Welcome to the postmodern era of hi-tech investing. Where once all you needed for a successful dot-com IPO was big ambition and a lot of hype, the byword of today's investor is "profitability." To achieve that goal, a new generation of companies is testing the waters for a radical new approach to online services.
They want you to pay.
Leading the charge on this front is Napster, which stunned its legion of music-swapping users with the announcement that it would soon launch an expanded, subscription-only service. Analysts now expect Napster to roll out this for-pay offering around June or July, with a predicted cost of $4.95 per month.
Meanwhile, beleaguered gaming company Sega has hinted that it, too, may be banking its future on pay-to-play. According to Sega representatives, a forthcoming next-generation device, offered by British vendor Pace Micro Technology, will enable users to play Sega Dreamcast games downloaded over a digital television hookup — presumably, for a monthly fee.
And even Microsoft is getting in on the act. With the foundation laid by its new .NET strategy, the software giant is hoping to move toward a service-oriented model for its applications business. In this vision, customers would no longer buy software; instead, they'd subscribe to it.
This for-pay approach is a daring one in the "free for all" environment of the Internet, where subscription-based services have suffered a troubled past. Take the online edition of the Wall Street Journal, for instance. Though generally lauded as one of the subscription model's few successes, five years after its launch, WSJ.com still claims just over 500,000 subscribers, compared to 1.6 million for the print edition.
Still other attempts at subscription network services have failed outright. Microsoft aborted an early effort to launch its MSN.com as a for-pay competitor to America Online. And Sega tried a subscription gaming service once before, with its short-lived Sega Channel.
Yet it seems that the fatal flaw of these past paid online services has been their approach. Consumers are forced to subscribe as they would to magazines, with each provider bidding independently for their dollars. A new generation of subscription services might stand a better chance to succeed, if instead they looked to the example of cable television.
Like most television channels, today nearly every online business relies on advertising for at least part of its revenue. Many of the new developments in client-side Web technology, like Macromedia's Flash, are driven by the desire of advertisers to hook potential customers with richer, more engaging content. And yet, unlike TV advertising, the actual effectiveness of Web ads remains uncertain.
Most analysts agree that "click thru" for banner ads occurs only rarely, and attempts to attract attention with larger or more intrusive ads are often poorly received by end users. Though the market for online advertising continues to grow, one survey conducted by AdRelevance last year suggested that some $26 million in potential online ad space goes unsold each week.
Add to that the wave of recent closures of dot-com companies — which had long been the largest segment of online ad buyers — and many voices on Wall Street are beginning to question whether an online business model based largely on advertising is truly sustainable.
Cable television is a much older medium than the Internet, however, and it long ago grew beyond advertising as its sole means of funding. And while it's true that most TV networks have been built on advertising revenue, some have become phenomenally successful without relying on ads at all.
In the early 1970s, Time Warner's HBO Networks managed to carve a profitable niche by screening uncut, theatrical-release movies, free of commercials. Not unlike Napster, at first there was concern that taping from HBO could undermine the market for home video. The animated film Heavy Metal, for example, was distributed via tapes bootlegged from HBO's subsidiary Cinemax, years before its commercial release on videotape.
But over time the industry changed, until today few perceive pay cable channels as a threat to the motion picture industry. In fact, some of HBO's most successful programming is its own original content. And still to this day, all HBO subscribers pay monthly fees in addition to their regular cable bills solely to receive HBO.
A comparable future would be a godsend for Napster, whose need for revenue is particularly dire. It has to provide not only profits for its own investors, but also royalties for the countless recording artists whose works are traded on its file-sharing service. Only then can it hope to escape the persecution of the Recording Industry Association of America and major record labels.
Could Napster become the Internet's equivalent of HBO — a subscription-only "premium service" for digital music delivery? It could — especially in a future where Internet service itself more closely resembled cable TV.
Today, consumer ISPs generally provide access to the Internet, an e-mail address, and the opportunity to host a personal Web page — and little else. It's up to each user to seek out actual network content.
By comparison, cable operators don't just connect a wire to the back of your TV. They typically offer numerous options, including groups of channels tailored to specific demographics. There are different levels of content available for different budgets, and premium services for those who want them.
Similarly, rather than just a "plain" Internet connection, the price of your monthly subscription to an ISP could include bundled access to third-party branded content. Revenues for the content services would come from quarterly fees paid by the ISPs themselves, rather than from individual end-users.
In this model, ISPs would act as aggregators of subscription services, the way cable operators offer packages of channels. Additionally, online services that offer a greater value proposition to the consumer — such as SegaNet, Napster or Microsoft's .NET subscription-based applications — could be provided as "premium" services, for additional cost, with the ISP still acting as middleman.
Not only is such a future possible, but more and more it seems downright likely. AOL, the nation's largest Internet provider, has always had the advantage of maintaining its own proprietary content. Now, after AOL's merger with Time-Warner, the company is in an unprecedented position to become the first truly full-service Internet access provider, offering both network access and world-class branded content.
Faced with such a juggernaut, a competing ISP would likely be forced to counter with content offerings of its own. To a content service struggling to succeed with its own subscription-based business model, partnership with such an ISP could prove to be a marriage made in heaven.
But what remains unknown is whether the Internet access industry would actually be able to successfully complete such a transition. It could be that the needs and goals of today's ISPs and content providers are simply too diverse and fragmented to provide serious competition for an AOL Time Warner.
If this proves to be the case, or if the industry fails to move quickly enough, then it could spell a dark and uncertain future for those companies that are today gambling on the success of subscription-based online services.
Pay-to-play seems to be the future. The question is: How many players will be left on the field?
