The Future Of Small Internet Service Providers

What is going to become of small Internet Service Providers (ISP) in the near future? Over the past year or so, the competition to satisfy the enormous demand for Internet connectivity has grown fierce. There are presently over 3,000 ISPs in the United States, mostly recent start-ups, all jockeying for the chance to carve a niche for themselves and grow. And some have. ISPs such as UUNet, Netcom, and PSInet have been successful enough to go public. But the majority of ISPs go under shortly after starttup, or generate just enough income to get by, but rarely grow.

Taking Stock

One might suppose that stock performance is a meaningful measure of ISP success. In the past year, the stock values of both UUNet and Netcom have resembled an arrhythmia on an electrocardiogram. From the day of their IPOs up until the Christmas season, both UUNet and Netcom's stock values were going strong. Wall Street seemed to be sensing that there was a good amount of money to be made from the Internet and were quick to invest in companies that ended in either .net or .com. Investors were looking for another Microsoft or Netscape in the ISP business and, as a result, there was a blind-faith feeding frenzy that rocketed stock values (at least those ofUUNet and Netcom) through the roof.

So, for a while at least, ISP's wildly successful stock market values could be attributed to a wide-spread feeling that anything Internet-related was a hot commodity and should be invested in. Outside of the Stock Exchange, this sentiment may help to explain the huge explosion oflocal ISPs (LSP) around the country.

But in fact, recent ISP stock performances are misleading indicators of what is likely to happen to the business as a whole. Since the previous Christmas season, both UUNet and Netcom have been watching their stock values decrease proportionate to their previous increase. PSlnet, another public ISP whose stock earnings were performing consistently low since its IPO, began to show a decrease in stock value similar to those of DUN et and N etcom.

Why the sudden change in ISP stock market performances? One possible explanation is investor education. Since the cyber feeding frenzy that took place in the beginning of last summer, Wall Street has smartened up. Investors are now taking the time to understand the Internet and the differences between its providers. The number of ISPs has dramatically increased (and continues to increase) and as a result, they are no longer seen as a rare and hot item, but as a commodity and one may be just as good as another.

Enter the Telecom Giants: Eat or Be Eaten

Another (and more likely) reason for dramatic ISP stock value decline is the entrance of telecommunication giants AT&T and MCI into the ISP game. On March 14th AT&T opened up its service to its 80 million residential customers and 10 million business customers. The company has been aggressively marketing its new services (all of which fall under the umbrella name: AT&T WorldNet Service) to its huge customer base by offering a one-year free Internet trial, a flat monthly rate of $19.95, and unlimited Internet access. The MCI Dial Access service (which is not yet in effect) would also provide a flat monthly rate of$19.95 to its huge customer base.

It is easy to see why an announcement of this magnitude would scare ISP stock holders into selling whatever they were holding. Wall Street is a fickle and easily intimidated place. Despite the fact that AT&T only recently opened its doors to the Internet and MCI's service is still pending, the buzz that such an announcement created on the Stock Exchange is probably the direct reason for the pyramid stock performances ofUUnet and Netcom.

But, in addition to influencing the stock performances of public ISPs, AT&T and MCI's role as ISPs will (and probably already has) unquestionable affect the livelihood of the over 3,000 local Internet Service Providers presently struggling to carve a niche for themselves. As the telecommunications giants begin to win over their huge customer base with special services and rates that are comparable to (if not better than) many existing ISPs, smaller companies will have great difficulty competing.

Content is King

In addition to the threat of AT&T and MCI, smaller ISPs also have to contend with content providers such as America On-Line (AOL), Compuserve, and Prodigy. Content providers are a particular threat to the ISP market share because they are skillfully tailored towards the new user. In a sense, content providers serve as a kind of Cliff Notes to the Internet. They provide their users with key information and services (such as stock quotes, access to airline ticketing, electronic news papers and magazines, email, news groups, chat rooms, and so on) without overwhelming them with what the Internet has to offer. For many users who have neither the time nor desire to figure out the nuts and bolts of the Internet by way of an ISP, a content provider can be a welcome alternative. As users mature and desire increased services (i.e. Internet or World Wide Web access), content providers have (albeit recently) expanded to meet those needs. Also, content providers have benefited by being first to the line. They have grown big and, as a result, have the spending power to embark on massive advertising campaigns. Open up any computer-related magazine and you will probably find an AOL diskette or (more recently) CD-ROM inviting you to install and subscribe.

In the case of America On-Line, its massive advertising campaign (and strong content) has undoubtedly drawn potential business away from ISPs and increased its standing on the Stock Market. While most ISP stock values have been decreasing since the previous Christmas season, America On-Line's value has been steadily increasing and is still going strong.

Given the above evidence weighing against ISPs (recent poor stock performances, growing numbers of new companies, and the increasing threat imposed by AT&T, MCI, and content providers), it would seem that many of them have a bleak future. While I would argue that this is at least true for a majority of the struggling ISPs trying to make their way, I also feel that many of them will continue to thrive if they focus on community content. In other words, if a number of ISPs develop their Internet sites so they reflect the qualities and characteristics of the region that they are trying to market to, I believe that customers will feel a kind of allegiance towards their provider and, when courted by larger companies, will remain faithful. While giants such as AT&T, MCT, or AOL may already have a huge customer base and the spending power for an aggressive advertising campaign, their largest weakness may be that they are too large to be able to provide users with a location-specific feel.

Also, while it is true that ISPs have taken a dramatic hit in the stock market recently, I believe that the weighing of a company's stock value is not a good barometer for their potential for success or failure as a whole. In the case ofUUNet, Netcom, and PSInet, all of these providers have strong businesses. The dramatic decrease in their stock value was most likely a response to the telecommunication giants announcements rather than a reflection of their true worth.

The Small, Nimble, and Focused Will Survive

To summarize, the small ISP business might surprise the investment community by producing some unexpectedly successful companies. We may also see a larger number of small ISPs fail as the telecommunications companies win over their customers and the content providers diversify their services. If a small ISP is intelligent in the way it markets to (and provides proprietary services for) its region, there may be a surprising number of smaller providers left standing after the storm. If this turns out to be the case, my guess is that they may survive profitably as specialized tributaries to the very large carriers. What is going to finally matter in the ISP business is how well individuals get served. Small and local may be better than big and global when it comes to meeting the needs of individual Internet users.