How High Will AOL Rates Go?

America Online has raised its rates again. But will the nation's dominant Internet service provider now lose customers? And how much higher can rates climb?

For the moment, most Internet industry analysts are saying AOL — by far the biggest, most-profitable Internet service provider in the United States — will not lose business because of its 9 percent, $1.95-per-month hike, which takes effect in July.

"I don't think it's going to slow them down," says Paul Noglows of investment bank J.P. Morgan in New York. "I think they're being judicious."

"Some price increases are more painful [for consumers] than others," adds John Corcoran of investment bank CIBC Oppenheimer in Boston. "But AOL hasn't had a price increase in years and they've added a lot of services."

Still, the increase, coming four months after the federal government approved the Virginia-based online giant's purchase of Time Warner, has raised eyebrows among some consumer watchdogs.

"When AOL first announced its plans to acquire Time Warner, [CEO] Steven Case ticked off a list of benefits," says David Butler of the Consumers' Union in Washington. "Somehow, a rate hike didn't make his list."

Justifying the Price

On May 22, AOL announced it would raise its monthly fee for unlimited Internet access to $23.90, a hike that could translate into a windfall of more than $400 million for the company in the next 12 months.

About 18 million of AOL's 23 million users in the United States use its standard plan, and will be affected by the hike. After the last fee increase, which in early 1998 lifted its basic rate from $19.95 to $21.95, relatively few subscribers canceled their service, and industry analysts don't expect this one to cost AOL much traffic either.

"There's still a remarkable amount of inertia out there," says Zia Daniell Wigder, research director of Internet research firm Jupiter Media Metrix in New York. "People don't want to switch their e-mail addresses, and they get used to their services, their chat rooms."

For its part, AOL has justified the increase by saying that in addition to Internet access, it has added so many features for consumers since 1998.

"We're confident that our members and prospective members will realize we're the best site on the Internet," says AOL spokesman Jim Whitney.

Indeed, for many users, AOL is virtually equivalent to the Internet, with its myriad chat rooms, online shopping opportunities, and links to the full range of Time Warner content now available since the merger. The site is also the key online destination for advertisers, and has taken to running ads in the pop-up window that accompanies its instant messaging.

Among the AOL features that continue to grow in popularity are its instant messaging service — both AOL Instant Messaging and ICQ — and its Buddy List, which notifies users when people they know are also online. The company has also added new features to its mobile services, inlcuding Mail Alert, which notifies users of high-priority e-mails, and new versions of multimedia players, allowing customers to use the MP3 format.

Competition Could Raise Prices

Still, some AOL competitors, including Microsoft, view the online service's rate hike as a chance to grab users away. The software giant announced a $50 million campaign on Tuesday to lure AOL users to its MSN service, the second-biggest U.S. Internet Service Provider, or ISP, with 5 million subscribers.

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People joining the MSN network by June 30 will get three months of free access, followed by unlimited access guaranteed at $21.95 per month through January 2003. That means a user switching to MSN at the end of June would pay a total of $329.25 for access through the end of 2002. An AOL user would pay $430.20 over the same period.

"MSN will enjoy some incremental subscriber growth," predicts Corcoran. "But the difference in size between AOL and MSN is so large, it won't make a great deal of difference in terms of the big picture."

And although other ISPs, like NetZero, continue to plug their lower rates, AOL's rate hike could ultimately serve to increase industry prices, rather than driving them down through competition. Some rivals of AOL — like Earthlink, the nation's third-biggest Internet service provider, with 4.8 million customers — could use this as an opportunity to raise their own rates.

Are There Still Bargain ISPs?

Earthlink executives have said they are considering a corresponding price increase from their standard rate of $19.95 per month for unlimited access.

How High Will Rates Go?

So, how high could rates go?

AOL's Whitney declined to speculate on the timing or size of any future fee increases, and industry observers are reluctant to predict a specific monthly price rate at which users will rebel.

"There is a limit, but nobody knows what that limit is," says Corcoran.

Noglows, for one, speculates that the $25-per-month rate could be a sticking point, but thinks dial-up ISPs won't encounter much consumer resistance so long as their fees remian below those for basic cable television. And as Wigder points out, consumers recognize they are paying AOL — and, to a lesser extent, the other service providers — for more than just access to the Web.

Still, additional rate hikes are inevitable. The main question is whether their frequency will increase. Noglows thinks that AOL will only raise rates in the future when it can point to additional services being offered to consumers.

"They will need to show that the service has been expanded and improved," Noglows says. "Increases will have to be justified. I don't think this is something you'll see every six months."