HOW AOL LOST THE BATTLES BUT WON THE WAR

By JOSHUA COOPER RAMO

Being a visionary is not the same thing as being popular. Odds are, if you're a visionary, most of your years have been a struggle to get others to see what is so apparent to you. This requires arguing people out of long-held beliefs, absorbing countless verbal assaults and clinging to your judgment while friends wonder when you'll start explaining your position to your dog. Yet with every passing day, you grow more certain that you're right.

For the best part of 15 years now, Steve Case has nurtured a vision. Back in the days when modems creaked along at 300 bits a second, when it took half an hour to download a small black-and-white photo and when most Americans were obsessing over CB radios, Case imagined a world where ordinary folk, like the ones he grew up with in Hawaii, would find real utility in connected computers.

Almost everyone considered that a perfectly ridiculous idea. Since 1985, when he founded the company that would become America Online, Case has jousted continually with the doubters. Even his loyal board members lost the faith: in 1987, after a particularly rough patch, they were ready to fire him until someone argued that surely Case had learned something while spending millions without a penny of profit. Whatever that was didn't seem apparent as his online service hit rock bottom last winter, suffering through one gaffe after another--remember the mess over busy signals?--leaving Case exhausted and his critics smirking. When he called a reporter while on his way to Japan one day last spring, his enthusiastic charm had folded. "Look," he snapped, "what I've figured out is that I can predict the future. I just can't predict when."

Try last week, Steve. On Monday, AOL astonished the computer and media world with the news that it will swallow CompuServe, the nation's oldest online service, and its 2.6 million members. As part of the deal, AOL sealed a long-term pact with WorldCom, a telephone company based in Jackson, Miss., with scads of capacity, that will help AOL lock in access to phone lines at low rates for the next five years--and probably boost profits. In the three-way agreement, WorldCom bought CompuServe and then handed AOL the online company's 2.6 million subscribers in exchange for AOL's networking and Internet-access division, called ANS (see box).

If the deal goes through--and it will certainly get a hard look from antitrust officials--AOL will have 12 million members, almost six times as many as its nearest competitor, the Microsoft Network. But while the news was big, AOL had no idea the coup would so clearly signal that the company had finally arrived. As congratulatory calls poured in, AOL employees shared a moment of collective corporate shock: "Well, I guess Steve was right."

Only in the digital age can an outfit go from worst to first so quickly. In the past 24 months, AOL has dodged everything from a Bill Gates bull rush (his Microsoft Network spent millions to compete with AOL) to a tussle with the Internet, whose wide-open spaces threatened to make AOL's narrower "gated community" irrelevant. Case, 39, has been famously (if inadvertently) self-destructive, infuriating AOL members by offering too little capacity and too many headaches. Overeager users have crashed parts of the service twice in the past year by bombarding it with more calls than computers could handle. And as "America On Hold" angered customers, it perplexed Wall Street. Accountants demanded that AOL refigure its books, erasing every dollar of profit the company ever made. It faced potential lawsuits from the attorneys general of 36 states over billing practices. William Razzouk, a hotshot executive from FedEx, split after just five flabbergasted months as president of the service. The company endured, inevitably, a collapse of its too-rich stock price. Twice.

Many of the same problems remain. AOL, which has always had a high turnover of subscribers, still serves for many as training wheels from which they eventually graduate by getting directly onto the Internet. Retaining customers will become even harder as phone companies, cable companies, Microsoft and Netscape make it even easier to use the Internet's open standards for browsing the Web, chatting and sending mail. AOL hopes the WorldCom deal will eventually allow it to offer higher-speed access through phone lines, but cable and wireless technologies could lure impatient users away from cumbersome dial-up services. Customers could also become turned off by the increasingly intrusive ads, upon which AOL's flat-price business model now depends. And while Microsoft has yet to perfect its own MSN service, even Case observes that Gates' behemoth usually gets things right on the third or fourth try; when Microsoft finally gets its browser, mail, Internet access and content fully integrated into its Windows operating system, users may find it easier to get to the rich content of the Web that way rather than through the suburban environment of AOL. But despite all these challenges and the predictions of doomsayers over the years, Case's company showed last week that it has at least the potential to thrive.

The WorldCom-CompuServe deal certified AOL as cyberspace's first true empire, a global online service that's adding 6,000 members a day and will soon be available in more than 100 countries. Revenues have pumped up with impressive speed, even for a high-tech firm, from $53 million in fiscal 1993 to nearly $2 billion this year. And, slowly, profits are emerging. The stock price, which traded at $22 a year ago, hit a high of $80.50 this week. Even at a perilous 80 times projected 1998 earnings, it will beat the market, think Wall Street pros. "AOL has won the battle to become the No. 1 brand in home online access," says Keith Benjamin, an analyst at Robertson Stephens.

The anchor for this success is a truism as relaxed as Case's laconic charm: easy is better. In a world of overfeatured, tech-heavy computers and Internet gadgets, Case built a business on the simple idea that the electronic world should be easy to use. "The geeks don't like us," Case said last week as he kicked back in his Dulles, Va., office, sporting a new green CompuServe shirt. "They want as much technology as possible, while AOL's entire objective is to simplify." It was Case, for instance, who introduced the first graphical interface to the online world in 1985, allowing users to point their mouse arrows at whatever they wanted and click to get it.

Simplicity has let AOL build an electronic community that includes not only the geek next door but the geek's parents and grandparents as well. It's a place where a generation of Florida retirees has found that the keyword Jewish links to the "Ask a Rabbi" feature, where teens can buy MTV clothes and where Business Week and the New York Times come free with a subscription to AOL. (TIME is available on CompuServe; other Time Inc. publications are carried on AOL. Time Inc. has a joint venture with AOL to develop a health site called Thrive.) Case hopes for a service that is as clean, organized and trouble free as the manicured suburbs that surround AOL's Dulles headquarters. "There's an inside Silicon Valley syndrome that is out of touch with what consumers want," Case says. "Our market is everybody else." Internal research suggests "everybody else" could push AOL to 25 million members by 1999. Says Case, once a PepsiCo marketer: "We want to be the Coca-Cola of the online world."

In a sense, Case has spent his whole life preparing to build and run a multibillion-dollar business. His childhood on the island of Oahu was sprinkled with the fiscal adventures of a boy to the cash register born. With his older brother Dan (now 40 and CEO of Hambrecht & Quist, an investment firm that specializes in technology), Case started his first business before he had fully mastered a bicycle. The venture was a variation on a classic model: converting backyard lemons to lemonade. Next the brothers started Case Enterprises, which peddled everything from seeds to watches. Case Enterprises stumbled--"I can't understand why no one wanted to buy Swiss watches from a 12-year-old and an 11-year-old," Dan jokes--but it gave the boys a feel for the joys of capitalism. "From the beginning," Steve says, "it was clear I'd be an entrepreneur."

Upon graduation from Williams College (where he started four businesses, including a lucrative airport shuttle), Case leaped into a life in corporate America. Working for giants like PepsiCo and Procter & Gamble, he chafed at the implacable peculiarities of management, but he also took careful notes. At P&G, for instance, he had a front-row seat for corporate marketing. He still chuckles about the P&G executives so dazzled by the success of Bounce--a tissue impregnated with fabric softener--that they jumped to the odd conclusion that the idea might work for hair care. The result was a conditioner-impregnated tissue. Case helped invent a catchy slogan--"Towelette? You bet!"--and then watched the product implode. "Consumers," Case says, "are smart. Good marketing can only get you a trial. If the product's bad, sales will go over a cliff."

Case refined his education at Pizza Hut, chewing his way through a yearlong assignment to scout the latest in pizza innovation at the unhealthy rate of eight to 10 pies a day. He helped the Hut launch a "pocket" pizza called Calizza--it followed the towelette into oblivion--and divined what he says is the single most important law of business: success requires you to sit taste bud to taste bud with your customer.

Case's own tastes were going digital. He bought a Kaypro, a clunky home computer connected to a snail-paced modem. Even for a hobbyist, the machine was a nightmare--hard to set up, impossible to maintain, boring to use. But the modem was a revelation. As he connected to early online services such as CompuServe and the Source, Case felt the electronic rapture that would one day seduce millions of AOL users: "There was something magical about the notion of sitting in Wichita and talking to the world."

The convergence of Case's entrepreneurial spirit and his hobby came in 1983, when his brother Dan helped him land a job at Control Video, a Virginia-based company with the premature idea of shipping Atari video games to home computers over telephone lines. Two weeks after Case arrived, the firm's capital dried up. Out of the ashes, Case crafted Quantum Computer Services. His idea was to create an online bulletin board for owners of Commodore 64 computers. It wasn't a sexy niche, but he thought it might have potential.

From 1985 onward, Case nurtured Quantum from a few thousand members to more than 100,000. Along the way he refined his ideas about how computers should communicate and what his audience needed. In 1991 Quantum--what a geeky name--became America Online and, with 150,000 members, prepared to battle CompuServe, which had 800,000 members, and Prodigy, an IBM-Sears joint venture with 1.1 million.

This seemed nutty. Compete with IBM? Sears? Even Case's mother, a retired teacher in Hawaii, worried a little. But Case was operating with a bit of screwy good luck and the market savvy that comes from hard knocks. He looked at American consumers and somehow understood what it would take to get them online. IBM and CompuServe bet that the real lure would be lots of fancy computer features. Case, with the taste of dozens of complex pizzas still in his mouth, knew better. What America wanted was cheese, tomato sauce and occasionally some pepperoni. AOL would reek with simplicity.

The online experience wasn't an easy sell, but when the business began to pick up in the early 1990s, it picked up fast. From 200,000 members in 1992, AOL surged to 1 million by 1994, 4 million by late 1995 and 8 million by last January. As AOL shot up, it passed CompuServe and Prodigy on the way down. The market changed overnight, and forever. Millions of Americans instantly recognized the value of getting online, and AOL was their first, best hope.

Case and Robert Pittman, chief executive of AOL Networks, are working to make AOL even easier. They hope to capture the mindless simplicity of a television: on, off, a channel tuner. AOL says, for instance, that 60% of the calls that spill into its help center come from people who are having basic computer problems--not difficulties with AOL. And many of the problems float around the "Is it plugged in, sir?" level of difficulty. Of AOL's 7,500 employees, more than half spend their days on the phone helping customers. And they get an earful: AOL customers are a cantankerous lot, and many are still dramatically unhappy with the service. "The customers keep us from kidding ourselves," says Pittman, who makes his 72-year-old mom call customer support if she has a billing problem.

In Case's marketing terms, simplicity is what puts the fingers on the mice. A new generation of the AOL software, due later this fall, has been relentlessly tested by potential users--self-confessed computer idiots all. Case's target audience said they wanted the Net organized and edited for them. Who, after all, has time to pore over 10,000 pages in search of just the right nuggets of data? So AOL's new interface offers a nearly seamless link between the Web and AOL. Everything is as neatly organized as a small-town library. AOL has put a frame around the chaotic tumble of the Internet. The frame, Case hopes, will make the Net easier to use, simpler to understand and more carefully edited to keep kids from seeing things they shouldn't see. Above all, need we mention, the goal is to make the Net seem well worth paying for. "We don't really care about the technology," Case explains. "We've tried to recognize that it is a means to an end, and the end is to improve the way people get information and communicate." While Case is worried that the service will lose some of the more technically sophisticated members it has acquired from CompuServe, he hopes a customer-friendly outlook will induce many to stay.

Pittman, who helped build MTV from a low-budget cable channel into an empire of hair and attitude, believes in that consumerist approach. He's fond, for instance, of telling the story of the time when, as CEO of Six Flags, he spent time working as a street sweeper in pursuit of a broom's-eye-view of its New Jersey theme park. Pittman has an intense charm that makes him a natural for AOL's dichotomous culture, where V.P.s brag alternately about late nights and mountain-biking exploits. "I've spent my whole life building brands," he says. "And we're focusing more on brand building than others. My experience tells me that's a good thing." He talks in a soft, deliberate voice, and his vision for AOL is as clear as Case's, though there's always the possibility of an ego conflict between the two.

Pittman has begun to shape AOL, primarily through a series of deals that will morph the firm from a plain online service into something more akin to a personal butler. He and David Colburn, one of his top dealmakers, persuaded Tel-Save, a long-distance reseller, to use AOL to market and bill for a phone service. This means AOL members will be able to pay their monthly phone bill online and use interactive software to pick the calling plan that works best for them. In exchange for this efficiency, Tel-Save has paid a record $100 million to AOL. Tel-Save CEO Daniel Borislow says he feels lucky: "AOL has 9 million subscribers with the best demographics in the business, and the only other place we could have offered this type of service to consumers is Microsoft, at one-fourth the size." AOL is also banking on the growing business of selling products online. Firms such as 1-800-FLOWERS and bookseller Amazon.com have paid for a crack at AOL's audience. It's one of those warp-speed inversions you hear about in cyberspace: two years ago, AOL execs were shoveling out millions to get content to come to them. Now Case is often the one cashing checks. And all the dealmaking is matched by astute strategy. AOL is looking for fast revenue and long-term partners. Merger watchers say the firm's cherished goal of a buyout by a giant such as AT&T is still a real part of their calculus.

Case has also moved into the business of creating content, with mixed results. Last fall the company formed AOL Studios, a group that has begun producing content for AOL users and the Web. But for the tens of millions of dollars Case has spent on that pursuit, the service has one certifiable winner: the stock-market site called Motley Fool. Among AOL Studios' current projects is Digital City, an electronic newspaper for cities as diverse as Denver and, soon, London. The newspaper hasn't caught fire yet, but neither has Microsoft's competing version, called Sidewalk. AOL's much heralded online conferences are still small potatoes: its last big attraction was a Rosie O'Donnell chat that drew 16,000 readers.

AOL officials like to point out that users spend 80% of their time inside the service and just 20% on the Web. That's somewhat deceptive since much of what AOL offers is also available on the Web. But AOL must be doing something to attract customers. Motley Fool may be the only homegrown hit, but the fragmented online world may not be about huge hits anyhow. AOL thinks just assembling the eyeballs is enough to win. "Five years ago, I predicted that more people in prime time would be on AOL than watching a cable channel," says Ted Leonsis, who heads AOL's content operations. "Now more people come to AOL than are watching Larry King Live."

AOL has begun to capitalize on its audience--members with seductively high disposable incomes--by selling advertisers a chance to reach them. In the next year, analysts expect AOL to sell close to $150 million in ads. Says Henry Blodget, an analyst at Oppenheimer & Co.: "AOL viewership, the number of hours spent looking at the screen, is now approaching that of ESPN, MTV, CNN and a few other cable companies. If you fill that time with advertising, the power of the revenue-generation machine is phenomenal."

What makes these riches especially sweet is that Case has come close to wrecking his magical money machine. The self-demolition derby started last fall, when AOL's strained network backed up like a kitchen sink. New York City users were calling access numbers in places as far away as Alaska before getting through. In December, when AOL changed its pricing structure to allow for unlimited access at a flat rate, the mess worsened, and customers screamed. Attorneys general threatened to sue AOL for promising service it couldn't deliver. Wall Street analysts argued that this was the sort of problem that would drive AOL users into the arms of other Net firms. Though Case settled with the state officials, it took him months to win back consumer confidence.

Not to mention a couple of hundred million dollars. In the past six months, AOL has learned the hard way about the fixed costs associated with building an empire. In the lot next to its Dulles headquarters, the company is erecting a $50 million network facility, on top of $300 million spent adding modems from Florida to Alaska. "We're building the equivalent of a Prodigy every month," says Mike Connors, AOL's president of technology.

Members still complain of being shut out during busy times. Yet the slowing of AOL's once brisk cancellation rate and the acceleration of new arrivals seem to show that Case is at least one step ahead of the complaints. "These guys flirted with disaster," says Daniel Hart, a new-media strategist at Viacom. "Fortunately, they were smart enough to pull it out."

Successful as AOL has been, Case knows that his company could still end up being the RC Cola of the Net rather than the Coca-Cola. With the Web spilling onto platforms as diverse as TV sets and cell phones, Case sees that his business may be preparing for another big shift. "Even though we've been at it for a decade, this is like the second inning in terms of the development of this medium." The online business, he says, is about to become "the most competitive market in the world."

In fact, the hidden victory of the WorldCom deal is that it gives AOL a technological leg up. WorldCom is building bigger pipes--broadband, in the parlance--over which AOL can push a richer service. Although some industry watchers see broadband as a weapon for rivals like cable companies to use against AOL, Case naturally holds the opposite view that his product will be more effective in a new era. If AOL can attract 12 million users just with snappy graphics and chat, imagine what it will be able to do with full-motion video and stereo sound.

Imagine too what Microsoft can do. No company is a bigger threat, yet Microsoft is both partner and competitor for AOL. Case says it's a relationship based on "ambivalence and, to some extent, fear." Soon AOL will unveil new alliances with Microsoft that include everything from licensing the online magazine Slate--on AOL starting this fall--to becoming part of Microsoft's "Active Desktop," which will let AOL deliver information to Windows computers using new Microsoft technology. Pittman, for one, feels AOL holds a better hand: "Microsoft's destiny is not MSN."

AOL is also taking its first tentative steps as a media company. Case has vowed, for example, to make AOL as smut-free as possible, but on any given night, mild chat-room conversation about Proust is likely to be outgunned by what AOLers--to get around the service's auto-delete features--euphemistically call "bikini talk." The ultimate goal, Case says, is a self-regulating environment, but in litigious America, that's almost a pipe dream.

The service has already landed in court over what can and can't be said online. Sidney Blumenthal, a White House aide, is suing the service for carrying the gossip sheet known as the Drudge Report, which alleged Blumenthal had a history of spousal abuse. Denying the story, Blumenthal and his wife filed a $30 million complaint against AOL and Matt Drudge, who writes the eponymous report. Case says the firm shouldn't be held responsible for simply distributing information. But as AOL becomes more of a media company, Case will have to learn that it will be held responsible, legally and morally, for the information it passes along, especially from those with whom it has contracts.

Case knows there are more battles coming, and the best offense is his passion. Last week, to celebrate the CompuServe announcement, he took the show on the road to Columbus, Ohio, CompuServe's headquarters. In front of a packed room of demoralized, worried employees, he praised CompuServe as a leader in technology and recalled his own early days using the service in the 1980s. As the room warmed to his rhetoric, Case described the AOL he envisions, a place as simply wonderful as the Oahu beaches he knew as a child, and a business as secure as his old lemonade stand. To seal his deal with his new employees, Case stripped off his ratty shirt and slipped into a CompuServe polo someone had handed him. "Now don't look!" he joked as he unveiled a pasty-white beer belly in front of the crowd. But Case's new employees, laughing and cheering, disobeyed AOL's visionary. They couldn't take their eyes off the future.

--Reported by Daniel Eisenberg, Stacy Perman and Bruce Van Voorst/Dulles, Lisa Granatstein/New York and Jenifer Mattos/Seattle

With reporting by DANIEL EISENBERG, STACY PERMAN AND BRUCE VAN VOORST/DULLES, LISA GRANATSTEIN/NEW YORK AND JENIFER MATTOS/SEATTLE