Survival of the Fittest

Are PC vendors offering "free" Internet access sounding a death knell for ISPs? Let's take a closer look at who's likely to eat whose lunch.

by Kevin Beauchamp [July 20, 1999]

It's hard to ignore the doom-and-gloom media these days. In a sector filled with as much change as the technology industries, the media seem to find it all too easy to level ominous predictions of what will happen in our future: by the year 2000, by next quarter—even tomorrow.

Most of the time, it seems to me they're all dead wrong with their broad predictions, especially those that extend beyond 12 months. Take the consolidation in the ISP industry. In 1997, many in the technology press predicted that there would be only a handful ISP remaining by the year 2000. Today there are more ISPs than ever before—and consolidation is rampant as well. They were just flat wrong. These media people seem to like to hide their predictions behind someone called an "analyst." If the prediction is wrong, blame the nameless, faceless analyst. Just a pet peeve. If I'm wrong, you can blame me.

Several new predictions have recently surfaced in light of the emerging trend of PC makers bundling their computers with Internet connections. Some are more dire than others such as Peter Henig's recent article in Red Herring, Are ISP's Dead? Such writers bolster their predictions with facts like the following:

• Compaq is now bundling NetZero with its home systems.
• Gateway, which has had Gateway.net since 1997, is looking to maybe buy into EarthLink or acquire Mindspring.
• Dell is rumored to be looking at starting its own Internet service.
• MicronPC recently announced that it would be bundling Internet access with its PC's, either for a one-time payment or under a 36 month payment plan with a plethora of value add-ons.

Death reports are premature
As usual, while the rest of the analyst world once again sees this as the death knell for ISP's, I see things from quite a different perspective. Who is really eating whom here? America Online recently announced that it was looking at buying Microworkz to offer a low-cost AOL brand PC. Other free PC vendors who support their hardware costs with ISP services and/or advertising seem to have a bear of a time keeping up with demand.

PC prices and margins are not what they used to be, and if you hold your breath for 60 seconds, the price of a new PC will fall yet again. Margins for PC makers have been eroding like crazy over the past year, and to bolster the value of their machines, they've had to come up with some value-added features to justify the higher price of their wares and maintain yesterday's margin of profitability. When you strip the profit margins, billing, and support costs from ISP dial-up services, you find a pretty palatable value-added service to add to your PC system for about $100 a year. This has been interpreted by many analysts and subsequently the techno media crowd as the doom of ISP's. Guess again.

It's the PC makers, not the ISPs, who are having the problem with rapidly eroding margins. While we ISP's certainly have our concerns about free service providers like NetZero (not to mention traditional aggressive competition) our access costs and margins haven't really moved much at all. They have moved some, though; they've improved over the last 24 months as CLECs have moved into the game, offering traditional telco services at a fraction of the ILEC's fees. All this time retail prices have basically remained static at around $20 per month. Savvy ISP's have used these additional resources to build more value into their ISP services which brings me to the point of this article.

go to page 2: Fighting fire with fire