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THE ONLINE WORLD OF STEVE CASE

So far, he has beaten all the odds. Can he keep America Online on top?

Dressed in trademark khakis and open-collar shirt, Steven M. Case is the star attraction at the PC Forum. This annual March gathering of the digital elite, held at a resort near Tucson, is a combination of a three-day free-form think tank and schmooze-athon where the latest trends are dissected and, in the corridors or on the golf course, deals are hatched. The first time Case attended, a decade ago, he was an unknown 27-year-old entrepreneur pushing a chat service for owners of Commodore computers. He was, he recalls, lost in a crowd obsessing over which microprocessor would dominate. ``I felt like I was from another planet.''

Now, everybody wants to be on Case's planet. The ballroom is packed when he gives his opening-day speech, and wherever he appears, a knot of reporters, industry heavyweights, and wannabes gather. At this moment in high-tech history, Case is the man whose opinion is sought, the person everyone wants to make a deal with.

For it is Case's America Online Inc. that has shown how to turn a community of cybernauts into a mass market and how to successfully turn a computer network into a new medium for entertainment and news. With more than 5 million customers and 75,000 more joining every week, AOL is the most potent force in cyberspace.

So powerful, in fact, that the two greatest forces in computers and communications--Microsoft Corp. and AT&T--have handed Case lucrative deals aimed at boosting their own cyber plans. In exchange for pushing Microsoft's Internet browser software to AOL's millions, Microsoft has made an unprecedented concession: to bundle AOL software with every copy of Windows 95. Under an agreement with AT&T, the phone giant will provide a link to AOL from its new WorldNet service. That gives AOL an in with 80 million AT&T customers being offered WorldNet on a free trial. (Rivals Prodigy Services Co. and CompuServe Inc. quickly announced they are negotiating similar deals with Microsoft, and CompuServe on Mar. 3 signed a deal with WorldNet.)

``He's done a masterful job. Steve Case walks on water as far as I am concerned,'' says Roger B. McNamee, a general partner with Integral Capital Partners, a venture-capital firm. Indeed, given all the experts and rivals who have predicted AOL's great fall, its continuing rise is sort of a miracle. Ever since 1993, when the company launched the bold drive for market share that has brought it to this point, naysayers have predicted that Case would falter and AOL spin out of control.

There has been plenty of reason to believe the forecasts of doom. After flooding the mails with diskettes and offers of free trials--luring hundreds of thousands of consumers--AOL found its network was often overloaded, inspiring the sobriquet ``America On Hold.'' Short-sellers suggested that, by using aggressive accounting methods to allocate the costs of acquiring customers, AOL intentionally overstated its earnings to boost its stock (table). Then, there was the growing threat from Microsoft, which planned its own online service.

WHITE FLAG. The biggest cloud over AOL--and the one that looms largest today--has been the Internet. With the World Wide Web giving ``content providers'' a way to reach millions of consumers directly, who would need AOL? Consultants Forrester Research predicted in 1995 that new subscriptions for AOL would have slowed to a crawl by now as consumers jumped to the Net.

Wrong. Up to this point, at least, Case has consistently confounded the critics. The Microsoft Network was no barn-burner, which the AOL deal tacitly acklowledged. To silence the busy signals and keep customers online, Case paid $35 million for his own data-network. Following a review by the Securities & Exchange Commission, the company modified its accounting methods--although the shorts say the way it keeps its books still creates a potential earnings time bomb. And instead of running from the Web, Case has embraced it. AOL now generates 30% of all Web traffic, according to Find/SVP, a market researcher. AOL's Internet-only service, Global Network Navigator is a hit, attracting 100,000 subscribers since last fall.

BIG GAMBLE. ``Every time people ask, `How is he going to survive?' he makes the right moves,'' says Gordon Bridge, chairman of Internet software maker Connect Inc. and a former AT&T executive. Adds Alexander M. Haig Jr., a longtime AOL director: ``If you look at how this young fella has positioned this company, he has ventures with every big player in the business. Instead of being beaten to death by Microsoft, as everyone predicted, they came courting him.''

No wonder AOL is one of the hottest--and most controversial--plays on Wall Street. Its shares are in the mid-50s, a thirtyfold leap from the March, 1992, public offering price of $1.84, adjusted for three splits and despite two secondary offerings. AOL carries a staggering $5 billion valuation--132 times estimated fiscal 1996 earnings of $38 million and five times estimated revenues of $1 billion. That gives Case, 37, a paper fortune of $165 million. More important, the buoyant shares have given AOL a cheap source of funds to buy technology and content.

Still, Case is running a high-wire act. The whole setup depends on continuing rapid growth: A slowdown in subscriber sign-ups, a price war that drives down per-subscriber revenue or, worst of all, a loss of subscribers could spell real trouble. Right now, AOL is pulling out the stops to bring in new members and hit its new goal of 10 million by 1998. It's getting costlier to find and keep subscribers. The company added 1.8 million in the December quarter, but lost 950,000, making net additions 880,000. The true cost of landing a newbie is now $93, more than double the $45 that AOL executives cite, figures Cowen & Co.

That adds up to a huge gamble. The company, which had just $132 million in cash at the end of last quarter, saw its deferred subscriber acquisition costs surge to $189 million from $58 million the previous December. Also, although AOL now expenses costs such as advertising, it still treats as capital expenses items such as producing sign-up diskettes. But, based on projections that customers will stay on for an average of 42 months, the company has extended the period over which it pays off those costs--to 24 months. If growth slows, those deferred costs could erase future earnings.

As if that weren't enough to balance, Case is also branching out in all directions. He's adding business-oriented services to generate daytime traffic and launching a European network. And, he's still dealing with the results of nine acquisitions made over the last three years--many of which have yet to show signs of paying off (table, page 82). Meanwhile, AOL Senior Vice-President Theodore J. Leonsis is constantly wheeling and dealing for fresh content (page 87). ``You have to ask at what price are they getting this growth?'' says David M. Simons, managing director of Digital Video Investments, an investment research firm.

Whatever the price, at this point in the industry's development, Case thinks it's essential for AOL to get as big as possible. That's in sharp contrast to a scenario that the techno-pundits are spinning. They're now talking of ``disaggregation,'' an inelegant mouthful that means instead of getting a single package--content, network access, billing, and so on--from one supplier, consumers will shop around. They'll buy network access from the phone company at cut-rate prices and content a la carte--from Web sites or from services such as AOL. ``Disaggregation theory immediately blows up the model of proprietary online services,'' says John Petrillo, executive vice-president of strategy at AT&T.

DUMBING DOWN. True to form, Case has little use for the conventional wisdom--or the pronouncements of the ``visionaries'' who litter the high-tech landscape. There's nothing visionary about AOL, he submits. Its success results from simply paying better attention to what consumers want than technology-obsessed rivals do. ``The industry pundits were out of touch with consumers. That was a huge mistake,'' says Case, who, fresh out of Williams College in 1980, did a two-year stint at Procter & Gamble Co.

``The secret of Case is that he has figured out a way to make consumers like their computers,'' says Eric E. Schmidt, vice-president and chief technology officer at Sun Microsystems Inc. ``Look at AOL's customer base--it's normal people, it's consumers.'' Indeed, AOL was so successful in dumbing down technology that for years, rivals and pundits dismissed the service as the ``Kmart network.'' Says Schmidt: ``It was extremely arrogant of the high-tech industry to criticize that.''

And short-sighted. Now, the mass market is the Holy Grail that all online services and content providers seek. They have seen that AOL's relatively unintimidating slice of cyberspace is the kind of place where the unwired millions of consumers may wind up. ``It's still the early days of this medium,'' says Case. Despite all the cyber hype, only 11% of U.S. households are plugged into the Internet or commercial online services.

As AOL and its rivals try to drag the other 89% into cyberspace, Case figures the online market will start to approach critical mass. He likens it to the development of cable TV, which really only became an economically viable medium when it reached 20% or 30% of homes. An admirer of John C. Malone of Tele-Communications Inc., Case is on a Malone-like quest for market penetration. That's why he's punching AOL's accelerator now. Powerhouses in media, technology, and telecommunications are all trying to grab their slices of the new mass market, too. Companies from Microsoft to Disney to Rupert Murdoch's News Corp. are looking to build online empires. Phone giants AT&T and MCI Communications are giving away Internet-access service--to compete with thousands of local Internet-access providers.

Case is confident that the masses will prefer the comfort of AOL to the wilds of the Internet. Even via the easy-to-maneuver Web, he notes, the Net can be overwhelming. And surfing the Web from a home PC with a standard 14.4 kilobit-per-second modem can mean lengthy waits for images and text to appear. Reaching out to the mainstream market ``will require even greater degrees of simplicity,'' argues Case.

That's why Case is upping his bet on his grand plan to put together all the pieces for consumers. He's building up his own nationwide Internet-backbone network, which is already bigger than AT&T's. He continues to add content, including a growing roster of online publications such as BUSINESS WEEK. An update of AOL's software set to debut in a few months will expand the number of ``channels,'' groupings of content such as news and travel, from 14 to 20. Case figures there will only be a handful of brands that consumers will flock to in cyberspace, and he's working to make sure AOL is one of them.

``HIGH MARGINS.'' Case has never lacked for self-assurance--or business sense. ``He's always been an independent thinker,'' says Daniel Case III, Steve's older brother and first business partner and now president and chief executive at Hambrecht & Quist, a top San Francisco investment bank. The two grew up in Honolulu, along with an older sister, Carin, who now teaches preschool in Santa Rosa, Calif., and a younger brother, Jeff, now an insurance executive in San Francisco. Their father is a corporate lawyer and their mother a teacher. Both were born and raised on Oahu.

Dan and Steve, born 13 months apart, were a team from the start. When Steve was 6, the brothers started a juice stand using limes from the backyard. They charged 2 cents a cup, but many people gave them a nickel and let them keep the change. ``We learned early the value of high margins,'' says Dan.

A few years later, they formed Case Enterprises, a business Dan describes as an ``international mail-order company.'' They sold everything from seeds to greeting cards by mail and door-to-door. ``We made a fortune, tens of dollars,'' says Dan. Case Enterprises also became the Hawaiian distributor for a Swiss watchmaker. They didn't sell one watch, but that didn't faze them.

Before long, the brothers created an affiliate, the Aloha Sales Agency, to sell ad circulars. Dan recalls Steve waking him up in the middle of the night with the perfect name for the circular, Budget Booster. The pair also shared a newspaper route. Why the entrepreneurial bent for a pair of comfortably middle-class kids? ``It was the challenge, the pursuit of the idea,'' recalls the younger Case.

Later, Steve wrote album reviews for the Punahou School newspaper. ``He'd write reviews of albums in dinky student newspapers and write letters to record companies saying he wrote for the leading newspaper read by teenagers in Hawaii, which was true,'' says Dan. That got his name on record-company mailing lists--and free albums and concert tickets poured in. Steve loved basketball and, like any good islander, was a bodysurfer. A good student, he was ``normal, relatively shy, and creative,'' says Dan.

At Williams College, Steve majored in political science. ``It was the closest thing to marketing,'' he says. He was on the All Campus Entertainment Committee, which booked bands, and despite possessing what he describes as ``rather limited singing talent,'' served as lead singer in two groups: The Vans, a knockoff of The Cars, and The The, inspired by The Knack, whose one hit was ``My Sharona.''

Upon graduation, Case joined Procter & Gamble, where he worked on the venerable Lilt home-permanent kit and a new item called Abound, a hair-conditioning towelette. (``Towelette? You bet!'' was the slogan). ``It was a disaster,'' recalls Case. After two years, he grew bored. ``Managing a mature business is not my thing,'' he says.

His next stop was PepsiCo's Pizza Hut unit. As manager of new pizza development, Case spent months traveling from city to city eating slice after slice in search of new ideas for toppings. Nights on the road gave Case time to indulge his interest in a new gizmo: the PC. He bought a Kaypro, paid $100 to subscribe to The Source, and spent hours on this online service, chatting and perusing bulletin boards. ``I thought there was something magic in sitting in a hotel room and connecting to all of this,'' says Case.

Meanwhile, brother Dan was the family pioneer in high tech. A Princeton grad and Rhodes scholar, he became an associate with Hambrecht & Quist. He was soon representing the firm on the board of Control Video, a gaming service for Atari computer owners.

Steve's turning point came in 1983. He joined Dan at the Consumer Electronics show in Las Vegas, where Dan introduced his brother to the founders of Control Video. They offered the younger Case a job as marketing assistant on the spot. He took it. Soon after, the company ran out of money. The board fired the management team and installed as CEO Jim Kimsey, an entrepreneur who had been working part time at Control Video. Dan soon left the board. Steve helped Kimsey bring in venture money, and in 1985, the company was reborn as Quantum Computer Services Inc., an online service for owners of Commodore computers.

Almost from the start, Kimsey groomed Case for the top spot. The apprenticeship had its bumps, though. Case landed a deal with Apple Computer Inc. in 1987 basically by sheer persistence, practically camping out at its Cupertino (Calif.) headquarters for four months. ``I wore them down,'' he says.

After he won the Apple business, he quickly signed Tandy Corp., too. Case plowed much of the $5 million in fresh capital into overhead to support the deals. But it was too much too fast, and Quantum had to retrench. ``I had most of my venture-capital board members calling for him to be fired,'' Kimsey recalls. ``I said, `We have $5 million invested in this boy's education. Do you want to throw that out?'''

That education has apparently paid off. ``He has grown dramatically over the last 12 years,'' says Kimsey. So has the company. Case took over as CEO in 1992, a year after Quantum was renamed America Online, and shortly after the initial public offering raised $66 million. Back then, revenue was $27 million and AOL trailed both CompuServe and Prodigy with just 200,000 subscribers. It had 250 employees.

Case laid out a growth-at-any-cost strategy in 1993 and never looked back. Today, AOL has 4,000 employees, and some 200 are being added every month. It is decamping from Vienna, Va., to a 113-acre spread in nearby Loudon County.

Managing growth has become a key issue. AOL is still absorbing the people and facilities snapped up during its $100 million buying binge. And, in retrospect, it looks like some of those deals were hasty. ANS and GNN have brought a badly needed data network and Internet-access capabilities. But many of the software startups it acquired--including Navisoft, WAIS, and Medior--have languished. Booklink Technologies, a maker of browser software for which Case paid $41 million in 1994, looks like a loss, given that AOL now plans to use browsers from Netscape Communications and Microsoft.

To help keep things under control, Case in January hired his first chief operating officer, William J. Razzouk, a former Federal Express Corp. executive. ``My job is to make sure the mass stampede is managed and orchestrated,'' says Razzouk. That will lighten the day-to-day load for Case, who friends describe as a workaholic. The move comes too late, however, to save his 11-year marriage to his college girlfriend. The couple has three children. Case notified his directors in early March that he now has a ``personal relationship'' with his vice-president of corporate communications, Jean Villenueva.

Now, with Razzouk minding the shop, Case is making head-turning deals. Consider how he got what he wanted from Netscape and Microsoft. Dissatisfied with terms of a deal with Netscape, Case got a better one with Microsoft, which agreed to rework its Internet Explorer for use on AOL. That prompted Netscape to do what AOL wanted all along: to make its browser work seamlessly with AOL, too.

Overcoming his shyness, Case is now a prominent spokesman for AOL. ``He's the best at staying on-message than anyone I have met,'' says Michael Kinsley, the ex-TV commentator who is creating an online political journal for Microsoft. Anything to keep customers coming and the revenue flowing. Wherever he roams, Case is racing to make AOL the premier channel on what he sees as the new mass medium. Says Case: ``This is a momentum game.''

As he is well aware, there is something in cyberspace with greater momentum than AOL: the Web. With content providers launching sites every day and hundreds of Internet- access services hawking low rates, AOL is under pressure. The immediate issue is price. Case brags about how average monthly bills have risen to $18 (the rates are $9.95 a month for five hours and $2.95 for each additional hour). But AOL is testing a ``heavy usage plan'' for its best customers, the third of its clientele that generates two thirds of revenue. These are the ones most likely to switch to Net services, typically priced at $19.95 a month for unlimited use. Longer-term, Case is preparing for the day when the Web takes over--and customers cruise AOL from the Net and vice versa. The first step is the AT&T deal, which gives WorldNet customers access to AOL at a discount. Before long, the Web and commercial services such as AOL will be almost indistinguishable.

That's when a mass audience will pay off. Today, subscriber fees account for 90% of AOL's revenue. Partly because of Web competition, AOL will have to find new sources of revenue. Advertising could be a major one. And Case plans to deliver advertisers the biggest online audience. They might log on via AOL's network or the World Wide Web. What will matter is that they'll be there by the millions.

That is, if AOL has the right programming. So it's furiously forging partnerships with media giants. The roster includes Capital Cities/ABC, Time Warner, and Viacom in the U.S. In Europe, AOL has an online service with Bertelsmann, the German publisher. Any of these partners can also go up on the Web, and plan to. But they also want to reach AOL's audience. ``It's naive to think that even if you have a powerful brand name like ABC that someone is going to find it'' on the Web, says Lauren Marrus, vice-president of Capital Cities/ABC's multimedia group, which has a partnership with AOL. ``We see a role for both the commercial services and the Net.'' AOL plans to make sure that remains the case.

By Amy Cortese in New York and Amy Barrett in Vienna, Va., with Paul Eng in New York and Linda Himelstein in San Francisco, and bureau reports


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Updated June 14, 1997 by bwwebmaster
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