AUGUST/SEPTEMBER 1998

AOL's Balancing Act:

The Need for Nearness vs. 'Virtual Space'

by Jack Lyne

When AOL hit cyberspace hell in 1996, it's problems were rooted in old-fashioned physical space. But the online king has come back, centralizing brainpower and technology to fuel rapid global expansion.

Cyberspace may be where you make your fortune -- but not without top-flight facilities support.

That's one of the real estate lessons America OnLine learned from its explosive growth. From 1993's 300 employees in only two U.S. facilities, AOL has become a formidable global force valued at US$26 billion.

“We had about 900 people when I started here almost three and a half years ago. Now we have 9,500,” says Mark Stavish, AOL vice president of human resources.

But that abrupt expansion has left AOL with a real estate tiger by the tail, one that bit where it hurts in late 1996.
Offering flat-rate unlimited access expanded AOL's subscriber base so rapidly that it overwhelmed capacity. Customers began repeatedly receiving the dreaded “503 error message” -- “The server is too busy to accept your request. Try again later.”

Demand Outstrips Facilities' Supply

Best known for its clout in cyberspace, AOL was staggered by problems grounded in old-fashioned physical space. Online demand had outrun what real estate could supply, shaking AOL to its cyberspace core.

“Back in the latter part of 1996 and early 1997, when we really were under siege in terms of productivity and service quality, we were in three buildings in Vienna, Va.,” says Stavish, who also oversees AOL's facilities, reflecting the connection between real estate and employee productivity. “Originally, we were in one owned building, and we'd leased two others nearby to cope with rapid employee growth.

“A lot of the problems had to do with building out our network. But as customer usage grew, we had to have computer capacity. And that starts with having a facility to put the capacity in.”
At the time, AOL simply didn't have a facility big enough to effectively house its network.

The fallout wasn't pretty: class-action suits, refunds and a glut of bad press. “People depending on AOL for email services might think twice,” said John Aronsohn, an analyst at Boston-based Yankee Group.

Relocation Fuels Comeback

Today, though, AOL is on a business roll. Kate Delhagen, a senior analyst at Cambridge, Mass.-based Forrester Research, called AOL's comeback 1997's “Cinderella” business story. “They were buckling badly, but they bounced back very successfully.”
Much of that comeback is due to the key competitive advantages provided by AOL's new 90-acre (36-hectare) headquarters campus in Dulles, Va., where Stavish sits on a sunny summer afternoon.

With information technology's ascendance, most companies are grappling with space management issues. In particular, they're struggling with balancing two distinctly different kinds of space: space that supports operations that must be centralized, and so-called “virtual space” -- the distant, diffuse, often international facilities that must operationally mesh. Add cyberspace, AOL's bread and butter, and the equation is even more complex. (In fact, some industry analysts are using the term “virtual real estate” for the value-adding assets of firms like AOL and Amazon.)

In Dulles, AOL seems to have found a location that optimally supports its core concentration.
Significantly, the new site has promoted stronger network reliability -- something AOL has dearly needed in refurbishing its reputation. In the last two years, subscribers have doubled to 12 million, easily the world's largest online service. Daily, AOL is accessed 800 million times, a 300 percent increase over 1997. Peak demand of 675,000 simultaneous users is a 200 percent uptake from 1997. (Those figures would be even higher with the five million users of CompuServe, which AOL acquired in late 1997.)

What's more, the expansion-ready Dulles site provides huge flexibility in meeting sharp demand surges that can turn online to offline in the blink of an eye.

“The campus provided a short-term solution, plus long-term room to grow,” Stavish says.

No Thanks, AT&T

Today's AOL is so strong that on June 17th it rejected a takeover offer from mighty AT&T, the world's biggest phone company. An underperformer in cyberspace, AT&T reportedly bid well above AOL's market value. But with its new site's strengths and an internal realignment, AOL had moved to a position of strength.

That strength was evident in a June 17 email to employees from CEO Steve Case and President Robert Pittman. “Independence is critical to our continued success,” Case and Pittman wrote. “It provides us with flexibility in establishing alliances [and] nimbleness in managing our business.”

Flexibility and nimbleness have helped AOL rebound since the dark days of 1996-97. It's now expanded its global presence into Europe, the Asia-Pacific and the Middle East. In fact, it's Europe's No. 1 online service.

The Fast-Track Dulles Deal

None of that ambitious diffusion, though, would've been possible without the Dulles headquarters, located in northern Virginia's Loudoun County. Without it, AOL might still be online in Dante's Inferno.

“People always say, 'They must be giving you terrific incentives.' But it's not really that at all,” Stavish says. “In our business, as quick as we've grown and as quick as we need to move, time really is money.

“What the Loudoun County economic development people have given us is terrific service. They've expedited things, getting inspectors quickly onto our site and removing red tape.”

AOL decided to move its headquarters to Dulles in August of 1996, when capacity problems were a distant rumble. A few months later, relocation was the stuff of survival. “Moving into this campus was absolutely mission-critical,” Stavish says.

It's the Speed, Stupid

That fact wasn't lost on Loudoun County officials, who'd long courted AOL. They expedited approval of the headquarters site plan, slashing it to 30 days, a third of the standard time. More time was saved by simultaneously reviewing and approving building plans and issuing building and occupancy permits on a floor-by-floor basis.

With that whirlwind pace, AOL moved into its new headquarters, floor by floor, only five months after submitting its renovation plan.

That turbo-charged clip has continued. AOL now occupies well over 500,000 sq. ft. (46,450 sq. m.) of space at the new headquarters campus, including a renovated office building, a renovated and expanded Creative Center, and a new data processing center, each roughly 180,000 sq. ft. (16,700 sq. m.). A second, 230,000-sq.-ft. (21,400-sq.-m.) Creative Center is under construction.

“With our data center, it was literally only 12 months from the start to when began putting the computer boxes in,” Stavish explains.

“With a facility as intricate as that data center, that's as hyper-track as is humanly possible, which we couldn't have done without county support. That's been a big advantage in gaining capacity to meet subscribers' needs.” (In fact, local officials even renamed the headquarters road “AOL Way.”)

The White Elephant Dances

Ironically, the cyberspace king found its new home in a space and air industry player's stalled expansion. Years earlier, British Aerospace (BA) had vacated the 250,000-sq.-ft. (23,200-sq.-m.) facility, now considered a white elephant.

For AOL, though, the elephant looked like opportunity. The site was immediately available, along with a yawning expanse of adjacent land. BA's old facility would up AOL's space by almost 40 percent, providing critical capacity room. What's more, it would facilitate the right mesh of the knowledge workers that are the lifeblood of knowledge-based firms like AOL.

Without that one-time white elephant, AOL was facing huge real estate problems, Stavish says.

“Two or three years ago, we looked at our growth,” he explains. “We realized that if we didn't find or build a campus setting, we would end up with our people in eight to 10 different locations, because no large facilities had been built in northern Virginia in five years.”

That would've been an operational nightmare, given the complexity of AOL's operations.

“A big part of our company is AOL Interactive Services, a large programming group that functions much like a TV network,” Stavish says. “Then we have a big computer operations group with some 130,000 sq. ft. (12,100 sq. m.) of raised-floor space, and a big software development organization that does our systems engineering. Plus, we have a big service organization that manages call centers.

“All those pieces really have to fit together hand in glove. Distance would be very difficult to manage with those kinds of inter-relationships. With this big, concentrated campus, we get the synergies of having our knowledge workers at one basic location.”

Call Centers Scatter

The larger part of AOL's operation, however, lies far from its campus headquarters.

Says Stavish, “Sixty percent of our work force of 9,500 people is in our call centers. In most cases, that argues to geographically break up the centers, so you tap multiple markets with maximum time zone coverage.”

AOL has located its U.S. call centers in a widely dispersed group of what some analysts call “second-tier cities” -- Albuquerque, N.M.; Jacksonville, Fla; Ogden, Utah; Oklahoma City; and Tucson, Ariz.

“We try to site our call centers in markets that can support our labor needs, maximizing the labor market,” Stavish says. “For example, all our U.S. call centers are in areas with a lot of colleges and universities, and many have nearby military bases.

“Those pools flush out labor needs. A major portion of our calls are technically related, and a lot of work is in the evenings and on weekends. So it's the perfect job for college students, who've been a key source of talent.”

Partners Going Global

AOL might well stand for “Alliances OnLine.” It's elevated alliance-making to a cross between art and mass production.
That army of alliances has been a particular boon in AOL's rapid expansion in the global market, where its subscriber base is expanding most rapidly.

Joint venture partner Bertelsmann AG, a $13 billion-a-year media company that's the world's third-largest, has been a key in AOL's nimble European expansion. With facilities in 40-plus countries, Bertelsmann is a long-time power in print and electronic media (recently acquiring Random House). Of late, European multi-media has become part of its orbit.

That powerful partner has enabled AOL, in less than three years, to establish European offices in Paris, London, Baar, Switzerland, and Hamburg, Ger-many, plus call centers in Dublin and Saarbrucken, Germany. Bertelsmann's real estate savvy added speed and cost-effectiveness to AOL's European entry, Stavish says.

“All facilities are owned by the AOL Bertelsmann Online 50/50 joint venture,” Stavish explains. “Because Bertelsmann had such a terrific presence in Europe and a huge amount of European market knowledge, we were able to use their corporate infrastructure to outsource work like site selection and hiring.

“When you go international, you find very different laws, customs, practices and cultures. When you have a successful partner like Bertelsmann, you want to use their know-how, rather than trying to figure it out on your own.”

With that fast-track expansion assistance, AOL Bertelsmann Europe has rapidly penetrated the market, landing more than 2 million subscribers in 30-plus countries. “We have exceeded our expectations and can claim to be the first interactive service to become a pan-European mass medium,” says Heinz Wermelinger, AOL Bertelsmann Europe president and CEO.

As in most of AOL's key alliances, Bertelsmann also supplies content, online's ultimate make-or-break factor. In March, for example, Bertelsmann's RTL channel began distributing its evening news online in Germany, its first step in creating an all-news AOL channel.

AOL has followed a similar model in setting up operations in Japan, where it's allied with Nikkei, a leading publishing concern, and Mitsui, one of the world's largest trading firms.

Profits Back Business Model

For all its recent success, AOL is at a critical juncture in its business evolution.

Right now, the bottom line looks good. Third-quarter fiscal revenues of $575.6 million were up 50 percent from a year ago, while advertising and commerce revenues of $117.9 million mark a 74 percent increase.

Those figures bolster the business model to which AOL has doggedly adhered. Having reached a critical mass of customers, AOL's revenue from sales by online merchants is starting to subsidize the rising equipment costs necessary to serve customers.

“We've always felt that a balanced revenue model is the key to our business,” Stavish says. “For example, about 10 percent of the cost of producing a newspaper is paid for by subscriptions; the other 90 percent is in advertising. We see that as where the value is going to be migrating.”

But AOL is certain to face further fierce competition -- and, likely, further criticism.

Says Mark Mooradian, an analyst at New York-based Jupiter Communica-tions, “AOL is doing a lot of the right things now. Still, it faces big challenges that could make its past problems look small.” Past problems also still fuel the ire of a lot of hard-core cyber-citizens.

Going It Alone

AOL's biggest challenge, though, lies in media moguls like AT&T, CNN, Disney/ABC, Fox, Microsoft, Sony and Warner Brothers, who're lusting for a slice of the cyberspace pie. AOL President Case seems undaunted. If deep-pocketed cable TV, phone, and satellite firms develop faster Internet access, they'll still carry AOL if it delivers what consumers want, he maintains.

So AOL goes it alone, banking on the alliances and acquisitions that are extending its global empire in both geographic and virtual space.

On one hand, AOL in early May paid $25 million in cash for NetChannel, a direct competitor with Microsoft's WebTV.

“TV is largely viewed by groups, while a PC has an audience of one,” Stavish says. “So even as extend the brand, we'll probably build in a unique functionality for that platform.”

On the other hand, AOL three weeks later entered the Middle East, paying $287 million in cash to acquire Tel Aviv-based Mirabilis, whose ICQ (“I seek you”) technology creates virtual communities more sophisticated than AOL's “Buddy Lines.” In addition, AOL is eyeing new markets, particularly South America.

Time will tell whether AOL's strategy keeps the big boys at bay. In cyberspace, “rules” are still being written -- and promptly rewritten.

One thing, though, seems certain in AOL's geographic and virtual expansion. After the debacle of 1996-97, its internal real estate house will surely be in shipshape order.
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Features

AOL’s Balancing Act: The Need for Nearness vs. ‘Virtual Space’

AUGUST/SEPTEMBER 1998 AOL’s Balancing Act: The Need for Nearness vs. ‘Virtual Space’ by Jack Lyne When AOL hit cyberspace hell in 1996, it’s problems were rooted in old-fashioned physical space. But the online king has come back, centralizing brainpower and technology to fuel rapid global expansion. Cyberspace may be where you make your fortune — […]

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