PALABRICA, Flora Anne R.

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 worlds 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
Warners media products such as their music, news, and films, would be distributed
to millions of consumers through AOLs 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 AOLs 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 Porters 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 Warners divisions and Time Warners broadband
systems providing a platform for AOLs 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 Porters 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 companys 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 companys overall strategy and
operations and focus on value creation that its competitors wont be able to
replicate. The use of the internet should serve to enhance a companys abilities to
create new and unique products and true economic value.