The Wages of Success

In the fiercely competitive internet world, commercial promises can be hard to keep. Last November, when London-based Internet service provider CallNet launched its "free" Internet access service, consumers signed up in droves, delighted to spend unlimited time online without racking up the sky-high telephone bills that often accompany Web surfing in Europe. But the bonanza proved too good to last last week, CallNet said it will withdraw the free service come September, labeling it unprofitable in its current form.

CallNet's experience is not unique. In the past year in the U.K., a series of companies have launched free or unmetered Internet access plans in which the customer pays a simple one-off or flat-rate fee, or nothing at all only to be overwhelmed by massive consumer response. In April the ISP Breathe launched a "free for life" Internet plan, charging customers a one-off $75 fee. Last month it was forced to expel 500 subscribers for overuse after claiming they were clogging the network. LineOne, which launched an unmetered service in March, also withdrew it in July after declaring it "unviable." CallNet itself, which offered users the free Internet access if they signed up to CallNet's telephone service, intends to revert to metered access in the near future, and then offer several restructured flat-rate products.

What's going wrong? "It's the problem of underestimating customer demand and not getting the business plan right," says James Eibisch, an analyst at tech consultancy IDC. "These providers are wearing a very large cost base per customer, but getting very little revenue in return."

Indeed, in the land-grab mentality of the Internet, some access providers are using low pricing structures to accumulate as many users as possible as quickly as possible. Such companies generally do not expect to make money from providing Internet access. Instead, they work on the theory that a critical mass of users will eventually attract advertising and other sources of revenue.

The business reality has turned out to be quite different. "People that are using unmetered services are in many cases early adopters and very heavy users," says Noah Yasskin, director of European research at Jupiter Communications. "Many of these ISPs are subsidizing the costs of these consumers without making up the difference in revenue from advertising and e-commerce."

Despite the U.K. experience, ISPs on the Continent continue to take the leap into the unknown. "We're buying telephone units on a per-minute basis and selling at a flat rate," says Julian Riedlbauer, a director of German provider AddCom AG, which launched its flat-rate offer at the beginning of this month and is already claiming 10,000 new customers. Riedlbauer says it is too early to comment on the plan's potential profitability: "It will depend how our customers behave," he says, "and we don't really know that yet."

Even though unmetered access is experiencing teething troubles, many analysts and companies continue to insist that it will be the wave of the future. Jupiter Communications' Yasskin predicts that in the long term, three-quarters of all U.K. users will be on unmetered access, up from about one-quarter today. Major providers like BT and Freeserve in the U.K., and T-Online in Germany which either own telephone lines or have close ties to companies that do are preparing for that future by offering unmetered packages, including both fully unlimited packages and hybrids which give users unlimited flat-rate access in off-peak periods like evenings, but metered access at peak times.

Freeserve, which has about 2 million registered users for its access products, already claims 140,000 users for the two flat-rate plans it has launched since April. "The pay as you go model will not disappear," says Paul Barker, a Freeserve spokesman, "but we expect most people to migrate over." The company is large enough and has enough clout, says Barker, to make unmetered access a viable part of its operation. Smaller companies, he notes, "haven't got the scale or the leverage to negotiate with telecom providers."

That may be about to change. Following a torrent of protests at high telephone charges, British regulator Oftel prompted BT to make wholesale flat rates available to other network providers, who can then pass lower charges on to ISPs. Similar moves are afoot in the Netherlands and Germany.

But the real revolution will come when regulators and the European Commission finally force Europe's telecom providers to open to their competitors the "local loop" the line between consumers and their local exchange. That could allow some ISPs to install their own connections to customers' homes. Unmetered access providers would then have more control over their costs, enabling them to nail down more accurate business models. And for the growing number of Europeans eager to spend unlimited time online with a reliable ISP, such changes can't come too soon. The clock is ticking.

With reporting by Steve Zwick/Cologne