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AOL's Iffy Broadband Deals

America Online may be close to striking cable broadband carriage deals like the ones it has with Comcast and corporate sibling Time Warner Cable.

But the hefty carriage fees it faces from cable providers add up to iffy prospects for making money off broadband, consumer advocates say.

On Tuesday, AOL Time Warner's Chief Executive Richard Parsons said the company is getting close to striking deals with cable providers in order to expand AOL's high-speed Internet service.

"We're not there yet," Parsons said during a keynote address at the UBS Warburg media conference in New York. "We're close. I believe that by the end of the year, we'll have additional things to say on that front."

Consumer groups lobbying the Federal Communications Commission to change its open access policies regarding cable Internet networks say AOL faces an uphill battle to strike favorable terms on the cable deals.

They point to a ruling the FCC issued last March, which said cable Internet networks are under no obligation to guarantee ISPs access to their networks. Many cable providers do, of course, but they are not required to offer wholesale rates on access, for example.

Unlike telephone companies that use regulated phone lines to deliver high-speed access via DSL, cable companies face no regulatory parity forcing them to allow competing ISPs on their Internet network.

So while AOL has no trouble getting wholesale rates for providing AOL over DSL lines of Baby Bell companies such as Verizon and SBC (an open policy that helped AOL build its dial-up base), the rules are not the same with cable providers.

In addition, when federal regulators approved the mega-merger between Time Warner and AOL in 2001, they imposed open access rules to give other ISPs access to the company's Time Warner Cable network. The idea was to promote competition and more choices in ISPs for consumers.

"It is what it is," Lisa Hook, president of AOL Broadband, said about the policy. "I'm taking the world as it is and looking at the most rational way to create a business" of providing broadband connections. "We're in discussions with almost all of the cable operators" on carriage deals, she said.

"If you look at how the cable industry works, (cable providers) can charge whatever rents they want because they own the wire," said Mark Cooper, director of research with the Consumer Federation of America. (The CFA is part of a lawsuit consumer groups filed against the FCC over its decision to declare cable modems an "information service" which frees them from the same open access rules applied to telecommunications providers.)

Cooper and other analysts note that AOL's carriage deal with number one cable provider Comcast, part of Comcast's merger agreement with AT&T Broadband, came with tough terms because there are no open access rules. For one, Comcast gets to maintain the billing relationship with cable customers that sign on to AOL's broadband service, not to mention the premium AOL is paying for access to Comcast's network.

But Hook maintains that AOL has more marketing savvy to bring to the carriage arrangement than maintaining a billing relationship. "If the only time you speak to a customer is in the bill at the end of month, that's not good marketing."

In addition to the higher carriage fees AOL faces in negotiating with cable providers, it is also pitching "bring your own access" customers to pay an additional $14.95 a month for AOL's services on top of the $40 to $50 month they already pay for broadband access.

"How is AOL going to maintain its edge when it's starting $40 behind the next competitor's price?" said Cooper. "AOL needs to find a way to escape the grasp of the bottleneck facility owners. They should become wild-eyed unlicensed spectrum advocates and join with IBM and Intel in the wireless Internet provider race."

But analysts such as David Willis of META Group point out that the content from the Time Warner side of the house gives AOL more negotiating leverage with cable and telco providers.

"We know there's going to be more consolidation among cable providers," Willis said. "There's really no other growth engine for these guys. They don't have the content and they're seeing migration to digital satellite services. What they've got to sell is broadband. They need economies of scale that justify a big broadband buildout," he said, which would make them more agreeable to letting multiple ISPs on their systems.

He said content from AOL Time Warner's media properties leaves AOL better positioned to strike reasonable carriage rates than its ISP competitors such as Earthlink and United Online that can't offer content or shopping deals similar to AOL's.

"What's going to make up the difference with cable companies that are going up against ILECs and DSL providers is some form of content," Willis added. "Who are the two ISP providers that can provide compelling content that would justify a broadband purchase? That would be AOL and MSN" Microsoft's Internet service, he said.

Right now, Willis gives MSN an edge in the content category because in his view MSN has a better articulated online gaming strategy than AOL.

Microsoft's gaming strategy is helped by the dominance of its operating system on personal computers, where gaming got its start. It also has its XBox game console offering. But AOL Time Warner's content, such as "The Lord of The Rings" movie trilogy, is also an example of the kind of content that gaming companies are happy to license.

Just look at the explosive popularity of Sony's online game Everquest, which charges $10 a month for users to play the fantasy game online, Willis noted. "If you can tap into the irrational spending habits of the addicted online gamer, then you've got a new growth opportunity."