did not include the Bertelsmann deal in the bad stuff that they acknowledged in the $190 million confession? Indeed, FORTUNE has learned that when AOL Time Warner signed off on the $190 million in October, it did not know the SEC had any problems about Bertelsmann. The SEC, for that matter, didn’t then know it either, because only later did it become educated about the Bertelsmann affair.

AOL Time Warner and Ernst & Young are not only defending the accounting but have also explained to the SEC in writing why it was sound. FORTUNE asked to see a copy of the explanation but was refused. We then directly asked Ernst & Young to brief us about the accounting issues, and they refused that request as well, saying they could not “breach the confidentiality of client matters.”

So we turned to some outside accounting experts. One, Jack Ciesielski, publishes the highly regarded Analyst’s Accounting Observer and is also a member of the Financial Accounting Standards Board’s emerging-issues task force. To Ciesielski, there’s no gray area to this issue at all. “I agree with the SEC,” he says. “The timing of the advertising contracts indicates they were part of the deal.” So what he sees is a “rebate” that should never have been accounted for as revenues but rather as an offset to the cost of the deal.

A sharper opinion still comes from Walter Schuetze, a former KPMG partner who also served as a board member of FASB, chief accountant of the SEC, and chief accountant of its enforcement division. “I suspect,” he says, “that the SEC staff is saying to AOL that only the fair value of the advertising that Bertelsmann bought can be booked as revenue. But that is such a diaphanous number that I wouldn’t put much stock in it. I think the entire $400 million should be credited to the purchase price.”

He refers to Bertelsmann’s buy of advertising as a “forced purchase,” similar to many others that AOL had cranked onto its books. As for Ernst & Young, Schuetze is not respectful. He says that on AOL, it has been the “most pliable auditor” he’s ever seen: “AOL’s accounting has been rubbish,” he says, “and Ernst & Young agreed to rubbish accounting.”

It is hard to follow an act like that, so we won’t try.

nairda3 writes us with a real good scoop if this deal turns out to be real: “Crikey.com.au recently reported that it ‘doesn’t break many global stories but here’s one we got from a well-connected music industry insider in LA: The world’s largest chipmaker, wants to diversify into the copyright business and is negotiating to buy Warner/Chappell Music, the music publishing business of AOL-Time Warner, in a $US2 billion all cash deal to be announced in three weeks. The sale of Warner/Chappell, the second biggest music publishing company in the world by market share (to EMI Music Publishing), would represent one of the largest efforts to alleviate AOL-Time Warner’s worrying $45 billion debt problem. “If true, the acquisition would be the first effort by a large tech company to invest in the business of protecting content copyrights, following the recent agreement between major tech firms and Congress that they would self-regulate copyrights with customer hardware. The acquisition would leave Murdoch’s News Corp one step closer to becoming the world’s largest media company. Without their copyright business, AOL Time Warner could possibly merge its recorded music division with EMI and avoid the anti-trust concerns that it once experienced. The Inquirer and Guardian both quote Crikey on this one and eventually the truth of the matter will emerge. Ultimately, this rumour could likely become fact in view that Intel may now need content to leverage its just announced Trusted Platform Module. This platform seems to be build upon the new Trusted Computing Group’s open standards that involve the tech industry’s largest players. This group will perhaps end in failure as did the very similar SDMI initiative.

“What will possibly submerge is Intel’s shareholder value when their encryption is inevitably cracked by unemployed (non-Indian) software engineers tinkering with their Intel chips and relive the open-season days of Napster. An alternative is Sun chief scientist Bill Joy’s idea of having record labels ‘ship me a box with all their music in it, and then I could license what I wanted from them.’ Like Cringely’s idea, mine is for free content no matter what its delivery and providing an efficient way for optional payments.”

eewittme writes in with a similar story: “The Los Angeles Times is reporting that Apple Corp. may spend as much as $6 billion to acquire Universal from its flagging parent, Vivendi Universal. If completed, the deal would instantly make Steve Jobs the world’s biggest music mogul, as well as completely reshape the record industry almost instantly. Visions of a Def Jam parent-owning Jobs wearing a fur coat and chatting on his cellphone as he drives his fly honeys around Cupertino in his Escalade are already dancing in my head. Universal’s roster includes U2, 50 Cent, Shania Twain and Luciano Pavarotti. Can Ellen Feiss be far behind? The Times report says the deal’s been in the exploration phase for a while, but a sale could come by April 29. All of this, the Times reports, would dovetail nicely with Apple’s plans to roll out a new fee-for-song music download service, for which Jobs has already secured deals with four of the Big Five.”

> From: “Mr. FoRK”
> Date: Thu Dec 19, 2002 9:05:58 AM US/Pacific
> To:
> Subject: AOL patents IM?
>
>
> http://story.news.yahoo.com/news?tmpl=story&ncidX1&e=1&cidX1&u=/
> nm/20021
> 219/tc_nm/tech_internet_aol_dc
>
> Patent
> Thu Dec 19, 8:56 AM ET Add Technology – Reuters to My Yahoo!
> By Bernhard Warner, European Internet Correspondent
>
> LONDON (Reuters) – Media giant AOL Time Warner has quietly won a U.S.
> patent
> for instant messaging (news – web sites), a potential goldmine as the
> online
> activity rivals mobile phone text-messaging as the most popular new
> communication tool.
> The patent, issued in September, grants AOL’s instant messaging
> subsidiary
> ICQ broad ownership rights to the technology, which enables users to
> chat
> quickly and cheaply across the Internet.
> The broad wording of the patent means AOL could get an important legal
> leg
> up on rivals Microsoft Corp. and Yahoo, the other players in the
> potentially
> lucrative instant messaging (IM) arena that have their own proprietary
> technologies.
> AOL has offered little comment on the patent or whether it intends to
> enforce it.
> “There are no plans to do anything with the patent at this time,” a
> London
> spokesman for AOL’s Internet division, America Online, told Reuters on
> Thursday.
> Microsoft and AOL have recently embarked on a project to develop
> secure chat
> applications for corporate users, the first major effort to cash in on
> what
> has been a largely free software tool. Reuters Group is one of the
> biggest
> corporate clients, using Microsoft’s IM technology.
> AOL has scores of other technology patents, including one for Internet
> browsing memory tags, or “cookies,” and another for Secure Sockets
> Layer
> (SSL), an application that secures e-commerce transactions. But it has
> never
> sought to enforce these.
> It has, however, been notoriously protective of its IM technology. It
> did
> not permit rivals’ proprietary IM applications to communicate with its
> own
> AOL Instant Messenger (AIM) and ICQ for years. It now allows this,
> albeit in
> a limited fashion.
> The new patent defines AOL’s IM application as one that enables users
> to
> chat with and identify one another across a specific “communications
> network,” opening up the possibility for AOL to collect royalties from
> rivals.
> Developed in the mid-1990s by a group of Israeli technologists at a
> company
> called Mirabilis, ICQ was the first breakthrough chat application. It
> filed
> a patent for its technology in 1997 and was acquired by AOL in 1998
> for $287
> million.
> AOL said it has 180 million registered AIM users and 140 million
> registered
> ICQ users. The company said 2.1 billion instant messages were sent
> across
> its network daily.
>

———–

Sun Micro to Pursue Billion-Dollar Microsoft Suit Fri Nov 1,10:06 PM ET

SAN FRANCISCO (Reuters) – One of Microsoft Corp.’s (NasdaqNM:MSFT – news) most tenacious rivals, Sun Microsystems Inc.(NasdaqNM:SUNW – news) vowed on Friday to keep fighting Microsoft with a billion-dollar lawsuit and urged state attorneys general to appeal their antitrust case despite a legal setback.

A federal judge on Friday endorsed an antitrust settlement between Microsoft and the U.S. Department of Justice (news – web sites), dismissing the protests and proposals of nine states that sought stricter terms against the software maker.

A 2001 federal court ruling that Microsoft had illegally used its monopoly power in the Windows operating system eventually led to the settlement with the Department of Justice (news – web sites) and also supplied Microsoft competitors with ammunition for civil lawsuits.

Santa Clara, California-based Sun filed suit in March seeking more than $1 billion in damages and claiming its business was damaged by Microsoft’s abusive monopoly, which impeded the use of Sun’s Java software platform.

Sun’s Java and Microsoft’s .NET are competing architectures for the next generation of the Internet, especially for mobile and wireless uses.

“We will… continue to pursue our civil case and to cooperate with the European Commission (news – web sites)’s case against Microsoft to ensure that the company does not continue to use its monopoly position to become the gatekeeper of the Internet,” Sun Special Counsel Michael Morris said.

He said the nine states that had challenged the Department of Justice settlement also had plenty of ammunition to appeal their case.

“The weak steps that Microsoft has taken to comply with the requirements already show that the settlement will be ineffective in curbing Microsoft’s monopolistic and anti-competitive practices and how difficult it will be to enforce,” Morris said.

Microsoft also faces private antitrust suits from consumers and from the world’s largest Internet media company, AOL Time Warner(NYSE:AOL – news).

A Microsoft spokesman said that his company was working on the Sun suit.

“That process is moving forward. We need to work together with others in the industry… including our competitors. (The settlement) offers opportunities for our competitors, but we will continue to compete in the marketplace,” he said.

Microsoft also faces private antitrust suits from consumers and from the world’s largest Internet media company, AOL Time Warner(AOL.N).

———–

by Ben Fritz

Intertainer, the dominant player in the Internet video-on-demand (VOD) space, has shut its doors, most likely for good.

The L.A.-based company raised approximately $125 million in VC money, about twice as much as the infamous DEN. Only a small amount of that is believed to be left.

CEO Jonathan Taplin says Intertainer is no longer able to operate due to alleged price fixing and unfair competition by the major studios that provide its content. Last month, Intertainer filed a lawsuit against AOL Time Warner, Sony, Vivendi Universal, and MovieLink, the online VOD joint venture the three are planning to launch along with MGM and Paramount.

“We came to the conclusion that it would be better to get the business model straight in court so we no longer are faced with negative gross margins,” Taplin told DCR. “Studio demands have gotten much worse over the past year to the point where they’re no longer reasonable. At one point, we had around 1000 movies from every studio except Paramount. Now we have only 50, and with the exception of Dreamworks and MGM, which have been straight up with us, those are provided only due to advances we paid.”

Taplin accused the studios of engaging in unfair practices to undermine Intertainer as soon as they decided to band together to form MovieLink. He singled out Sony, an Intertainer shareholder, accusing the studio of suddenly refusing to provide Intertainer with its content and of using its position on Intertainer’s board to share proprietary information with MovieLink.

None of the studios would comment on the suit, although a Warner Bros. spokeswoman called it “ludicrous.”

Since launching a broadly available VOD service last year, Intertainer has signed 147,000 subscribers, although it’s unknown how many of those signed up for just one month or were regular customers.

The company has said its site will only be down until its lawsuit against the studios is resolved. Even if Intertainer wins, however, the only likely result is that it will recoup some cash for its investors. The chances of studios providing content to a company that has sued them is virtually nil.

With MovieLink still facing an anti-trust investigation by the Department of Justice (DOJ) and waiting to launch, the remaining players in the VOD space are CinemaNow, which offers a small selection of content from major studios along with independent films, and MovieFlix, which has mostly public domain films and an increasing number of independent movies.

Both companies said they are in negotiations with major studios to add their content and, whether out of a desire to stay on Hollywood’s good side or a genuinely different experience than Intertainer claims to have had, said their dealings with the studios have been slow, but fair.

“A year ago, I think the studios were very wary of Internet distribution, but that seems to have slowly changed,” said Curt Marvis, CEO of L.A.-based CinemaNow, which has short-term distribution deals with MGM, Universal and Warner Bros. “All the studios are currently in business with us or are in negotiations and we haven’t seen anything that leads us to feel we can’t run a successful business with them.”

Robert Moskovits, COO of L.A.-headquartered MovieFlix, was harsh in his analysis of Intertainer’s downfall, accusing it of being another dot-com that failed due to too much VC money and optimism about the space’s growth.

“They were shooting for the stars, but this space is just a primordial soup now and there are no stars to be had,” he stated. “Going through over $100 million in this business is just criminal. We’ve done this for half a million of our own money and while we’re much smaller than Intertainer, we’re still around.”

Both CinemaNow and MovieFlix offer monthly subscriptions to view their premium content, priced at $9.95 and $5.95 respectively. CinemaNow also charges $2.99 for downloads of its major studio films, such as “Erin Brockovich” and “Harry Potter.”

Marvis declined to release the number of CinemaNow subscribers, but said there was a “major up tick” in the past two months since CinemaNow began signing major studios. Moskovits said MovieFlix currently has 6300 and projects it will have 10,000 by the end of Q1 2003. MovieFlix, which is run by Moskovits and a partner, is currently cash flow positive, while CinemaNow, which has major investors such as Microsoft and is majority owned by independent studio Lions Gate, is shooting for profitability in the first quarter of 2004.

Both companies expressed optimism that the launch of MovieLink will bring increased attention to the VOD space, increasing their own opportunities as purveyors of more niche content. CinemaNow is also looking to profit from its deals abroad, as MovieLink will only be available in the U.S.

MovieLink has said it will launch by the end of the year, but the DOJ investigation is ongoing and launch dates have been repeatedly delayed over the past two years. Some industry insiders have told DCR they believe MovieLink may never launch due to DOJ anti-trust concerns.

If it does, though, MovieLink will no longer have to face the one competitor that was in a position to be a direct rival. It now remains to the courts and the fate of MovieLink to prove whether Intertainer’s failure was due to illegal behavior by studios, or a space that’s not yet ready for prime time.

———–

-Ian.

———- http://biz.yahoo.com/ft/020715/1026553453991_2.html

Monday July 15, 11:53 am Eastern Time

FT.com Controversy haunts AOL six years on By Richard Waters and Tim Burt

 AOL Time Warner is no stranger to accounting controversy.

Six years ago, bowing to criticism about the way it capitalised some of the costs of acquiring subscribers for its online service rather than write them off immediately, the company changed its policy and took a write-off of $385m, a move that turned a once-profitable company into a loss-maker.

A new spate of accounting and disclosure questions has now returned to haunt AOL, echoing the wider disquiet about financial reporting by American companies. 

And while most analysts and investors discount the risk of any deep problems to do with the company’s reported figures, the issues at the heart of the accounting debate touch on the same questions raised by AOL’s six-year-old controversy: are some of the costs of the company’s subscription businesses incorrectly capitalised, and what exactly is the state of its core online services business?

John Malone, chairman and controlling shareholder of Liberty Media, which owns a near 4 per cent stake in AOL, is among those who expect the company to come under a continuing barrage of questions about its accounting. Some of that scrutiny may even throw up valid questions about the company’s financial reports.

Speaking last week at the Sun Valley media conference, Mr Malone said he would not be surprised if “there were income recognition issues at AOL”. But he insisted that such issues were not material and would not alter his view of the company’s value.

Mr Malone said AOL’s underlying cashflow was robust, adding that the “only softness” was in its music business.

That is a view echoed by analysts and investors, who point to the underlying strength of the Time Warner media and entertainment businesses. “They may be low-growth media assets, but they’re good assets,” says Rob Gensler, a portfolio manager at T Rowe Price.

However, that has not stopped the continuing round of questions about AOL’s accounting and disclosure policies. Adding to the nervousness has been a succession of financial revelations this year that have surprised Wall Street, including the scale of losses from the company’s European operations, which it has been forced to assume in full after the end of a partnership with Bertelsmann.

The questions about the AOL online service in recent months have revolved around two issues: whether the quality of its subscriber base is deteriorating more than the company’s financial disclosure would suggest; and whether its dependence on advertising from other AOL Time Warner divisions, led by Richard Parsons, is masking a deeper underlying deterioration in its advertising and e-commerce business.

Despite concerns among some analysts in recent weeks, AOL is expected to register another increase in its core subscriber numbers when it reports its latest earnings next week, from the 34.6m reported in March. However, the income it earns from each subscriber has fallen, prompting questions about whether subscriber numbers have been inflated by the inclusion of people on free service trials. 

According to Jessica Reif Cohen, media analyst at Merrill Lynch, the average monthly revenue per customer (a key metric for all subscriber businesses, known as ARPU) has fallen by $3 in the past two years, despite a $1.95 increase in the price of basic service.

Among the factors behind the fall is the fact that AOL’s 10-year-old policy of including a new subscriber once it gets the person’s billing details, even if this is followed only by a free trial period, remains. That policy has not changed in 10 years and AOL’s practice of offering free trials is a effective way of expanding its audience, says Ms Cohen.

Defending its policy on subscriber numbers, Bob Pittman, chief operating officer, said earlier this year that AOL manages its customer base for growth and market share, rather than ARPU.

Mr Pittman has also been a vociferous advocate of AOL Time Warner’s policy of directing more advertising from its Time Warner divisions to its online service – a plan that has helped to stem some of the decline in AOL’s reported advertising amid the broader collapse in internet marketing. Despite that, the AOL service is still expected to report a fall of about 40 per cent in second quarter advertising and e-commerce revenues next week.

Meanwhile, AOL’s cable operations have become a second focus of accounting questions, amidst following the wider concerns that have hit the cable sector recently.

The question, for AOL along with other cable companies, has become: “What’s capitalised, what’s real?” says Mr Gensler.

AOL’s policy of capitalising some of the costs of providing new services, such as high-speed internet access, to existing cable customers is in line with other cable operators and US accounting rules, says Ms Cohen.

———–

> From: Lucas Gonze
> Date: Tue Jul 09, 2002 08:54:08 PM US/Pacific
> To: “Joseph S. Barrera III”
> Subject: Re: Reuters.com – Gnutella Developer Gene Kan, 25,
> Commits Suicide – July 09, 2002
>
>
> Gene was a dark guy. Also quiet and smart. I liked him.
>
> Funny the way this happened. Death cements his status as the face of
> Gnutella. It’s wierd the way that Justin Frankel and Tom Pepper
> are still
> hidden away back there behind Gene, right where they’d have to be
> to keep
> AOL Time Warner cool and generally avoid the media shitstorm. The
> whole
> association between them and Gene and Gnutella started because
> they were
> roommates. …
>
>> From
> http://www.salon.com/tech/feature/2000/09/29/gnutella_paradox/index1.html:
>
> It’s June 1999. The programming community is shocked. Justin
> Frankel, the
> talented young programmer who helped create the Winamp and
> Shoutcast MP3
> players, had sold his company Nullsoft to America Online. For at
> least a
> year, Winamp had been the most popular software program in the MP3
> underground, one of the first tools that made it really easy to
> listen to
> music nabbed off the Net. Frankel was an icon for script kiddies
> everywhere, and had a history of doing whatever he felt like
> doing — but
> selling out to AOL? Even though the price tag was rumored to be $100
> million (and Nullsoft was also seeking relief from a troubling lawsuit
> that alleged that Winamp stole its code), many found this hard to
> swallow;
> even more suspected that AOL might not know exactly what it had gotten
> itself into.
>
> For nine months, Frankel and his team worked in silence behind the
> corporate wall of AOL, in the company’s San Francisco music
> headquarters.
> And then, one day in mid-March, the statement: a little program called
> Gnutella, hidden on a back page of Nullsoft’s Web site. It was an early
> “alpha” version of what was to be an open-source (the code would
> be freely
> available to all) file-sharing system, like the increasingly
> controversial
> Napster program, but lacking the vulnerabilities — centralized
> servers,
> lack of anonymity — that made Napster so easy to attack.
>
>
> What was Frankel thinking? AOL was in the process of merging with Time
> Warner, which in turn owns the EMI and Warner Music record labels.
> And EMI
> and Warner Music, as two of the five biggest members of the RIAA,
> are not
> fond of programs that allow users to pirate MP3 files. The program
> appeared on the Nullsoft Web site for just a few hours before AOL
> yanked
> the page down, issuing a terse statement declaring that “the Gnutella
> software was an unauthorized freelance project.” Was Frankel trying to
> peeve his new corporate owners?
>
> Nullsoft engineers had been watching the controversy surrounding
> Napster,
> and threw together Gnutella in the space of a few days as a way to
> prove
> that a decentralized system could out-geek the law. Their goal was
> less to
> annoy their new owners than to figure out how to improve upon
> Napster. As
> one person close to the Nullsoft staff explains, “They have ‘fuck you
> money,’ they can do whatever the hell they want and AOL can’t take back
> what they gave them. I don’t think that Gnutella was just done to
> [thumb
> their noses] — AOL is insignificant. It was just the most interesting
> thing you could possibly be doing, AOL or no AOL.”
>
> AOL’s punishment for its rogue programmers was minor: The company
> publicly
> disassociated itself from Gnutella, forbade Frankel to work on the
> program
> and hoped the embarrassment would end there. (Although Frankel,
> six months
> later, unleashed a second surprise for AOL: a little program called
> AIMazing, which helps eradicate ads from AOL’s instant messaging
> program
> … but that’s another story.)
>
> AOL’s actions did not mean, of course, the end of Gnutella. Avid
> developers were savvy enough to download Gnutella before it
> disappeared,
> and before long they had reverse-engineered the program and distributed
> the protocols; in a matter of weeks, the Web was peppered with sites
> offering both the original Gnutella program and a number of clones. Six
> months later, more than two dozen versions of the software have been
> released by assorted developers.
>
> The initial Gnutella software was hard to use: It had a confusing
> interface, and to connect to the network users had to scramble to
> find the
> Internet address of another Gnutella host (not always an easy
> task). But
> new versions such as Gnotella incorporated friendly Napster-like
> interfaces, let users design their own skins and smoothed out some
> basic
> networking issues. Shaun Sidwall, the Canadian programmer behind
> Gnotella,
> plans to incorporate a built-in host in the next version of his
> software,
> so that newbies can automatically connect to the network.
>
> Dozens of programmers were thrilled to get a chance to tinker with
> Gnutella. But any technology needs its figurehead, and with
> Frankel hidden
> away in the back rooms of AOL, Gnutella needed a new spokesperson. It
> found one in Kan.
>
> Gnutella — and, for that matter, the entire P2P movement —
> couldn’t ask
> for a better representative. Like Frankel, gonesilent.com founder
> Kan is a
> quiet and youthful programmer with a love for technology. Unlike
> Frankel,
> however, he’s a master at industry diplomacy. He’s young and
> soft-spoken
> and chooses his words as carefully as a law professor, excising
> any “ums”
> or “likes.” He sits stiffly, with his hands in his lap, and other
> than his
> collection of zippy cars (including an RX7 and a BMW) is utterly
> lacking
> in ostentation.
>
> Kan has done an excellent job as an evangelist: He’s appeared in
> the pages
> of the New York Times debating industry heavyweights like RIAA
> president
> Hilary Rosen and antitrust attorney David Boies. He’s flown to
> Washington
> to discuss policy with Sen. Orrin Hatch, R-Utah, and earlier this month
> attended a P2P summit organized by computer book publisher Tim
> O’Reilly.
> Thanks to all the free publicity, Gnutella’s traffic has steadily
> grown: A
> recent study measured 35,000 users in a 24-hour period. Much of this
> growth came during the days after the RIAA won a preliminary injunction
> against Napster, as fans rushed to find a new program to use. (An
> appeals
> court later stayed the injunction until next week’s hearings.) Kan
> estimates that roughly a million copies of the program were downloaded
> from his site that day. Today, on an average day, tens of thousands of
> users use Gnutella to exchange MP3 files, plus porn, pirated software
> “warez,” illegal movies and other digital detritus, both pirated and
> legitimate.
>
> But all the traffic has put a strain on Gnutella, and the program’s
> weaknesses are starting to show. Kan, ever the upbeat evangelist
> for the
> technology, cheerfully admits that Gnutella has had its faults; but he
> also believes that Gnutella is ready for widespread use. “At first you
> focus on building the car, and once the car is built then you focus on
> refining the car,” he enthuses. “We knew the refining was around the
> corner and it just takes some time. We wanted to accelerate the best we
> could by coordinating developer efforts and encouraging them to
> raise the
> bar on usability. And it happened.”
>
>
>
>
>
> http://xent.com/mailman/listinfo/fork

Will AOL Go The Way Of The Model T? Mark Lewis, 04.19.02, 12:40 PM ET FORBES MAGAZINE

Is Robert Pittman following in Henry Ford’s footsteps? If so, that may not be good news for AOL Time Warner shareholders.

Ford was a revolutionary who changed the world, only to grow complacent and eventually lose his industry leadership position. His wildly successful Model T car put the horse and buggy out of business, but then Ford stuck with the Model T too long while rivals stole customers by adding bells and whistles.

Pittman, co-chief operating officer for AOL (nyse: AOL – news – people ), may be on the verge of making a similar mistake. Pittman has taken direct control of the firm’s America Online unit, which has been plagued by slow growth as Internet dial-up customers defect to rivals offering high-speed broadband connections. America Online has made slow progress in migrating its huge base of dial-up customers to its own broadband offerings.

Now AOL reportedly is retrenching. Friday’s Wall Street Journal reports that the media conglomerate “is rethinking its cornerstone strategy of promoting such broadband access nationwide.” The paper quotes Pittman to the effect that America Online should focus on getting its current customers to retain their AOL dial-up service, even after they have signed up for broadband service from a rival firm.

Apparently, Pittman has been pleasantly surprised by the number of AOL customers who have retained their dial-up service as a kind of backup to their broadband service. “A lot of companies go broke trying to speed up the consumer adoption curve,” Pittman told the Journal. Whereas AOL will happily milk its high-margin base of dial-up customers for as long as these folks are willing to keep sending in their monthly $23.90.

The problem is that as broadband gains mass acceptance, even technophobes will eventually gain the confidence to venture out beyond the reassuring confines of AOL’s walled garden. And broadband is gaining momentum. On Friday, BellSouth (nyse: BLS – news – people ) reported that it added another 108,000 digital subscriber line (DSL) customers during the first quarter, bringing its total to 729,000. Earlier this week, SBC Communications (nyse: SBC – news – people ) said it added 183,000 subscribers during the quarter to push its total to 1.5 million. The cable firms–and AOL’s own Time Warner cable unit–continue to push ahead with broadband, and EchoStar Communications (nasdaq: DISH – news – people ) has pledged to offer satellite broadband access nationwide if federal regulators will approve its proposed acquisition of DirecTV.

AOL finds itself in a tough spot, little more than a year after closing on its acquisition of Time Warner. That deal was supposed to create a content-and-distribution colossus, but the Internet distribution part of the equation has not yet worked out as promised, so the stock price has shriveled. Already there is talk on Wall Street that AOL should spin off its online unit and revert to a content-and-cable play.

Neither Pittman nor his boss, AOL Chairman Steve Case, seem eager to embrace that idea. “The promise of the merger remains intact,” Case told the Journal. “We just hit a speed bump.” AOL’s soon-to-be chief executive, Richard Parsons, also defended the merger. So it’s full speed ahead–except that Pittman seems to be keeping one foot on the brake by talking about a renewed focus on maintaining that dial-up base.

Perhaps he is correct. And that Henry Ford analogy may not be such a dire portent, since even after losing its leadership position, Ford Motor (nyse: F – news – people ) eventually moved beyond the Model T and continued to be a profitable business (at least until recently).

But when AOL acquired Time Warner, it had grander things in mind than to merely continue as a profitable firm. This merger was supposed to remake the media environment. It was all about the future, whereas dial-up service is well on the way to being a relic from the past–like the Model T. When even the stodgy old Baby Bells are talking up broadband, does Bob Pittman really want to be known as Mr. Dial-Up? He is right that AOL should make as much money as possible from dial-up before it goes away. But that hardly sounds like the centerpiece of a visionary growth strategy.