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Is Google Investing In An Obsolete Business?

I startled myself the other day when I realized I didn't know whether my laptop computer has a modem. I had to think about it a couple of minutes. It's been that long since I've used a dial-up connection. Not long ago, having a laptop computer without a modem was like having one without a display or keyboard--completely useless. But these days, everywhere I go, I can count on a high-speed Internet connection, and in many places I can get a Wi-Fi connection. That's been true for quite some time. That's half of America Online's problems right there. AOL built its business on dial-up access, and dial-up is rapidly becoming obsolete.

But dial-up is only part of the value that AOL offers its subscribers. It also offers training wheels for the Internet. If you're a civilian who's heard about this "Internet thing" from a nerdy friend or relative, you can get online fast, cheap and easy through AOL.

Neither of those things are as valuable as they once were. Consumers are stampeding away from dial-up access, looking for high-speed and wireless connections instead. And, by now, pretty much everybody in the developed world who's going to get on the Internet has done so. Moreover, consumers realized that AOL offers a commodity service at boutique prices. You can find services just as good as AOL, or even better, elsewhere.

AOL's subscriber base is fleeing fast: It has only about 20 million subscribers, down from 36 million in December, 2002. Pretty soon, it'll be down to the level it was in fiscal 1999, before it bought Time-Warner, of 17.6 million members. (Source of those numbers: AOL's own financial reports, for the third quarter of 2005, annual 2002, and 1999 They're PDF files.)

In the face of that, AOL is scrambling to convert itself from the world's largest Internet service provider to providing a portal, competing with Microsoft and Yahoo. But there's lots of competition in that market, and no assurances that AOL will succeed.

So why on Earth would Google invest $1 billion to take a 5% share in a 20th Century company?

Actually, Google had lots of reasons to want to do the deal. It gets a potential advertising audience of 20 million, an opportunity to stick it to Microsoft, preservation of a substantial, existing ad revenue stream, and an investment in a sizeable, family-friendly island in an ocean of Internet porn.

Earlier, I said AOL only has 20 million subscribers, but there's nothing "only" about 20 million people. That's more people than live in any individual state of the U.S. except for Texas and California. Even fallen on hard times, AOL still commands a gargantuan advertising audience, and, while Google's avocation is to provide search and to organize the world's information, its business is the ad business. Its revenue is overwhelmingly advertising-based.

The deal is a stick in the eye against Microsoft, which was also in negotiations to invest in AOL. Google likes sticking it to Microsoft.

The deal cements a relationship with a strategic business partner. According to a story from the Associated Press last week: "AOL is Google's biggest customer, accounting for about $420 million, or about 10 percent, of Google's revenue during the first nine months of this year, according to regulatory filings. Most of the $420 million came from the ads Google distributes on AOL's Web site. The two companies first began working together in 2002 when Google wrestled away AOL from another online advertising network currently owned by Yahoo Inc."

Had Microsoft scooped up the Google investment, Microsoft would certainly have cancelled the Google relationship--and all those hundreds of millions of ad revenue dollars flowing into Google's coffers--faster than Microsoft CEO Steve Ballmer can pick up a chair and throw it across the room.

Likewise, unlike the Internet at large, AOL is family-friendly. Or, at least, it tries to be. If you don't want your kids growing up knowing more about porn than they know about long division, AOL's family-friend controls are very attractive. USA Today discusses those, and other reasons why an AOL customer might think twice about jumping ship.

But the deal has its risks for Google. As my colleague Tom Claburn points out, it threatens the company's reputation. Google has built its business on being completely objective in search results, segregating sponsored links from search links. The AOL deal calls for Google to give prominent placement to AOL content. Users may lose trust in Google. That could be a silver lining for Microsoft.

Speaking of Microsoft: The terms of the deal hint at an intriguing might-have-been. Part of the deal calls for AOL and Google to work towards making their separate instant messenger services interoperable. Had Microsoft made the deal instead, we might well have seen AOL IM and Microsoft Messenger become interoperable, which would have been terrific for millions of users of those services.

What do you think? Will the AOL-Google deal be good for those customers? What will it mean to users?

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