AOL Goes Far East[(]

On an uncharacteristically warm day in Tokyo in December 1999, John Barber, a managing director of AOL Japan, absentmindedly glanced out the widow focusing on the sunlight gleaming off a nearby skyscraper. This was his third marketing meeting today and he had the same sinking feeling about this one that he had had about the other two and the hundreds before them. Like 90% of the other material that came from the marketing department, this one would flop. The local marketing staff was just not up to speed and a great deal of resources was being wasted on this exercise in futility.

John had been in his current position since AOL Japan was established in 1997 and he was starting to get impatient. The company was not too far off on its subscription targets and the company was inching towards profitability, however, John was not satisfied. John felt that the company was not living up to the potential that one would expect of a JV between the largest internet provider in the world and one of Japan’s largest companies.

Some critics complained that AOL entered the Japanese market too late. When AOL Japan started service in April of 1997, Niftyseve and BigGlobe already had a large stable of dedicated users. However John dismissed this as being a major factor in the current difficulties. After all, when AOL Inc. registered it’s first online subscriber, CompuServe had been in business for more than 18 years. Whatever the case, John was determined to find a way to catapult the company into the leading ISP position in Japan.

The Parent: America Online Inc.

America Online Inc. had a modest beginning. Founded in 1985 as Quantum computers, the company began by offering online services for Commodore Business Machines. By the time the World Wide Web came along almost 12 years later, AOL was well positioned to take advantage of it. The company grew at a steady pace for most of its history but within the past two years, it’s revenue shot skyward as if gravity had suddenly dissolved. The company grew internally as well as acquiring many promising businesses. Exhibit 1 shows some of the major units of AOL Inc. in 1999. The company also acquired MapQuest in 2000, an online provider of travel information and road directions.

In January 2001, the parent company finalized the acquisition of a large portion of the assets of Time Warner, on what was touted to be one of the most significant mergers of the decade. However, almost two years later, the merged company is facing several problems and declining earnings.

Business Unit / Type of Business / Members / Access / Acquired or Developed
AOL / Internet Online Service / 19,000,000 / Subscription / Developed
CompuServe / Internet Online Service / 2,000,000 / Subscription / Acquired
Netscape Netcenter / Internet Portal / 17,000,000 / Free / Acquired
AOL Instant Messenger / Web-based communication
Service / 25,000,000 / Free / Developed
ICQ / Web-based communication
Service / 50,000,000 / Free / Acquired
Digital City / local online content provider / 4,300,000 core / Free / Partnership
AOL MovieFone / Movie Guide and Ticketing
Service / 150,000,000 hits in 1998 / Free / Acquired
Spinner Networks / Internet Music provider / 2,000,000 core / Free / Acquired

Finances

In 1999, the last year before AOL began its merger with Time Warner, 69% of total revenue came from the 20 million paying subscribers to the AOL and CompuServe services. Due to the dangers of relying heavily upon subscription fees in such a competitive market, the company had clearly stated that it intended to move away from subscriptions and rely more heavily upon advertising. Therefore, it was not a surprise that the fastest growing segment of revenue came from the “advertising, commerce and other” category. This category included online advertising fees, sales of merchandise as well as other revenues. In 1999, the “Advertising, commerce and other” segment accounted for 21% of total revenue as compared to 14% of total revenue in 1997. The Enterprise Solutions generated revenue from licensing fees, technical support, consulting and training services. This segment continued to decrease in importance. In 1997, this segment provided 16.9% of total revenue and this figure declined to 10% in 1999. The financial information shows that 1999 was AOL’s best year ever. Exhibit 2 shows operating income and net income from 1997 to date as well as the cash held in 1999 (before the merger). Since then, the company has merged with Time Warner and after repeatedly revising its financial outlook in the lower direction, in 2002 reported that its earnings would not be as high as expected.

International Expansion

AOL’s 1999 Annual Report stated “The Company’s international strategy is to provide consumers with local services in key international markets featuring local language, content, marketing and community”. AOL started its international expansion in Germany almost five years ago. Since that time, the company has expanded into Australia, Brazil, Canada, France, Japan, UK, Sweden, and Hong Kong. Jack Davies, Vice President of International Operations, led the expansion.

All the Joint Ventures have been undertaken with a partner in the local market. In Germany, AOL chose Bertelsmann AG (Multimedia Company) and in Latin America, they joined with Cisneros (media, entertainment and Telecommunications Company). However, in Japan, AOL chose Mitsui & CO., one of Japan’s largest and oldest general trading companies.

Mitsui & CO.

Mitsui Company was founded in 1941. The company was originally part of the Mitsui Zaibatsu that was broken up after the end of World War II. Mitsui has more than 11,000 employees in 60 countries and in 1998 had capital of US$1.9B. Mitsui is known as one of the most traditional trading companies in Japan. Exhibit 3 shows a list of products they are most familiar with. Like most “General” trading companies in Japan, Mitsui’s real strength is in facilitating large transactions for commodity type products. Their core competency if any, is in import, export and financing.

Mitsui certainly has all the connections and money that are required to succeed in the Japanese “general products” market but they had very little experience with anything concerning the internet, especially in 1995 when the discussions with AOL began.

Overview: Internet in Japan

Japan, although catching up, is still lagging behind the US in terms of connectivity. There are an estimated 46 million households in Japan, of which 33% (15 million) have a PC. In addition, only 18% of households (8 million) are connected online. Nevertheless, the number of online households is expected to grow significantly, fueled by a number of factors. First, the number of PC shipments domestically reached 10 million by 2000 (a 12% increase from 1999). This would mark the third-straight year of double-digit PC growth. In addition, there are clear trends toward lower connection costs for end users. The high cost of connecting to the Internet has been recognized as a primary barrier restricting the percent of Japanese going online. Lower access charges are expected to reduce this barrier and get more consumers connected.

There are five primary ISPs in Japan fighting for market share. The largest is Niftyserve (19%), followed by Biglobe (7%), DTI (7%), AOL Japan (3%), and Compuserve (1%). A plethora of small-to-midsize ISP companies comprise the remaining 63% market share.

A-1

AOL Japan

AOL Japan was established in February 1996 and rolled out its services on April 15, 1997 amid much excitement, as people familiar with the “AOL success story” in the US held high expectations for AOL’s entry into the second largest economy. Wired Magazine hailed AOL’s entry into Japan, stating “AOL's Japanese service is certain to cause waves in a nation unaccustomed to competitive pricing for Net access." In an interview at this time, Jack Davies, then AOL’s president of new market development stated, “Our focus is going to be in the consumer market. We think that is going to be the major growth area in the Japanese market over the next five years." Indeed, AOL had hopes for its Japan operations to become its second-largest subscriber base.

Setting up the Business

AOL decided on a joint venture collaboration with local partners as its entry into the Japan market. AOL Japan was established as a joint venture between AOL (50%), Mitsui & Co. (40%) and Nihon Keizai Shinbun (“Nikkei”) (10%). According to AOL management, the collaboration with two well-established Japanese companies was an essential component to their strategy and “wouldn’t think about going into a major international market without partners." AOL’s relationship with Mitsui dated back to the early 1990’s, at which time Mitsui USA began researching Internet service providers and was attracted by the potential of AOL. Mitsui USA research on AOL led eventually to meetings with AOL in 1994 to explore entering into the Japanese online service market. In late 1995, Mitsui and AOL agreed on the structure of the JV. Mitsui believed it was crucial to have fresh, Japanese content provided to consumers, and therefore introduced Nikkei to AOL, who later agreed on Nikkei becoming a partner in the business. At the onset, Nikkei and Mitsui provided the necessary capital and invested a combined $50 million to get the Japanese business up and operational. For its part, AOL provided value to the collaboration in the form of its technology, know-how, and brand name.

With the aim to increase the number of subscribers to its service, AOL displayed an interest to enter strategic alliances with other companies. NTT DoCoMo bought a 42% equity stake in AOL Japan at the end of the year 2000 for around $100 million. The company hoped that this alliance with Japan’s leading mobile phone carrier would give it access to NTT DoCoMo’s huge and ever-growing customer base. Going one step further, AOL Japan was renamed DoCoMo AOL after just over three months of the alliance. Thus, as at the end of 2001, DoCoMo owned 42.3% in AOL Japan, AOL owned 40.3% while Mitsui held 13.2% and Nihon Keizai Shimbun owned 4.2% stake.

Management Structure

The Board of Directors of AOL Japan is comprised on seven people, including three non-Japanese people from the US AOL operations. Only one of these non-Japanese Board members, Mr. John Barber, is residing in Japan and participating in day-to-day operations. The current president of AOL Japan is Kozuo Hiramatsu, who joined the company in July 1999 after serving 8 years as President of IDG Corporation. The following five groups report to the president:

· Member Services

· General Affairs

· Marketing

· Content

· Technology

Recruiting responsibilities have rested almost entirely with Mitsui. This includes hiring of top management, although AOL has the ultimate power to approve or reject the nomination. Initially, AOL Japan was staffed almost primarily with Mitsui employees. In 1997, the company had 120 employees. This number has grown to 230 in 1999.

Management Difficulties

Almost four years after launching its services in Japan, AOL Japan has clearly not succeeded in meeting initial expectations. The subscriber base, although growing steadily each year, only totals approximately 400,000, a number that is dwarfed by Niftyserve’s subscriber base of over 2.5 million. In the two four years since its inception, AOL Japan has experienced a number of difficulties with management. The first two presidents, selected by Mitsui, were determined to be unable to take AOL Japan to the next level. After two such failures, AOL decided that they would be responsible for searching and hiring the next president. After a long search, the company hired Mr. Hiramatsu, who tried to convince insiders and outsiders alike that he has the “right stuff”. Following its alliance with NTT DoCoMo, the company appointed NTT’s Minoru Nakamura as the President of the company. By doing so, the company hopes that it will be able to fully tap the benefits of its latest partnership with NTT DoCoMo.

According to John Barber, the difficulty lies in finding top local people who have the necessary managing experience and who have the essential marketing savvy to compete in the world of “Internet time”. Such a person has become somewhat of a “Holy Grail”, according to Mr. Barber. The problem is that in Japan, most managers do not reach their position until after the age of 40. This would not be a problem, except that most people over 40 lack the leadership and vision necessary to run an Internet ISP.

AOL certainly has not helped this situation by placing only one non-Japanese AOL person on the ground in Japan. Many of the challenges facing the Japanese corporation are similar to those faced by the US business. One has to believe that AOL Japan would benefit by more “experienced” AOL non-Japanese participating in the daily operations and management of AOL Japan.

Marketing Organization at AOL Japan

Since its entry into the Japanese market, the staffing for the marketing organization in Japan was the responsibility of the Mitsui team. Mitsui hired all local employees in the marketing department. The marketing organization is one of the five groups that report directly to the President of AOL Japan. The marketing organization is also responsible for the MIS system used to drive their marketing decisions.

The marketing strategy initially employed was based on the strategy that was successful for AOL in the United States. The marketing group in Japan, however, does try their own strategies in addition to those recommended from the US.

The initial and primary strategy consisted of three main approaches to capturing market share in Japan. The first is referred to as bundling. The second is the use of magazine inserts. The third approach is the use of direct mail solicitations.