Case Study:

Challenges at Time Warner

Background

Time Warner was formed by merger of magazine publisher Time Inc. and prod
ucer film and television programming Warner Communications in 1990.

It sold 25% of Time Warner Entertainment to Media One Group.

Time Warner acquired Turner Broadcasting Systems in 1996.

It had revenues of $27B and net income of $2B in 1999.

Time Warner announced their intent to merge with AOL in 2000, and was com
pleted after a year.

Pre-merger

Time Warner Inc. is the largest media company in the world, with revenues in
excess of $38 B.

Time Warner Inc. has huge competitors like Disney, Viacom, News Corp. and
Sony.

FCC relaxed several regulations that restricted the number of media outlets a
company could own in any local market and increased the national audience that
any once company can reach.

These are designed to prevent any one company from controlling too much of
media and ensure some level of diversity in media.

American Online (AOL)

It is one of the earliest companies to provide Internet Service in US,

introduced in 1989.

It has provided no only connection to the Internet but also significant

Internet-related content.

They have provided great value to consumer with their propietary content,
and became the pioneer of mass-marketing Internet.

They had almost 5M members by end 1995, and began partnership with
German media conglomerate (Bertelsmaan AG) in 1996.

American Online (AOL) Environmental Scanning

Options for Internet Service Dial-up (63%) or Broadband connection (37%)

AOL provides traditional dial-up service.

AOL is one of the first large providers among the national companies.

Competition for dial-up access was increasing dramatically.

With significantly faster data transfer speeds than dial-up, broadband internet start to
boom. Large telephone companies benefited as early first movers.

American Online (AOL)

AOL suffered in declining membership due to:

growth of Internet and free services available that reduced AOLs proprietary content.
Discount ISPs competed through cutting monthly fees and providing less content.
Consumers switch to broadband internet connections to increase speed.

AOLs revenues derived from subscription services and advertising, in which

declined due to weakening economic conditions.

To combat decline in subscribers, new products were offered such as the

BYOA plan but it had increased value to broadband users.

American Online (AOL)

AOL operations include Netscape that offered variety of products and

search services.

AOL launched the popular AOL Instant Messenger in 1995 and made AIM
and MSN instant messaging compatible.

AOL Europe was launched in 1996 but just led to Bertellsman buyout due to
antitrust concerns.

Filmed Entertainment

Contributes to 27% of Sales and 20% of Overall Income in 2003.

Warner Communications merged with Time Inc. in 1990 and obtained complete ownership of
Warner Entertainment in 2003 and is currently operated by Warner Bros. Entertainment Inc.

Its core businesses are motion picture production and distribution.

Movie studio may produce movie itself or provide financing to independent producers.

Firms in movie compete mainly by improving product quality.

Time Warner is also the leading provider of television programming.

It is also in home video distribution distributes movies, television series, professional sports
events and other entertainment materials (DVD and VHS).

Publishing

Contributes to 13% of Sales and 11% of Overall Income in 2003.

Time Inc. is the publishing subsidiary of Time Warner.

Consumers have more choices for obtaining news and information, including
large amount of free content on Internet and television.

Cable channels may also become primary information source.

Despite these, magazine publishers are optimism about the idea that
television may become less reliable source for advertising.

Publishing

Time Warner also upload content to the Internet.

In 2003, it began restricting access to the Web sites, led to increase in

subscribers.

Time Warner also publishes books. Distribution channels include online and
traditional bookshops, jobbers and wholesales, special sales and direct-toconsumer sales.

Programming Network

Contributes to 20% of Sales and 31% of Overall Income in 2003.

It has 3 units Turner Broadcasting System, Home Box Office and the WB Network.

Turner focuses primarily in programming networks including general interest, news,

and special interest.

HBO operation not only the 18 premium cable programming but also produces
movies, mini series and programs.

Basic cable programming network revenue sources subscription fees, and satellite
carriers and advertising.

Cable Systems

Contributes to 19% of Sales and 26% of Overall Income in 2003.

Core service offerings Analog and digital cable TV, High-speed internet
access and telephone services.

With stagnant growth in traditional analog-based cable services, Time Warner

has turned to digital services for revenue growth.

Time warner charges additional fees for a digital upgrade and is capable for
ancillary series such as pay-per-view.

Cable Systems

Core service offerings Analog and digital cable TV, High-speed internet
access and telephone services.

With stagnant growth in traditional analog-based cable services, Time

Warner has turned to digital services for revenue growth.

Time warner charges additional fees for a digital upgrade and is capable for
ancillary series such as pay-per-view.

Cable Systems

Cable access is the most popular method of securing broadband access.

Time Warner Cable accommodates multiple ISPs on its network.

Time Warner Cable began aggressively marketing Road Runner broadband

service that competed directly with AOL that led to loss of nearly half million
subscriber in 4th quarter or 2003.

Time Warner is also into telephone service. It offered VoIP product that
exceeded penetration expectation over a year.

Cable Systems

Time Warner competes with Direct Broadband Satellite Operators and

Overbuilders.

DBS operators deliver high programming quality and local content with low pricing strategies.
Overbuilders are the new entrants who built their own infrastructure in the presence of an
incumbent cable company, who can build infrastructure from scratch.

Multiple programming services were bundled by cable system operators.

Cable systems distribute broadcast networks, advertisement-supported cable

networks, and payment-based.

Bundling is criticized as consumers should have the right to purchase those

programs that they are willing to watch.

Cable Systems

Cable operators were largely local monopolists. Cable prices increased twice or
thrice faster than inflation rate after the deregulation in 1999.

Price increase was due to increase in fees paid to cable networks especially
sports network.

Time Warner was among the first to explore HDTV technology, and carried cable
networks in HDTV format at no additional charge, while additional charges for
premium HD channels.

It is also one of the major players in cable industry to offer and promote DVRs that
allowed consumers to record TV programs and watch them at another time.

Post merger

In January 2003, it was announced that AOL Time Warner Inc. will be losing
$98.7 B for year ended 2002.

Several commentators and investor considered the merger as mistake or

the worst deal in history.

While company executives take this as a result of accounting changes

rather than the ongoing operational problems, others have the allegations
that AOL misled Time Warner prior merger in its online advertising outlook
and overstated revenues.

Memo 1 Revenue from Starz

Memo #1 states that Time Warner currently has 852 of its basic service
subscribers that are also STARZ members. The overall concern is that the
number of subscribers is much lower than what Time Warner had planned.
In order to increase the number of subscriptions to the STARZ Network,
Time Warner is considering offering a summer promotion to all current and
new members. The Pricing Manager needs to know if decreasing the price
of the service would result in higher revenues.

In addition, the manager also wants to determine an estimate of the

maximum monthly revenues from the STARZ Network.

MEMO 2 Re: How Low Can We Profitably Go?

Everest, a direct competitor of Time Warner Cable, started a new wave of
construction in Kansas City tightening the current competition. In relation to that,
Time Warner had invested a considerable amount to upgrade their infrastructure
in Kansas City.
Now, if Time Warner is going to a price war with Everest, how low should Time
Warner be willing to go with its pricing, before writing off the operations becomes
an option?

MEMO 2 Re: How Low Can We Profitably Go?

Everest serves bundled services at $84.95 per month. Approximately, there
321,000 household in Kansas City and Time Warner is planning to maintain a
65% market share.
Fixed Cost:
Investment - $500M at 8.7% amortized over 20 years.
Variable costs:
Monthly programming fees $32.50 per subscriber per month
Maintenance, service and billing costs $7.60 per subscriber per month

MEMO 2 Re: How Low Can We Profitably Go?

Wherein: (per subscriber)
AFC = [Investment X (1+Cost of Capital)] / number of months / (Total Market X Market
Share);
AVC = (Monthly programming fees + Maintenance, service and billing costs);
Therefore:
AFC = [$500,000 X (1+.087)] / (20YRS X 12MO/YR) / (321,000 X 65%)
= ($543.5M) / 240mos. / 208,650
= $10.85 / month
AVC = ($32.50 + $7.60)
= $40.10; Therefore, ATC = $40.10 + $10.85 = $50.95
As long as Time Warner charge their customers $50.95 per month. Then, they should
stay in the competition. They could charge higher than that to be profitable or otherwise.
Remember, Everest is charging $84.95 per month.

MEMO 4 Re: Possible Acquisition of Fox News

Time Warners President of the Network Television Division is writing to the Vice
President of Global Strategy to propose the potential acquisition of Fox News to
help strengthen the firms position in the U.S. and abroad.
Time Warner currently owns CNN, the largest cable news service in the United
States, and Fox News offers an additional of 83.6 million subscribers, the possibility
for potential synergies, and expansion into new markets.
High revenue growth at Fox News over the past year coupled with strengthened
position in the global market especially Europe and Asia makes this possible
acquisition appear phenomenal.

MEMO 4 Re: Possible Acquisition

There are a lot of things that Time Warner should carefully consider prior to its
acquisition of Fox News. Some of the main things are as follows:

Synergy
Government Regulations
Market Response

MEMO 5 Re: Strategic Analysis

Within the dial-up industry, AOL is facing increased industry rivalry as competitors seek to cut costs
and offer the most affordable access. Earlier on, the bargaining power of customers was small
because there were relatively few alternatives to typical dial-up depending on ones location in the
States.
Since their front-runner beginnings, AOL has been experiencing increasing consumer bargaining
power because of growing competition within the dial-up industry and the increasing threat of
substitutes. The two main substitutes for dial-up are broadband and DSL. Both of these substitutes
offer superior technology for a small increase in price compared to typical dial-up. With the relative
low barriers to entry into the dial-up market, AOL is also subject to an increased threat of new
entrants.

MEMO 5 Re: Strategic Analysis

Film Entertainment:
Regulation changes prevented movie studios from owning movie theatres which caused
Warner Bros. to shift their attention solely to film making.

Movie industry competes by improving product quality.

The demand tends to follow seasonal patterns.

Movie demand also tends to vary with movie lifes cycle.

Players in this market sometimes act strategically to avoid releasing movies with similar
themes at the same time.

MEMO 5 Re: Strategic Analysis

Publishing:
There is a high level of industry rivalry and the threat of new entrants. While
there are usually several substitute magazines covering relatively the same
topics, the threat of substitutes is also increasing as consumers upgrade
their leisure reading desires.
While many magazines have online websites to complement their prints,
there has been an increasing amount of web only demand for magazine
information. The initial compliment web service is slowly becoming the main
source of revenues for magazines.

MEMO 5 Re: Strategic Analysis

Programming Networks:
Revenue sources: Subscription fees charged to cable, and satellite carriers
and advertising.

Though cable systems have invested heavily in upgrading infrastructure, the

increase in channel capacity has not caught up with available programs. As
such, cable programming networks have to compete to be carried by cable
system dropping one network to be able to carry a new one.

MEMO 5 Re: Strategic Analysis

Cable System:
The final business area of Time Warner is its cable systems. Cable operations provide the
core for T.W.s services like TV, high speed Internet and telephone access. Typical cable
operations require a vast network of communication lines in order to deliver products to
each individual user. At one time, it was thought that this high investment could only be
compensated and successful through an almost monopolized system.

With the introduction of satellite Internet and television, there has been increased
competition to Time Warners cable systems. New entrants into the cable industry also
force T.W. to keep an upgraded infrastructure because competitors typically build from
scratch based on the latest and greatest technology. As competition increased, the
regulatory environment began to back off in order to let market forces work more freely;
however, consumers have been increasing their demand for additional regulation as cable
prices continue to climb substantially.

MEMO 10 AOL Europe

AOL Europe was launched in 1996 in partnership with Bertelsmann, AG owning 49.5% of the
entity. Unlike in United States, growth has been slower in Europe due to cultural diversity which
made it difficult for them to create a broad appeal.

On top of that, AOLs difficulty of penetration in the European market is being amplified by the
need of household to pay for phone companies in order to go online, and at the same time pay
AOL.

The venture suffered losses of $600,000 on $800,000 revenue having 2.5 million subscribers. To
make it worse, Time Warner was forced to buy-out Bertellsman at $6.75 million, a premium, due to
antitrust issues.

Subsequent to Bertelmanns buy-out, AOL Europe made a comeback having significant gains.
Subscribership increased to 6.4 million with annual revenue of $1.5 billion.

MEMO 10 AOL Europe

AOL Europe was launched in 1996 in partnership with Bertelsmann, AG owning 49.5% of the
entity. Unlike in United States, growth has been slower in Europe due to cultural diversity which
made it difficult for them to create a broad appeal.

On top of that, AOLs difficulty of penetration in the European market is being amplified by the
need of household to pay for phone companies in order to go online, and at the same time pay
AOL.

The venture suffered losses of $600,000 on $800,000 revenue having 2.5 million subscribers. To
make it worse, Time Warner was forced to buy-out Bertellsman at $6.75 million, a premium, due to
antitrust issues.

Subsequent to Bertelmanns buy-out, AOL Europe made a comeback having significant gains.
Subscribership increased to 6.4 million with annual revenue of $1.5 billion.

MEMO 10 AOL Europe

Before finalizing any decision regarding the sale of AOL Europe-related assets,
management should consider first the trends and the recent developments wherein
both revenue and subscriptions increased as they have parted ways with Bertelsmann.

However, the main question regarding the assets sale is whether they would be sold
piece-meal or in a collective deal; management is now contemplating which would be
the better course, and the best mechanism to utilize.

This may auctioned individually or collectively, this allows parties interested in buying
to compete for the assets and, ideally for AOL Europe, finally arrive at an elevated
price. Otherwise, this may be subject to commodity bundling the practice of bundling
several different products together and selling them at a single bundle price.