By John Borland
Staff Writer, CNET News.com
June 6, 2001, 4:00 a.m. PT

Some poetic justice lies in the news that free ISPs, once seen as a threat to America Online's market dominance, have instead taken AOL's place under the scrutiny of federal regulators.

Underscoring how far the once-ambitious free companies have fallen, the Federal Trade Commission this month warned consumers against taking free offers at face value, settling complaints against computer maker Gateway and one-time highflier Juno Online Services.

"These so-called free Internet access offers were anything but," said Jodie Bernstein, director of the FTC's Bureau of Consumer Protection. "Information about fees was hidden in the fine print."

The federal actions are just the latest indignity heaped on a business model that has suffered much in the past six months. A year ago, free Internet connections were offered by all the major portals and by smaller sites, and even free high-speed connections were coming to market.

Today, most of the companies offering free service have gone out of business, almost independently prompting the first-ever decline in the number of people on the Internet, according to one recent study. Companies that remain still have millions of subscribers but are working hard to persuade them to start paying for services.

The market has shown clearly that free services supported by advertising are not financially feasible, analysts say. While their services may be offered well into the future, they will be far more limited than at the peak of last year's mania for all things free.

"It'll still be the hook that gets people in the door," said Jupiter Research analyst Dylan Brooks. "But the days of free, unlimited service are a thing of the past."

Always a difficult business
At first glance, the sheer number of subscribers would seem to indicate that free ISPs are still in the game. NetZero, the largest of the companies, says it has more than 8.4 million registered users. In its last quarterly results, Juno reported more than 3 million active registrants on its free ISP services, despite a recent campaign to drive people to its paid products. Kmart's BlueLight.com says it has more than 2.6 million active dial-up subscribers.

However, those numbers have helped drive all but the most well-funded companies out of the business and continue to cloud the futures of NetZero, Juno and BlueLight. Providing access requires expensive physical infrastructure that gets even costlier as more people use the service: ISPs must pay for modems, servers and bandwidth from companies that own networks, such as Level 3 Communications or WorldCom.

The early idea of most free ISPs was to defray these expenses with advertising. To tap into the free connection, surfers would be required to keep a window about the size of a banner ad open on their computer screen at all times, showing a rotating stream of often distracting advertisements.

The early companies were well aware that customers seeking a free service weren't necessarily in the most desirable consumer category for potential advertisers. But they added enticements: Because they could track precisely where their subscribers were going online, this information could be used to target ads far more specifically than was the case for ordinary Web sites. A subscriber visiting AutoTrader.com, for example, would be more likely to pay attention to ads for car companies.

The most innovative companies also developed new advertising strategies, painting themselves as primarily advertising conduits as opposed to ISPs. NetZero offered its advertisers the ability to pre-empt their competitors, allowing Ford Motor to buy space on a subscriber's ad window whenever a surfer visited Chevrolet's Web site, for instance.

At the height of the idea's success, many began questioning whether industry leaders needed to react. Microsoft publicly toyed with the idea of free or discounted ISP service, and analysts asked whether AOL would be forced to lower its prices.

The giants stayed firm, though AOL's CompuServe and the Microsoft Network each pursued a parallel strategy of offering $400 rebates on computers for new subscribers, effectively subsidizing newcomers' ISP fees for several years.

"One of the mistakes the industry made is somehow convincing itself that the

	Desperation or innovation? Charles Ardai, CEO, Juno Online Services

The plunging market for online advertising proved to be the companies' undoing. ISPs began falling by the wayside by the middle of last year. Independent companies including Freewwweb neared bankruptcy, and many sold themselves to Juno. CMGI's 1stUp.com, a wholesaler that provided service for AltaVista, Excite@Home, Lycos and others, was closed after executives cited "insurmountable" capital costs for the business. Spinway.com, which provided service for Yahoo and Kmart's BlueLight, was bought outright by BlueLight.

Competitors in the traditional ISP market are on a death watch, hoping the no-cost alternatives will disappear so they can step in with discounted alternatives or remind subscribers of their own relative stability.

"There is a place for the discounted ISP," EarthLink Executive Vice President Michael Lunsford said, but "the free alternatives have to disappear completely first."

Not dead yet
The free ISP business isn't dead yet, even if many of its most visible proponents are gone and the stocks of those remaining have plummeted.

What has happened is consolidation around three main companies and their decision to concentrate on finding revenue. NetZero, Juno and BlueLight have cut back on their focus to offer free service, and in most cases the companies are trying to discourage extensive use of those connections. But they are still available.

NetZero, the first and largest of the free providers, has intensified its longtime concentration on marketing. It continues to find new ways to slice, dice and deliver its subscribers to advertisers, and analysts say it has done so fairly effectively.

Juno is heading down the path of high-speed, or broadband, connections. Once its subscribers get a small taste of the Web, Juno hopes they'll want larger, faster doses and will be willing to pay for them.

BlueLight, which last week announced its CEO was leaving and it would transfer much of its operations to corporate parent Kmart, has targeted Kmart shoppers in an effort to keep its subscribers close to home.

In common, the companies have acted to minimize their biggest threat: the subscribers who use their services for many hours a month, consuming expensive bandwidth.

"We took a close look at how people were using (the service) and found that the top sites were porn, Napster and games," BlueLight spokesman Dave Karraker said. "So what we did was say, 'If you're not using the ISP to shop, you can find another free ISP.'"

BlueLight limited use of its free service to 12 hours unless subscribers started shopping at its e-commerce site. Juno imposed more ads on its subscribers who weren't paying and kicked them offline more often. NetZero limited its free subscribers to 40 hours of surfing per month, stopping a little short of the others.

Each has also instituted a pay plan, charging between $9.95 and $14.95 for unlimited use. Analysts say this will quickly become the largest component of revenue, as it already has for Juno.

Whether that will be enough to help the companies succeed is still open to question. Aside from AOL, none of the large ISPs turns an unambiguous profit even though each charges nearly $20 a month. Analysts say the free or discounted ISPs may have more financial thinking to do.

"Looking at $9.95 a month, I think we're still within our rights to ask whether they can make a profit at that level," Brooks said.

Nevertheless, most analysts believe free access will survive if it is slimmed, limited in time, and used almost solely as a marketing tool. Access to the millions of free ISP customers remains valuable for those who can use it correctly, they say.

The companies "aren't yet out of danger," said Rob Lancaster, a Yankee Group analyst. "But they won't get rid of the free services. It's been the heart and soul of their operations."