Can NetZero Survive?

A competitor's analysis suggests that a combination of low ad revenues and high marketing costs make NetZero's free ISP business model unsustainable, even in the short term.

by Kevin Beauchamp [May 8, 2000]

Recently, Spire Communications [of which Mr. Beauchamp is a principal, Eds.] did a competitive analysis of the free ISP models now in operation across the US. One of the companies we focused on was the largest free ISP, NetZero. As a public company, its financials are an open book and much of what it does is more easily tracked than other free ISPs.

Without getting drawn into too much of the technical reporting, our analysis focused on the question that much of the industry has been debating since the incept of these companies: Are advertiser paid access services a sustainable and—more importantly—profitable business model?

The answer we arrived at is that, under current operations and conditions, the model is not sustainable. Here are our major findings:

• NZ subscribers (or free ISP users in general) typically have more than one connection, a paid one and their free (or backup) connection.
• Less than half of NZ's subscribers ("subs") actually use the service in any given month, which lead us to believe that either these subs don't use the service at all any more or they use it only rarely. By contrast, paying ISP customers typically use their service almost daily. NZ apparently does not "unsubscribe" users—at least not very well.
• The ad-supported model encourages users that do use the service to stay online longer so that more ads can be viewed and advertisers can be billed more for impressions. While this is good for ad sales, it's bad from an infrastructure point of view since NZ subs consume more online time than a typical user might need. As a result, ad supported users are more expensive to maintain on the network.
• From industry reports gleaned over the past several months, NZ does not provide the best service on the planet; in fact, it's somewhat substandard. NZ cannot afford to pay for premium services like technical support.

Feeble CPM
Perhaps the most damning evidence of NZ's lack of staying power is that its highly targeted ads are not commanding nearly the level of revenue trumpeted by the company's top brass last year. Looking at the averages now, NZ is earning a CPM of less than $2.50. Here's our math, based on the company's last quarterly report:

$12,200,000 quartely income / 90 days = $135,555 in daily revenues

$135,555 / 55,000,000 daily impressions = $0.00246 per impression

= a CPM of $2.46 for "highly targeted" user-specific banner ads.

The question burning our brains is: What happened to the $25 to $50 CPM rates we were told about when NZ first launched? It's obvious that NZ has not been able to command the impressive CPM rates touted by their top brass a year ago. The public's perception of banner advertising has been changing even as NZ was building to its first million subscribers.

Banner ads are all but invisible to netizens these days. One needs to ask whether or not NZ's "pinpoint" targeting of ads is really all that effective, judging from their bargain-basement CPM rates.

Zero demographics
With CPM rates starting at around $5 for non-targeted banners with other online advertisers, what is it about NZ's viewer base that is keeping NZ ad rates so low? With advertisers becoming ever more savvy about how well their online ad dollars should be expected to perform, it appears that advertisers are sending NZ a clear message.

NZ needs to at least double its current CPM rates to meet industry minimum averages. This may not be possible in light of the company's viewer-base demographics, or perhaps more importantly, psychographics. Do NZ subs view the service as a throw-away account? Clearly this is not the case for many NZ subscribers, but it is equally clear that NZ subs are not buying advertiser wares in quantities sufficient to meet NZ's command rates for targeted ads.

So, a nagging question continues to hover in the atmosphere around NetZero: Would we really choose to market to people who can't afford (or are too cheap to buy) a $20 a month Internet connection? A $2.50 CPM might seem to answer that question.

Looking closely at the financials and demographics behind a company like NetZero leads me to believe that NZ will—much sooner than later—implode under the weight of its subscribers unless its business model changes substantially.

Altered game plan?
And what of NZ's 3 plus million subscribers? Would they retain their subs if the company changed from free to paid service? NetZero based their marketing on championing the "free (Internet) world". It seems to me that reneging on this promise would be likely to more or less vaporize what the company has built. Even Juno has had only moderate success in converting its millions of free e-mail users to JunoWeb, the company's $9.95 paid Internet service.

Already, NZ is scrambling to tweak its business model to improve revenues. Recent alliances with General Motors and other high-profile, brick-and-mortar companies are proof that the company is sourcing new money outside of its original model. While this is a good sign that the NZ top brass are flexible in molding NZ into something that may work better, it seems obvious they are also aware that advertiser dollars alone will not suffice to keep their company afloat.

In what may or may not be an indicator of things to come from NZ, Apex Global (AGIS), one of NetZero's carriers, filed for Chapter 11 protection on March 1, when, according to AGIS, a NetZero payment for $480,000 bounced. While this is certainly not good for AGIS, it's also not good for NZ, potentially setting up some destructive vibrations with other carriers and creditors, even stockholders. NetZero denied that a check bounced, but did admit that they owed AGIS $900,000. (Problems with the company's bank, CIBC Worldwide, may have contributed to AGIS' demise.)

Looking on the bright side
In spite of any negatives surrounding NetZero, this is a company with a lot of IPO money still in the bank. On March 6, NZ's market cap was $2.3 billion, but at $22.56, the stock was near its 52-week low and well below $29.13, its close on the day of its IPO, September 25, 1999. Even though it is hemorrhaging close to $25 million per quarter on just 3 million subs, the company is in a huge brand-building mode at the moment and likely won't maintain these marketing expenses indefinitely. Cutting back on its own advertising expenses will slow the drain on its bank account.

In our final analysis, the report projects that NetZero will not be around forever under its current business model and demographic conditions. If this company does survive, you can bet it won't be running on its subscriber-viewed ad revenues alone.

—End

Related Article:
Note some prophetic thoughts, written at the time of NetZero's IPO.