America Online Gambles With Fee Increase How Many Subscribers Will Leave? How Many Competitors Will Follow?

No matter what your next few Internet bills may say, the age of $19.95 online access is officially over.

America Online has spoken.

The nation’s largest Internet company last week raised the cost of its all-you-can-surf service by $2 to $21.95 a month, starting in April. With 13 million subscribers, or 60 percent of the U.S. residential market, America Online wields enough clout to shake the industry.

“I don’t like it, but they sort of have you, don’t they?” said Dallas subscriber Mike Duncan. Like many AOL customers, he subscribes because the service has features designed to make the Internet less intimidating. “For $2 a month, who’s going to switch?”

Key question. The answer will determine the rest of the industry’s next move.

With high equipment, phone line and customer service costs, few national Internet providers are making money at $19.95 a month.

Subscribers flocked to flat-rate pricing in 1996, and they stayed online far longer than expected, straining resources at America Online and its rivals. AOL says its average customer spends 23 hours online each month, up from seven when it was charging by the hour. Many rivals, from national players to Dallas-based Internet America, a regional service provider, report usage of 30 hours or more.

At AOL, higher use under flat-rate pricing sparked service outages, long waits and rampant customer complaints, which forced the company to spend more than $700 million last year to beef up its network and staff and led to a $500 million loss in 1997.

But in the formative Internet industry, the race is for customers, not profits.

While there are about 4,000 Internet service providers, a handful of companies split about 90 percent of the subscribers, according to the Yankee Group, a Boston-based technology research firm. Companies are putting up with losses now to draw customers, advertisers and online programming that will help them make money in the future.

And alternate billing schemes, such as charging for time customers spend online or the information they download, require expensive systems many service providers can’t afford, said Gregory Wester, Yankee Group’s research director. “Most Internet service providers charge a $19.95 flat rate because that’s all they could charge. Otherwise it’s a billing disaster.”

So the pack pricing, at levels nobody but customers liked, has survived for more than a year.

Until last week, in fact, the price pressure Internet companies most feared was downward, from upstarts targeting niche markets that allowed them to spend less on equipment and turn profits on lower prices.

“There aren’t many people that could afford to move the price up,” Wester said. When AOL did, “there was certainly a collective sigh of relief in the Internet service provider industry.”

And cheers from Wall Street: America Online stock leaped nearly $12 to $110.44 after it announced the price increase Feb. 9. AOL says it needs the extra $2 a month to offset costs and fund continued investments.

Before the sun set that night, feisty EarthLink Network started advertising a “Get out of AOL free” program. “AOL just raised the price of inferior service,” chairman Sky Dayton said in a news release, citing reviews showing his company’s service is faster and more reliable.

But most other online rivals are on hold, pausing to gauge reaction from customers and competitors.

“We’re in a wait-and-determine mode,” said Michael Bolduc, director of product management for Irving, Texas-based GTE Internetworking.

Like many Internet service providers, GTE already had been considering profit-boosting changes.

Basic service at GTE goes for $19.95. The company offers additional e-mail boxes for a few dollars extra, up to four for $29.95.

GTE now offers 5 megabytes of Internet storage space with each Web account. Subscribers can use the space for their own Web pages, but fewer than 10 percent do. So the company is considering cutting the storage it gives basic customers to 2 megabytes and offering a premium tier with more capacity for $29.95.

GTE had expected to begin selling different pricing plans in January but is still fine-tuning its billing systems. Bolduc said the new plans would be out in two to three months. Customer and industry reaction to America Online’s $21.95 plan will help set their prices, he said.

“If that ($21.95) becomes the competitive baseline … we will be at that price point,” he said, with higher-tier plans priced upward from there.

At companies that choose to target new users, monthly bills could fall even though flat-rate prices rise, Yankee Group’s Wester said.

While 80 percent of today’s users pick flat-rate prices, he said, “Newbies (newcomers to the Internet) will be attracted by alternate pricing schemes.” He believes that households with Internet service will pay an average of $13.32 a month by 2000, down from $16.80 last year.

But other analysts disagree. Few AOL customers have picked its cheapest plan, which costs $4.95 for three hours per month online.

“People want access to everything, even if they only use some of it,” said Peter Krasilovsky, an analyst with Arlen Communications Inc., based in Bethesda, Md.

“I’m not thinking that the lower-price plans will catch on in a big way,” he said. “I think $21.95 is going to catch on and the majority of the U.S. will be paying $21.95.”