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									                             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.





 This case was prepared by Bill Baker, Steven Engen, and Trevor Nelson of Temple University
Japan and revised by Sonia Ketkar of Temple University under the supervision of Professor
Masaaki Kotabe for class discussion rather than to illustrate either effective or ineffective
management of a situation described (2003).
                                                                                         A-1
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              Web-based           25,000,000       Free         Developed

      Messenger             communication

                                Service

         ICQ                  Web-based           50,000,000       Free           Acquired

                            communication

                                Service

      Digital City        local online content     4,300,000       Free        Partnership

                               provider              core

   AOL MovieFone           Movie Guide and        150,000,000      Free           Acquired



                                                                                        A-2
                               Ticketing           hits in 1998

                                Service

  Spinner Networks      Internet Music provider    2,000,000      Free     Acquired

                                                      core
 Exhibit 1 (Source: America Online Inc. 1999 Annual Report)




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.




                                                                                 A-3
                               Operating Income                                                   Net Income

                             600                                                            600
                             550                                                            550
                             500                                                            500
                             450                                                            450
                             400                                                            400




                                                                  U S $ (m i l l i o ns )
      US $ ( m ill io n s)




                             350                                                            350
                             300                                                            300
                             250                                                            250
                             200                                                            200
                             150                                                            150
                             100                                                            100
                              50                                                             50
                               0                                                              0
                                   1997   1998    1999                                            1997   1998   1999

                                                 Cash 1999: US$
                                                 877,000,000
    Exhibit 2 (Source: America Online Inc. 1999 Annual Report)




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.




                                                                                                                       A-4
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.




                           Sample of Mitsui Product Portfolio

                  Iron and Steel                         Energy
                  Non-Ferrous Metals                     Foods
                  Property Development                   Textiles
                  Machinery                              General Merchandise
                  Electronics                            Chemicals


                  Exhibit 3 (Source: Mitsui & Co. Web Site:
                  http://www.mitsui.co.jp/tkabz/english/iandpp/index.htm)


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


                                                                                       A-5
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.




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


                                                                                        A-6
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


                                                                                   A-7
 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




                                                                                       A-8
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.




                                                                                   A-9
Bundling. Bundling is the process by which a PC maker includes AOL software pre-

installed on each PC. In this case, when the customer boots the machine, the AOL icon is

visible on the desktop. The customer also receives AOL documentation in the box. AOL

usually has an offer of X free hours at no-risk to the customer for trial usage. If the

customer decides that he wants to join AOL he can easily do so just by clicking the AOL

icon on the desktop.

          Another method of bundling is to have an agreement with the OS manufacturer

– in this case Microsoft. By bundling with Microsoft, AOL can ensure that it has a copy of

its software on each PC – whether or not AOL has an agreement with the PC

manufacturer. The only issue with the installation in the OS is that it is buried within a

folder in the operating system files so it is not easily accessible to the casual user.

        Bundling in the US has been very successful for America On Line. This promotion

was responsible for over 30 percent of the users in the US (somewhere around 6 million

customers). The US manufacturers such as Compaq, Dell, Gateway as well as many

smaller manufacturers initially were not interested in the ISP business so the relationship

with AOL was symbiotic with the PC manufacturer because internet access was an

application that drove the customer to upgrade their PC’s. The consumer received some

benefit from having the ISP sign-up form easily accessible from the desktop. In addition,

the PC manufacturers received some commission based on the number of customers that

signed up for the service.

          AOL Japan has also used bundling as the primary mechanism of signing-up new

users. They have been able to sign contracts with 12-15 PC manufacturers in Japan

(including US manufacturers active in the Japanese market). The PC manufacturers in

Japan, contrary to the US, are much more active in the ISP business. Fujitsu, which is one

of the top 3 PC makers in Japan, also owns the largest ISP in Japan, Nifty-Serve. NEC,

the largest PC manufacturer in Japan, also owns an ISP. The ISP is BigGlobe and it is the

second largest ISP in Japan after Nifty-Serve. Sony also owns Soo-net, an ISP in Japan.

The relationship between the ISPs and the PC manufacturers in Japan is more


                                                                                          A-10
complicated than in the US because of the tendencies of the PC manufacturers to be ISP

providers as well.

        After its partnership with DoCoMo, AOL Japan also planned to promote the use of

its service via the Internet accessible i-mode cellular phone system.




Magazine Inserts. Another successful marketing technique for AOL in America is the use

of magazine inserts to deliver the AOL software via CD inserted into the magazine. One

way of doing this was to shrink-wrap each magazine with a CD placed within the shrink-

wrap. Another, but more expensive, technique is to actually have the CD attached to a

page within the magazine itself. The magazine insert techniques were responsible for

initial enrollment of about 30% (around 6M users) of the AOL US customers.

         AOL Japan’s results with magazine inserts have been disappointing. One of the

issues is that the magazine companies, in general, have been tough to do business with.

In addition, the shrink-wrapping of magazines is not as prevalent in Japan as in the US.

AOL Japan has been able to do some magazine inserts but they have also gone a step

further in a couple of marketing promotions. AOL Japan has created its own magazine

which is issued when there is a major software upgrade. It is sold on the newsstands like

a normal magazine. Overall, however, the customer hit-rate per yen for magazine insert

promotions has been lower than the results obtained via bundling.




                                                                                 A-11
Direct Mail. Direct mail has also been responsible for initial sign-up of about 30% of the

US AOL customers.       However in Japan, this approach has not been particularly

successful. According to John Barber, there are two fundamental issues. The first is the

lack of available mailing lists that accurately pinpoint the desired customer base. The

second is the fact that the mailing costs in Japan are much more expensive than the US.

The combination of these two points causes the number of new subscribers/yen to be

much lower for direct mail marketing in Japan than in the US.



Take-Ones. Another marketing technique for finding new subscribers is called Take-

one’s. This is where the AOL software CD is prepackaged in a small, thin, package and

then put on display in places where potential customers might congregate. One natural

place is computer stores, such as SoftMap, where one can find a stack of AOL Take-one’s

next to the cash register. The customer sees the Take-one and if he is interested in

connecting to the Web then he would “take one” home. According to John Barber, the

Take-ones have been reasonably successful in Japan. The hit-rate for Take-ones is much

higher than direct mail or magazine inserts because if someone takes one home, they

have a much higher level of interest in signing up to an ISP than the reader of a magazine

or someone who receives an unsolicited mail offer.       In addition, AOL Japan usually

combines the Take-one’s with another promotion – such as Pokemon or a movie, like

Tarzan – to increase the hit-rate of the Take-ones. The cross promotion with Pokemon

had one unexpected drawback – the parents of the children swamped the AOL User

Support Line with orders for Pokemon cards!



Moving Forward



AOL Japan’s share of the Japan market is now about 3%. It has grown over the past three

years from 0 to the current 3%, while other ISP’s have been relatively flat. In addition,

AOL Japan has been capturing between 10-15% of the new subscribers to the Internet in


                                                                                  A-12
Japan over the past two years. While other ISPs might be satisfied with this progress,

AOL has about a 50% market share in the US and will not be happy with such a small

share of the market in Japan.



According to John Barber, AOL Japan looks at three different ways to grow their market

share:

   Increase marketing efficiency – if AOL Japan can lower the amount of yen it takes to

    capture a subscriber then they can capture a higher percentage of new users to the

    internet.

   Take advantage of watershed events – as technology changes the nature of the

    Internet or creates new ways to the Internet, there will be opportunities to capture new

    users through support of these technologies. If AOL anticipates these changes better

    than other ISPs then they have the opportunity to capture more market share. One

    example is Internet access via mobile phones. In less then one year, NTT Docomo,

    with its Imode Internet Access service via the displays on portable phones, went from 0

    to 3 million subscribers. This is despite the fact that the services via the portable phone

    are very limited.

   Buy other ISPs – there are many of thousands of ISPs in Japan. Many of them are

    very small and potential take-over candidates.




QUESTIONS TO CONSIDER



1. Was Mitsui the best partner for AOL to enter the Japanese market? If so, why? If not,

    who (or what kind of company) would make a better partner? Why?



2. Do you think the current JV structure should continue into the foreseeable future?




                                                                                       A-13
3. What structural impediments did AOL face in the Japanese market that did not exist in

   the US market? What actions should AOL take to overcome these obstacles?



4. Make specific recommendations as to what you think AOL should do to capture

   additional market share in each of the three areas mentioned: Lower the cost of ¥/new

   subscriber; Capitalize on watershed events; Buy other ISPs.



5. Now that AOL has partnered with NTT DoCoMo, will it be successful in Japan or is it

   too late?




                                                                                A-14

								
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