PALABRICA, Flora Anne R. 4 October 2014

2012 - 24581 Econ 198: Economics of

Strategy

The American Online (AOL) – Time Warner Merger

In 2000, AOL, the top internet provider in the United States merged with Time Warner, the

world’s largest media conglomerate. The deal was valued at $350 billion and is, until now, the largest

merger in American business history. The merger resulted in a combined company, called AOL Time

Warner, which aimed to create the first internet vertically-integrated content provider wherein Time

Warner’s media products such as their music, news, and films, would be distributed to millions of

consumers through AOL’s internet distribution network. With both companies’ dominating positions in

music, publishing, news, and entertainment, the AOL Time Warner was supposed to boast unrivaled

assets far ahead of its other media and online counterparts. When the deal was announced, top

managers from both companies had no previous information and were unhappy with the merger. This

lack of synergy compounded by the burst of the dot com bubble, as well as the discovery of the

falsification of AOL’s financial statements, paved the way towards the eventual separation of the

companies in 2009 and the devaluation of the companies’ stocks to about one-seventh of what they

were worth on the day of the merger.

With the advent of the Internet as a major tool in business transactions, many businesses found

themselves worried that this was going to render obsolete all established rules about strategy. Michael

Porter’s article, Strategy and the Internet, states that instead of rendering the rules obsolete, the

internet actually made them all the more vital. The increased competition through widespread

information dissemination leads to weakened industry profitability and strategy is the only way

companies will be able to adapt to the changing business environment. Faced by the dawning of the

new technological age, Time Warner scrambled to find a way to get customers to pay for its content

online and was concerned that the digital future had no place for its traditional paid-subscription model.

Its merger with AOL was meant to bring the company forward towards the technological age but instead

served as an example of companies rushing into misguided partnerships because of the dot com boom.

It was a widely generated belief that partnerships were always win-win but AOL Time Warner proved

this wrong. While the partnership between these two huge companies was supposed to be mutually

beneficial, with AOL driving the digital transformation of Time Warner’s divisions and Time Warner’s

broadband systems providing a platform for AOL’s interactive services, the cultural differences and

miscommunication between the two led to its failure. The merger was also supposed to create strong

network effects between the two companies being that there were 30 million AOL subscribers and 12.7

million Time Warner customers. However, in Michael Porter’s article, he states that, these network

effects often reaches a point of diminishing returns once a critical mass of customers has been reached.

These effects were also affected by a self-limiting mechanism which proposed that as audience and

penetration grows, the company becomes less effective in meeting the needs of the remaining market

customers. This provided an opening for the company’s competitors at the time like Vivendi Universal

and Newscorp. In order to fully utilize the advantages of the internet, the company should have

integrated internet initiatives into the company’s overall strategy and operations and focus on value

creation that its competitors won’t be able to replicate. The use of the internet should serve to enhance

a company’s abilities to create new and unique products and true economic value.