AOL Time Warner, Inc.

Case Study:Challenges at Time Warner

Background

• Time Warner was formed by merger of magazine publisher Time Inc. and producer film and television programming Warner Communications in 1990.

• It sold 25% of Time Warner Entertainment to Media One Group.

• Time Warner acquired Turner Broadcasting Systems in 1996.

• It had revenues of $27B and net income of $2B in 1999.

• Time Warner announced their intent to merge with AOL in 2000, and was completed after a year.

Pre-merger

• Time Warner Inc. is the largest media company in the world, with revenues in excess of $38 B.

• Time Warner Inc. has huge competitors like Disney, Viacom, News Corp. and Sony.

• FCC relaxed several regulations that restricted the number of media outlets a company could own in any local market and increased the national audience that any once company can reach.

• These are designed to prevent any one company from controlling too much of media and ensure some level of diversity in media.

American Online (AOL)

• It is one of the earliest companies to provide Internet Service in US, intro-duced in 1989.

• It has provided no only connection to the Internet but also significant Inter-net-related content.

• They have provided great value to consumer with their propietary content, and became the pioneer of mass-marketing Internet.

• They had almost 5M members by end 1995, and began partnership with German media conglomerate (Bertelsmaan AG) in 1996.

American Online (AOL) – Environmental Scanning

• Options for Internet Service – Dial-up (63%) or Broadband connection (37%)

• AOL provides traditional dial-up service.

• AOL is one of the first large providers among the national companies.

• Competition for dial-up access was increasing dramatically.

• With significantly faster data transfer speeds than dial-up, broadband internet start to boom. Large telephone companies benefited as early first movers.


• AOL suffered in declining membership due to:– growth of Internet and free services available that reduced AOL’s proprietary content.– Discount ISPs competed through cutting monthly fees and providing less content.– Consumers switch to broadband internet connections to increase speed.

• AOL’s revenues derived from subscription services and advertising, in which declined due to weakening economic conditions.

• To combat decline in subscribers, new products were offered such as the BYOA plan but it had increased value to broadband users.


• AOL operations include Netscape that offered variety of products and search services.

• AOL launched the popular AOL Instant Messenger in 1995 and made AIM and MSN instant messaging compatible.

• AOL Europe was launched in 1996 but just led to Bertellsman buyout due to antitrust concerns.

Filmed Entertainment• Contributes to 27% of Sales and 20% of Overall Income in 2003.

• Warner Communications merged with Time Inc. in 1990 and obtained complete ownership of Warner Entertainment in 2003 and is currently operated by Warner Bros. Entertainment Inc.

• Its core businesses are motion picture production and distribution.– Movie studio may produce movie itself or provide financing to independent producers.

• Firms in movie compete mainly by improving product quality.

• Time Warner is also the leading provider of television programming.

• It is also in home video distribution – distributes movies, television series, professional sports events and other entertainment materials (DVD and VHS).

Publishing

• Contributes to 13% of Sales and 11% of Overall Income in 2003.

• Time Inc. is the publishing subsidiary of Time Warner.

• Consumers have more choices for obtaining news and information, includ-ing large amount of free content on Internet and television.

• Cable channels may also become primary information source.

• Despite these, magazine publishers are optimism about the idea that televi-sion may become less reliable source for advertising.

Publishing

• Time Warner also upload content to the Internet.

• In 2003, it began restricting access to the Web sites, led to increase in sub-scribers.

• Time Warner also publishes books. Distribution channels include online and traditional bookshops, jobbers and wholesales, special sales and direct-to-consumer sales.

Programming Network


• It has 3 units – Turner Broadcasting System, Home Box Office and the WB Network.

• Turner focuses primarily in programming networks including general interest, news, and special interest.

• HBO operation not only the 18 premium cable programming but also produces movies, mini series and programs.

• Basic cable programming network revenue sources – subscription fees, and satellite carriers and advertising.

Cable Systems


• Core service offerings – Analog and digital cable TV, High-speed internet access and telephone services.

• With stagnant growth in traditional analog-based cable services, Time Warner has turned to digital services for revenue growth.

• Time warner charges additional fees for a digital upgrade and is capable for ancillary series such as pay-per-view.

Cable Systems

• Core service offerings – Analog and digital cable TV, High-speed internet access and telephone services.

• With stagnant growth in traditional analog-based cable services, Time Warner has turned to digital services for revenue growth.

• Time warner charges additional fees for a digital upgrade and is capable for ancillary series such as pay-per-view.

Cable Systems

• Cable access is the most popular method of securing broadband access.

• Time Warner Cable accommodates multiple ISPs on its network.

• Time Warner Cable began aggressively marketing Road Runner broadband service that competed directly with AOL that led to loss of nearly half million subscriber in 4th quarter or 2003.

• Time Warner is also into telephone service. It offered VoIP product that ex-ceeded penetration expectation over a year.

Cable Systems

• Time Warner competes with Direct Broadband Satellite Operators and Over-builders.

– DBS operators deliver high programming quality and local content with low pricing strategies.– Overbuilders are the new entrants who built their own infrastructure in the presence of an in-

cumbent cable company, who can build infrastructure from scratch.

• Multiple programming services were bundled by cable system operators.

• Cable systems distribute broadcast networks, advertisement-supported cable networks, and payment-based.

• Bundling is criticized as consumers should have the right to purchase those programs that they are willing to watch.

Cable Systems

• Cable operators were largely local monopolists. Cable prices increased twice or thrice faster than inflation rate after the deregulation in 1999.

• Price increase was due to increase in fees paid to cable networks especially sports network.

• Time Warner was among the first to explore HDTV technology, and carried cable networks in HDTV format at no additional charge, while additional charges for premium HD channels.

• It is also one of the major players in cable industry to offer and promote DVRs that allowed consumers to record TV programs and watch them at another time.

Post merger

• In January 2003, it was announced that AOL Time Warner Inc. will be losing $98.7 B for year ended 2002.

• Several commentators and investor considered the merger as mistake or the worst deal in history.

• While company executives take this as a result of accounting changes rather than the ongoing operational problems, others have the allegations that AOL misled Time Warner prior merger in its online advertising outlook and overstated revenues.

Memo 1 – Revenue from Starz

• Memo #1 states that Time Warner currently has 852 of its basic service subscribers that are also STARZ members. The overall concern is that the number of subscribers is much lower than what Time Warner had planned. In order to increase the number of subscriptions to the STARZ Network, Time Warner is considering offering a summer promotion to all current and new members. The Pricing Manager needs to know if decreasing the price of the service would result in higher revenues.

• In addition, the manager also wants to determine an estimate of the maxi-

mum monthly revenues from the STARZ Network.

MEMO 2 – Re: How Low Can We Profitably Go?

Everest, a direct competitor of Time Warner Cable, started a new wave of con-struction in Kansas City tightening the current competition. In relation to that, Time Warner had invested a considerable amount to upgrade their infrastructure in Kansas City.

Now, if Time Warner is going to a price war with Everest, how low should Time Warner be willing to go with its pricing, before writing off the operations becomes an option?


Everest serves bundled services at $84.95 per month. Approxi-mately, there 321,000 household in Kansas City and Time Warner is planning to maintain a 65% market share.

Fixed Cost:Investment - $500M at 8.7% amortized over 20 years.

Variable costs:Monthly programming fees – $32.50 per subscriber per

monthMaintenance, service and billing costs – $7.60 per subscriber per month


Wherein: (per subscriber)AFC = [Investment X (1+Cost of Capital)] / number of months / (Total Market X Market Share);AVC = (Monthly programming fees + Maintenance, service and billing costs);

Therefore:AFC = [$500,000 X (1+.087)] / (20YRS X 12MO/YR) / (321,000 X 65%) = ($543.5M) / 240mos. / 208,650 = $10.85 / monthAVC = ($32.50 + $7.60)= $40.10; Therefore, ATC = $40.10 + $10.85 = $50.95

As long as Time Warner charge their customers $50.95 per month. Then, they should stay in the competition. They could charge higher than that to be prof-itable or otherwise. Remember, Everest is charging $84.95 per month.

MEMO 4 – Re: Possible Acquisition of Fox News

Time Warner’s President of the Network Television Division is writing to the Vice President of Global Strategy to propose the potential acquisition of Fox News to help strengthen the firm’s position in the U.S. and abroad.

Time Warner currently owns CNN, the largest cable news service in the United States, and Fox News offers an additional of 83.6 million subscribers, the possibility for potential synergies, and expansion into new markets.

High revenue growth at Fox News over the past year coupled with strength-ened position in the global market especially Europe and Asia makes this possible acquisition appear phenomenal.

MEMO 4 – Re: Possible Acquisition

There are a lot of things that Time Warner should carefully consider prior to its acquisition of Fox News. Some of the main things are as follows:

• Synergy• Government Regulations• Market Response

MEMO 5 – Re: Strategic Analysis

Within the dial-up industry, AOL is facing increased industry rivalry as competitors seek to cut costs and offer the most affordable access. Earlier on, the bargaining power of customers was small because there were relatively few alternatives to typical dial-up depending on one’s location in the States.

Since their front-runner beginnings, AOL has been experiencing increasing consumer bargaining power because of growing competition within the dial-up industry and the increasing threat of sub-stitutes. The two main substitutes for dial-up are broadband and DSL. Both of these substitutes of-fer superior technology for a small increase in price compared to typical dial-up. With the relative low barriers to entry into the dial-up market, AOL is also subject to an increased threat of new en-trants.


Film Entertainment:• Regulation changes prevented movie studios from owning movie theatres which

caused Warner Bros. to shift their attention solely to film making.

• Movie industry competes by improving product quality.

• The demand tends to follow seasonal patterns.

• Movie demand also tends to vary with movie life’s cycle.

• Players in this market sometimes act strategically to avoid releasing movies with simi -lar themes at the same time.


Publishing:• There is a high level of industry rivalry and the threat of new entrants. While

there are usually several substitute magazines covering relatively the same topics, the threat of substitutes is also increasing as consumers upgrade their leisure reading desires.

• While many magazines have online websites to complement their prints, there has been an increasing amount of web only demand for magazine in-formation. The initial compliment web service is slowly becoming the main source of revenues for magazines.

MEMO 5 – Re: Strategic AnalysisProgramming Networks:• Revenue sources: Subscription fees charged to cable, and satellite carriers

and advertising.

• Though cable systems have invested heavily in upgrading infrastructure, the increase in channel capacity has not caught up with available programs. As such, cable programming networks have to compete to be carried by cable system – dropping one network to be able to carry a new one.

MEMO 5 – Re: Strategic AnalysisCable System:• The final business area of Time Warner is its cable systems. Cable operations pro-

vide the core for T.W.’s services like TV, high speed Internet and telephone access. Typical cable operations require a vast network of communication lines in order to deliver products to each individual user. At one time, it was thought that this high investment could only be compensated and successful through an almost monopo-lized system.

• With the introduction of satellite Internet and television, there has been increased competition to Time Warner’s cable systems. New entrants into the cable industry also force T.W. to keep an upgraded infrastructure because competitors typically build from scratch based on the latest and greatest technology. As competition in-creased, the regulatory environment began to back off in order to let market forces work more freely; however, consumers have been increasing their demand for addi-tional regulation as cable prices continue to climb substantially.

MEMO 10 – AOL Europe

• AOL Europe was launched in 1996 in partnership with Bertelsmann, AG owning 49.5% of the en-tity. Unlike in United States, growth has been slower in Europe due to cultural diversity which made it difficult for them to create a broad appeal.

• On top of that, AOL’s difficulty of penetration in the European market is being amplified by the need of household to pay for phone companies in order to go online, and at the same time pay AOL.

• The venture suffered losses of $600,000 on $800,000 revenue having 2.5 million subscribers. To make it worse, Time Warner was forced to buy-out Bertellsman at $6.75 million, a premium, due to antitrust issues.

• Subsequent to Bertelmann’s buy-out, AOL Europe made a comeback having significant gains. Subscribership increased to 6.4 million with annual revenue of $1.5 billion.


• AOL Europe was launched in 1996 in partnership with Bertelsmann, AG owning 49.5% of the en-tity. Unlike in United States, growth has been slower in Europe due to cultural diversity which made it difficult for them to create a broad appeal.

• On top of that, AOL’s difficulty of penetration in the European market is being amplified by the need of household to pay for phone companies in order to go online, and at the same time pay AOL.

• The venture suffered losses of $600,000 on $800,000 revenue having 2.5 million subscribers. To make it worse, Time Warner was forced to buy-out Bertellsman at $6.75 million, a premium, due to antitrust issues.

• Subsequent to Bertelmann’s buy-out, AOL Europe made a comeback having significant gains. Subscribership increased to 6.4 million with annual revenue of $1.5 billion.


• Before finalizing any decision regarding the sale of AOL Europe-related assets, man-agement should consider first the trends and the recent developments wherein both revenue and subscriptions increased as they have parted ways with Bertelsmann.

• However, the main question regarding the assets sale is whether they would be sold piece-meal or in a collective deal; management is now contemplating which would be the better course, and the best mechanism to utilize.

• This may auctioned individually or collectively, this allows parties interested in buying to compete for the assets and, ideally for AOL Europe, finally arrive at an elevated price. Otherwise, this may be subject to commodity bundling – the practice of bundling several different products together and selling them at a single bundle price.

AOL Time Warner, Inc.

Documents

time warner entertainment

premerger time warner

internet service dial

growth of internet

marketing internet

broadband internet connections

broadband internet start

aol europe