Ad growth for AOL called vital to a remake

Just over a year ago, AOL unveiled a radical plan to remake itself into a business built on advertising from one driven by Internet access subscriptions.

To a great extent, AOL had little choice in the matter. Customers were rapidly deserting its once-lucrative dial-up access service, and retaining them was costly.

The new plan certainly seemed to make sense. With the advertising business growing rapidly across the Web, AOL appeared to be in an ideal place to capitalize on that trend. It remains, after all, one of the most popular online destinations, with more than 90 million people visiting its sites in a month.

But a precipitous slowdown in advertising growth has raised new questions about AOL's transformation plans. AOL executives say the slowdown is probably temporary, but Richard D. Parsons, chief executive of Time Warner, which owns 95 percent of AOL, said this month that he no longer expected AOL's ad growth to match or exceed the overall growth rate of online advertising. The company's challenges highlight one of the quirks of today's Internet market. As advertising is moving from offline media to the Internet at a rapid clip, portals, which command some of the biggest audiences online, should be among the top beneficiaries. Instead, the travails of the mass market portals like AOL, as well as Yahoo and Microsoft, indicate a decline in power.

Online advertising in the United States is expected to increase 28.5 percent this year, according to eMarketer, a research firm. AOL's ad revenue increased 16 percent in the last quarter after gaining 40 percent in the previous quarter. Revenue at Yahoo, the No. 1 Internet portal, rose 8 percent in the latest quarter.

Part of the challenge for portals is that people are starting to approach the Internet in a different way. A new generation of Web users has grown increasingly adept at finding what it wants online and is less reliant on portals for guidance. What is more, younger audiences are spending more time on social networking sites and less time on traditional Internet portals. "Just like Yahoo, AOL is fighting MySpace, Facebook and others for audience and ad dollars, and those are tough competitors," said Jordan Rohan, an analyst with RBC Capital Markets.

Social-networking sites are not the only culprits. Thousands of smaller Web sites, like blogs, news collectors and niche content sites, are also attracting growing numbers of Internet users and advertisers.

AOL knows all this. It may even have been the first among the major portals to recognize this trend. In 2004, it bought Advertising.com, a network that collects ad space from across the Web and sells it to marketers, giving them a way to reach the Web's increasingly fragmented audience.

Since then, Yahoo, Microsoft and Google have all invested significantly to remake themselves into companies that not only sell advertising on their own sites, but also help sell or broker ads across the Web. And AOL has sought to further the success of Advertising.com by buying a string of online advertising companies.

Advertising.com is now AOL's fastest growing unit. "The brand that we build around Advertising.com might become more important than the AOL brand itself," said Randy Falco, AOL's chief executive.

Falco and other AOL executives reject any notion that their turnaround plan is in trouble. They say the slowdown in advertising growth in the most recent quarter was tied to specific events, including redesigns of several of the portal's channels and a change in the way it displays search results.

"In the first six months of the year, we have accomplished more in terms of a turnaround, in terms of fixing products and the platform, than in the past three years," Falco said.

Falco, a longtime NBC Universal executive who took the top job at AOL in December, said the company was systematically revamping its channels and services. It has redesigned many of its pages and embarked on an expansion into 14 countries.

AOL plans to re-engineer its site so users can choose various channels and services they like and include them in their blogs, personalized home pages or favorite social networking sites.

"We are not trying to build yesterday's portal," said Ron Grant, AOL's president. "We are trying to build a network of sites that users can combine or do whatever they are most comfortable with."

The efforts are beginning to pay off, AOL executives said, noting that page views have increased 4 percent in the second quarter from the first.

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Extra: How to hack Starbucks Not all changes have been well received. After an earlier executive team devised an innovative way to display AOL search results, which are powered by Google, Grant and Falco decided to roll back the changes and mimic Google's presentation of 10 links on a page. The decision led to defections.

John McKinley, the former president of AOL Digital Services, thought the imitation would serve to dilute the AOL brand. "Over time, the average consumer is going to develop more of a tendency to just go to Google.com directly," he wrote in his blog. Grant defended the decision, saying the change to the Google-like results stopped a decline in the use of AOL's search service.

AOL's revamping has focused not only on consumers but also on its advertisers. Advertising executives say that for the first time in years, AOL's customized ad packages are competitive with those of Google, Microsoft and Yahoo.

None of the improvements has been able to prevent the recent slowdown in growth at AOL. Gordon Hodge, an analyst with Thomas Weisel Partners, said that if the slowdown continues, it could spell trouble for AOL's turnaround plan. "I think the dial-up subscriber losses and profit losses could overwhelm the gains they could make from advertising," he said.
Louise Story contributed reporting from New York.
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