With AOL advertising on the Superbowl and mailing out so many free CDs, perhaps you've wondered how it can afford to throw so much money away. Maybe it can't.

by Alex Goldman ISP-Planet Associate Editor [February 19, 2004]

When we buy a product, we hope most of our money pays for the product itself, not for the packaging and the advertising, but it doesn't always work this way. With fast food, for example, the packaging can cost more than the food itself. Might this be the case with AOL?

We can't really know for sure, because the company does not give explicit cost-of-sales numbers in its financial statement. It does, however, provide enough financial information that we can extrapolate a number that the company thinks it's paying for service.

A close look at the company's finances reveals some surprises.

During the first nine months of last year, AOL earned $5.691 billion ($7.588 on an annual basis determined by simply multiplying the first nine months' revenue by 4/3). AOL also earned $0.583 billion from advertising ($0.777 billion on a crudely measured annual basis).

Determining costs is more complex. The trending schedules do not show them, but the SEC filing does detail net operating income for the nine months ending September 2003 as $0.554 billion. That means costs for those nine months were $6.273 billion - $0.554 billion = $5.719 billion.

Projected total annual costs were therefore $7.625 billion, against total revenues (including advertising) of $8.365 billion.

To put these numbers in perspective, let's divide them by AOL's subscribers (32,384,000) to get per subscriber numbers. Costs were $235 per subscriber per year or $19.62 per subscriber month. Revenues were $258 per subscriber per year or $21.52 per subscriber per month.

Even though AOL will probably eke out net profits of $740 million, that's only $22.85 per subscriber per year.

Any rise in costs or decline in revenues would hurt. Although there is no foreseen rise in costs, there is an obvious cause of declining revenues: AOL's $9.95 per month Netscape service.

Just looking at the finances, it's obvious that AOL cannot sell its cheap service the way it sells AOL because it cannot accrue costs of $19.62 per subscriber for a service that it's selling for $9.95. The company will have to use the cheaper marketing tactics that small ISPs know so well, such as radio and newspaper ads and local events.

Can the AOL elephant, used to trumpeting simple messages from national platforms like Time Warner Cable, roll out a completely different marketing message for Netscape? ISPs worried about a cheap AOL on their turf need only keep their ears to the ground. If a lot of ad space disappears suddenly, bought up by AOL, then the elephant is coming. But at the moment there seems little to fear.

The bottom line is this: how ever much you may want your portal to Look Like AOL, you want your finances to look nothing like AOL's.

—End