Flat Rates Are a Recipe For Internet Gridlock

Build a better mousetrap and the world will beat a path to your door. Build a better path and the world may run you over. Especially when that path is the Internet.

Just ask America Online.

Ever since the company began offering on-line access for a flat fee last month, users have swamped the system. Info-traffic jams have wreaked so much havoc that they have spawned at least three lawsuits against America Online, threatened legal action from 20 states, and one mocking television commercial aired by a rival during yesterday's Super Bowl.

Combined with recent on-line pileups elsewhere, the America Online brouhaha is a sure sign that the information highway has become as mainstream as Main Street. It also signals an alarming trend for the on-line industry and its consumers. Internet access has become so cheap that hardly anyone - not even America Online, the world's largest and most successful on-line service - is turning a profit from it.

After crashes, regulation?

The results are sobering for consumers. These market forces are likely to force a huge consolidation in on-line companies, reducing customer choice. Worse, the very pricing that makes the Internet so attractive is clogging up the system and, at times, causing it to crash in areas of heavy use. These crashes have occurred often enough that even federal regulators are thinking of getting involved.

On Thursday, Reed Hundt, the head of the Federal Communications Commission, said "We'd like to find out ... whether or not reliability is in fact an appropriate policy issue with respect to the packet-switched [data] network."

Flat-rate pricing lies at the heart of the problem. With typical fees of $19.95 a month for unlimited access, Internet-service providers, or ISPs, are having a hard time making money. "Many ISPs are operating in the red or on razor-edge margins," says Steve Conway, spokesman for CompuServe Inc. in Columbus, Ohio. The company's own Internet-only service, called SpryNet, is pretty much a break-even proposition, he adds.

The economics get worse when companies offering Internet access also try to provide their own content. CompuServe hit trouble last March when it launched its Wow! service. At $17.95 a month for unlimited Internet access plus extra content of its own, Wow! quickly proved unprofitable, and in November Compuserve pulled the plug.

America Online now faces a similar problem on a bigger scale. Bowing to competitive pressure, the company began offering unlimited access for $19.95 a month in December, instead of charging customers $9.95 a month for their first five hours on-line and extra for each additional hour.

Too-rapid growth

America Online's stated goal for some time has been to build the membership quickly to 10 million users. Company executives expected that traffic to convince corporate advertisers and turn the service into a bonanza.

But the company's rapid-growth strategy backfired. The service added 500,000 members in December alone and reached 8 million members earlier this month, far outdistancing its rivals and surpassing the company's most aggressive forecasts.

The result was on-line gridlock as consumers doubled the amount of time they spent on-line. The system slowed, sometimes crashed, and frustrated customers who could not even dial in to the service because of busy signals.

Users have filed at least three class-action suits against the network, saying it is charging for but not delivering the unlimited access it promised. Last week, prosecutors from 20 states met to discuss whether they should try to get America Online to offer some relief to its customers.

The company itself has announced a $350 million plan to expand its network and will reduce marketing efforts to new users. But it will take till June for the project to be finished.

Rivals gain customers

In the short term, other on-line companies are benefiting from America Online's troubles. After seeing an unexpected surge in membership, rival AT&T WorldNet decided to survey its new users and find out why they had signed up. One-third of them were disgruntled America Online customers.

CompuServe, which has seen a small increase in new members because of America Online's problems, took out an ad during the Super Bowl, poking fun at busy signals and touting its own service.

Should consumers switch? It depends on how much they use America Online's content. If it is simply a conduit to the Internet, other conduits should prove to be faster and more reliable. It also depends on pricing. By prepaying for two years, many members have been able to lock in a price of only $14.95 a month for unlimited access. Despite all the frustration of recent weeks, these users may wait to see if America Online can fix its problems, because they are unlikely to get as good a deal from other companies.