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REALITY CHECK ON ONLINE AND INTERNET SERVICES

"Reality Check on the Online & Internet Markets", is the first study from a five-report series, titled "Inter...Notª" The report series is based on a simple premise---that the press releases and hype have given a very distorted and inaccurate picture of the Internet and Online Services, with many different groups and organizations flinging around numbers and projections as if it was an amateur bake-off.

This report examines the current statistics, markets, and primary trends---cross referencing over 25 other research firm's findings, from Nielsen Media/Commercenet and FIND/SVP to O'Reilly & Asc. and Jupiter Communications.

ï Number of Online users is approximately 12 million, not 25 million. NNI's primary finding is that Online services is not a mass-market product today.

Total US Online Users and Households, 1996

92% of US households are not online

95% of the US population is not online.

11.9 million users were as of 5/96

8.2 million households were online as of 5/96

* Overall Demographics: There are a number of different user types for Online services. However, the majority of Online users are males (71%), approximately 35 years old, who are doing well, financially. Using the Internet mostly for work, the majority only goes online once a week or less. Overall, the average user goes online for 18 hours a month, with heavy users, (approx. 12%) representing 60% of usage. The major use of the Internet is e-mail.

Online/Internet Demographics vs US Census 1996

Online Nationwide.

Males 71%, Females 29% Males 48%, Females 52%

Income Avg. $50,000-$75,000 Nationwide Avg. $40,000

* Differences In Methodologies and Definitions Cause Major Statistical Variations:

Major discrepancies for the statistics are based a number of variants, including the definitions of the terms "user", "access", "household", "subscription", or specifics, such as "geography covered" or "random survey" vs "self-selecting" methodologies. The major differences and statistical problems include:

1. Consumer and business market analyses have been combined, which should have been done separately. 2. Different definitions: Each company examines and counts different criteria including: "Users", "Households" "Adults" , "Subscriptions" or "Access". 3. Different age groups examined: Some studies examine "adults", while others examine the total pop. Some define adults at age 16, others at age 18. 4. Different geographies: Nielsen discusses the US and Canada while some companies use total International markets, or just the US. 5. Methodologies: Online surveys are mostly self-serving or self-selecting "user" surveys--- They are not accurate for overall population usage. 6. Random surveys and populations: 5-8%% of US households do not have telephones, so telephone surveys have to have biases, sometimes not accounted for properly. 7. Consumers' ignorance of terms. Many consumers do not know the differences between the terms "Info. Highway", "Online", "Web" "Internet", or America Online (AOL), so random surveys are fraught with inconsistencies. 8. Geographic clustering makes random surveys mis-count Internet users. Large clusters of Internet users, from schools to specific business districts can not be analyzed through random surveys. 9. Online Service Provider subscription numbers, such as America OnLine (AOL) use various forms of puffery to cause number inflation, from counting "Free trials", to adding multiple subscriptions per household. 10. Politics: Different numbers are used by companies and associations to prove their point, regardless of the accuracy of the statistics.

* Users Should be Analyzed in Layers This report introduces a new analysis of the Online market titled "Stratification of Users Based on Layer Analysis". Based on proprietary interviews:

NNI's view is that there are distinct layers of users and each distinct layer is using the Internet for their own purposes, focusing on specific content, applications and services, with little, if any, overlap by different user groups.

Besides the stratification of users and their applications,

NNI believes that the average number of sites visited regularly by an individual will be only 7-15.

Therefore, each group must be thought of and analyzed as a separate entity for marketing, as well as current and potential growth and revenue projections.

It is ridiculous to think that all 12 million people would be customers of all services. This would be like saying that everyone with a TV set will watch the PBS programming. The primary groups identified by NNI are:

Composite of Industry Users by Percentage

% of users Population totals

Business applications % of users Population totals Business 27% 3,213,000 New Media Industry 5% 595,000 Schools 25% 2,975,000 Gov., Non-profit 15% 1,785,000 Entertainment & Personal use (Hobbies and Discussions) Entertainment & Information 15% 1,785,000 Kids 10% 1,190,000 Adult 3% 357,000 Total 100% 11,900,000

Each group also generates its own online traffic with different percentages of use for "Commercial", "Internet" and "Web" traffic. For example, NNI found that 5% of "the new media Industry", uses 15% of all commercial traffic, 14% of all Internet traffic and 30% of all ".Com", Web traffic. (See Attachment: "The New Media Industry" for a breakout, by category, of the New Media players. )

Entertainment is a broad based term, referring primarily to those online subscribers who focus on personal use (not business related) and hobbies. We include "Kids", children who are not using the online services for school work, as well as customers who's primary use of the web is to view adult entertainment.

The report highlights this group, as well as numerous sub-groups, such as entertainment topics such as Chat, Sports, financial services, etc.

Also, this group's use of the web would be more focused on commercial services, such as those supplied by AOL. In fact, AOL stated that only 11% of it's traffic goes to the web. As we will, see, many AOL subscribers do not have ample computing power to venture onto the Web with AOL's 8 meg browser.

Within each layer, various applications are used, such as communications with e-mail, or corporate customer services. However, many applications are not revenue producing, (except through productivity gains.)

Also contained within these layers are Phase 1 users. While user numbers have dramatically increased over the last three years, there is a long history of people online since the 1980s. The truth is that there has been five major groups who make up the foundations of all online services, which NNI refers to as Phase 1 users. These include:

* Bulletin Boards Now 100,000 strong, these mom-and pop services have quietly flourished for the last decade, though not 'hot' revenue producers. This group also includes the techno-files, who enjoy the computer, not just the information. * Corporate Databases Since the 1980's there have been hundreds of databases that have been available, including Lexus, Telerate and Westlaw. It should be remembered, that the tickertape, which is shown in old movies as a stream of paper giving stock information, then teletype, were the precursors to the newer data services. * Schools, Universities, government agencies: Since the 1980's there has been an active use of the Internet at colleges and scientific laboratories for the mainly the transfer of scholarly information and e-mail. * The New Media industry---The author and his industry associates have been online since the early 1980's, first as part of the French Minitel, then the various other online attempts in America. NNI believes that there are 350,000 people in the industry today, about 600,000 counting friends and family. * Journalists and E-mail: The computer and journalists was a natural fit, mainly because their business is words and the word processor facilitates writing. Probably half can now use a computer and know how to file a story with e-mail.

NNI's belief is that these groups constitute the entire 'bottom' the stable part of Online services in America.

* We've Seen it All Before: NNI found a series of "Old New-Media" marketing paradigms from the evolution of historic telecom products, including 800 services, Interactive Voice, 900 services, and Talking Yellow Pages that have direct correlates in the Online services markets. * In the case of Business, one of the paradigm models is "customer service". This model demonstrates that the web functions as a 'continuity' product with already existing other customer services, including "800", long distance, voice mail, e-mail, and even postal services. In this application, NNI believes that the Internet for business mimics the history and growth of 800 Services, another telecom product. o In the case of Business Commerce, Web sales growth is similar to many other new media sales and marketing efforts, from "Talking Yellow Pages" to "Voice classifieds and sponsorships". o In the case of Consumer applications, "Entertainment & Information" and "Personal use", the growth mimics the growth of other "content driven" Telemedia products, including 900 services, "Videotex", and "Audiotex."

These "New Media Paradigms" are used in the trend section of the report to help predict customer behavior as well as growth models for the Web.

* Advertising and Sales:

NNI contends that the traffic on the Web is highly exaggerated, and that Hits is a useless term.

Based on a proprietary software package developed with Mindvox which counts hits-per-page, per-visit, and per-person, the NNI sample found that there can be 123-hits-per-person for a site.

The term "hits", represents files transferred from a web site to a user and unfortunately, web sites can have 10-20 hits per page. The exhibit below presents gives the summary for visits made to Lycos, Pathfinder, Microsoft Corporation and Hit Wired, representing, 36 web pages. The chart shows that on the average, web pages had 15 hits-per-page, with an estimated 56 hits a visit, representing 123 hits-per-person.

Selected Sites, Hits Per Page, visit, Person,

H-P-page Avg. Visit Hits per person Pathfinder 14 52 115 Lycos 19 70 154 Hotwired 12 43 94 Microsoft 16 59 130 Avg. 15 56 123

Sources: NNI, Mindvox, 1996 "New Media" Traffic models:

Through out new media products, from 900 services to talking yellow pages, a standard rule found in most marketing book, called the "80-20" rule, can be applied to most Online service traffic.

80-20 Rule: This rule in essence states that 20% of callers will be responsible for 80% of all traffic.

NNI has found direct similarities between findings by numerous online services research studies that shows heavy users, representing 12%-18% of the callers can represent the majority of traffic.

Therefore, traffic of users to web sites most probably is based on a small group of individuals making the majority of calls.

Online Trends and Assumptions

* Commercial Business Sites: B-to-B * E-mail + There is no doubt that the Internet's primary use is e-mail, and NNI believes that the increases in this area, spurred on by companies going "online" will make many corporations to implement e-mail, just as the same companies implemented voice mail.

However, many companies are placing restrictions on Online use, so the argument that e-mail leads to web browsing is a stretch, with a much smaller amount going to Web have access.

* Intra-nets: However, Intra-net development, companies that build internal web sites for company uses, is an obvious growth area. Once called "Ethernet" and other from "LAN based services", to "Groupware", Intranets have captured the imagination of the corporate world and will grow, if for no other reason that it will be mandated throughout the corporation.

Corporate user acceptance requires three specific items to be before a company will successfully deploy Intranets:

1. A well thought out plan, implemented in phases 2. A strong internal champion who is responsible for directing and sometimes requiring changing corporate culture 3. Extensive internal education.

Based on interviews with companies who have installed LAN based Groupware services, in most companies, about 15-25% of the corporate population will be heavy users, and the others have to be conditioned to use online-Intranet services.

However, as an extension of the 1980's plan of a paper-less office, NNI considers the Intranet rollout in corporations an evolutionary step, requiring months, if not years, for full deployment and implementation.

* Customer Service continuity--- Cost savings and productivity model: NNI contends that the most significant use for the business community will be using the net for customer service functions. As shown by numerous research groups, the major use of the net is for business activities, and though the competition can also check out the site, giving specific access to customers, as well as functions such as lead generation, or handling complaints seems to be a major function of the nets good attributes.

However, NNI does not believe that business should use the net carte blanche for non-customers, primarily because approximately half of the calls are people "checking out the competition.

Please note--- This application does not directly produce revenues, but does offer productivity gains when used correctly.

* Boon to researchers, writers, and info. hounds: As one newsletter editor put it, "I can now write an entire issue without having to talk to anyone. I just use their press releases and web site stuff and I'm done. I can even download the material so I don't have to even re-key it.

Because of the connectivity of the web, from Hot-Linking to search engines, one primary business area, research, is now easier than ever. Before, a writer would have to call a company, find the right person to talk to, as well as have material sent, could take time, sometimes requiring traveling.

With the advent of the Net, research time has been dramatically reduced, with some caveats. First, many web sites do not contain a great deal of useful information, and therefore, contact with a human for details becomes a step. Secondly, the search engines spew out thousand to millions of potential sources, with little, if any useful, finds. This problem seems to be "topic-sensitive".

* Extra-nets: One phenomena which will be interesting to watch are Extra-nets, exclusive collection of web sites, and forums dedicated to specific business topics. One is reminded of the various database companies, such as West law, which started a lawyer's database of case information, or Lexus, which was a news-clipping service that provides search criteria.

Extra-nets extend this concept of online databases by offering other related information and forums to a specific client base. However, this is a niche market business model and requires both a large enough target audience, which are also online, as well as those willing to pay extra for the service.

* Overall Business market B-to-B and B-To-C: Inhibitors to growth:

There is a host of problems facing business, many of which are based on poor analysis of business models as well as expectations.

* Vanity Telecom--- One of the bad drivers of companies to offer web sites has been "Vanity Telecom". Simply put--- Joe's company has one so we have to have one also. Expect this to continue, regardless of the economic results of the net. * Digital Ghost Towns: A result of Vanity Telecom are "Digital Ghost Towns", web sites that are no longer updated or maintained, and the ill winds of new media are already blowing.

In almost all new media, unless there is a powerful money factor, i.e., people purchasing timely data, the information or advertisement usually starts to age quickly. For example, in examining the Talking Yellow Pages markets, NNI found that only 4%-15% of advertisers who could update their messages every day for specials, etc., did so.

Without dedicated staff, a very costly addition in a non-sales situation, information is slowly if ever changed, and this fact of corporate-human behavior is now occurring. In fact, NNI found that many sites had aging information, getting older every day.

* No one is making money today--- Besides the some ISP's, Netscape, a few sites, and a large amount of research firms and writers, there is few companies who are making any money from net, or he results worth the investment.

Few people remember that Prodigy has already lost an estimated billion dollars, USA Today has already closed down it's original site, And many sites are not based on realistic economic models.

* The primary problems: * The overwhelming majority of businesses use the net for e-mail, not purchases. * There are not enough users within the business layers to support the ever growing number of web sites. * Poor design and integration of the Web site into other marketing. * Lack of a Billing Network (please see "Access Wars" for a discussion of Billing networks) * Advertising & Site Subscriptions?

Selling subscriptions to a site, or charging for information seems almost antithetical to the users of the web, and except for special cases, NNI does not believe that most sites have been well conceived or that its raison d'être' correctly calculated.

As previously mentioned, NNI believes that the new diagnostic tools for calculating "hits-per-person", will reveal weaknesses in advertising prices.

Fears of using credit cards, based on perception, and not necessarily reality, and other still untried billing schemes, are a serious deterrent to Web sales for the next few years.

Pay-per-document, without a good billing connection or loyal niche customers, pay-per-document is doomed to failure. In most cases, the other, simpler method of payment, using a telephone, will not be surpassed soon. (This subject is discussed extensively in "Access Wars")

* Consumer and "Entertainment" Markets

NNI believes that the consumer markets will grow, but that the "Stick Factor" customers who continue to be active, will be low. Also, NNI contends that online services is not a mass-market product.

* Not a mass-Market in 1996: While the hype would make someone believe that the world is wired, the truth is that only 8% of households are online, while only 30% of total users, approximately 3.3 million people are online primarily for entertainment purposes. * Expect large growth of subscriptions, but "stick factor" will be low. With AT&T and the RBOCs entering the cluttered field of OnLine service providers, there is surely going to be a surge in the number of subscriptions, especially since the services will be free to try.

However, NNI believes that the issue of "stick factor" i.e., the number of customers that actually keep the service and use it, will remain low, for two primary reasons.

* "Fad Oriented" New Media models = Serious Churn Many new media services, such as "chat" services, are show 'fad oriented" behavior---the customer may use it for a while, 3 months to a year, and then lose interest. Based on NNI interviews, many online customers appear to be "fad oriented", and NNI expects serious "churn", customers who are short lived users. This will cause problems for entertainment oriented online services.

As discussed by INTECO and others, the number of subscribers who have used and canceled a service is higher than the number of current users. For example according to Inteco, Prodigy had 1,700,000 current customers in august 1995, while another 3,500,000 had tried it and canceled

Even AOL has serious churn. According to an article in Business Week, AOL had 1.8 million new subscriber 4th quarter 1995, but at the same time lost 950,000.

With 50% of new users stating that they started using online services in 1995 (source FIND/SVP), NNI believes that this market will show growth, but it will be hollow.

* Small Installed base of computers and Modems and not a lot of room to move.

The NPD Group found that 36% of the US households have a computer and about half, 18%, have modems, year end 1995.

According to Find/SVP there is a direct relationship between household income and the household's computer and online use. The research found that a small group of 14% of the population, generally well off, had 83% of all modems, and 93% of all CD-Roms. Two other groups, representing 65% of the population had only 14% installed base of computers and few modems.

With a major slowdown in computer sales in the residential markets, those with computers and modems today are primary targets for using online services. However, as shown by numerous studies, from Find/SVP to IDC, the number of new computer buyers, therefore becoming users, will be very low.

* "Ram Trashing" Stops Users from going on the Web Only 8% of the population had 8 megabits or more at the beginning of 1995, so many of the computer users will be effected by "Ram Trashing", companies trashing customers by designing software that can not be used without 8 megs or more. For example, AT&T's new service requires 8 megabits, so most homes will have to either by new machines or won't be able to go on the Web. * Massive slowdowns, brownouts, burnouts and disconnects--- The network continues to get slower and almost everyone has experienced not being able to get on services, from AOL to Pipeline. For entertainment customers it can be compared to having the cable service, or telephone service die, or that to change the channel it takes minutes, not seconds. This effects entertainment customers the most, because they will stop using the service, where as many businesses require the service. * Drugs Sex, Rock and Roll: Other factors that will limit growth are the perception of problems, regardless of the reality of those fears. This perception problem has occurred in many other, content driven new media, from 900 to Chat. This includes * Parent limiting their children's use for fear of adult and chat services * Viruses * Fear of giving out credit cards. * Fraud, and other 'avatar' problems caused by a disguise. * Dark Secrets Revealed: There are a number of issues that most industry insiders know, but is not common knowledge. These include: * Estimated 30% of the WWW traffic is sexual material. * Few, if anyone, is making money * Hundreds of companies are being investigated for fraud using the net. * Security has yet to be solved

At any time, these items are powderkegs waiting to explode and NNI believes that the computer industry is naive to just how serious these problems can be.

* The Other Side--- the Non-Users:

NNI conducted 108 interviews during the first quarter 1996, and the findings were that the overwhelming majority of non-users don't really care that the Web exists or that they should purchase a computer. The primary complaints:

* Don't like keyboards and don't really care about the Internet. The overwhelming majority of the population is not online and don't care about typing. * Can't compete with Cable TV In most interviews with non-users, the response was not that they couldn't afford online services, but that they just didn't feel a need because they already had cable TV. * Don't have telephones: A revealing statement about who is represented in this "5% of households" came from Larry Irving of the National Telecommunications and Information Agency. (NTIA) Testifying in front of Senate Judiciary Committee hearing about the proposed bills in Congress he gave a startling glimpse into the other side of the mass-marketplace... that of consumers that do not even have telephone service.

The Commerce Committee along with Commissioner Andrew Barrett of the FCC have done five hearings around the country. We've gone to South Central LA, Indianapolis, North Carolina, New Mexico, and we've looked at the issue of Universal Service and who's being left out.

Mr. Chairman, there are some really troubling problems out there.

We found that 20% of some communities don't have telephone service. I grew up in Brooklyn. In Bushwick Brooklyn, 28% don't have telephone service. Ten communities in New York City alone... one fifth don't have telephone service. Even worse, 65% of some Navajo reservations don't have telephone service.

We have a very, very, serious problem. If you are poor in this country you are less likely to have telephone service. If you are poor and a minority, you are even less likely to have telephone service. If you are poor, a minority, and a single woman you have a 43% chance of having telephone service in this nation.

You talk about the Super-Highway. We have people without a foot path and we have to do something about that.

BILLING AND ACCESS Topics not covered in this report:

Some things on the Internet seem too good to be true: Stay online all the time for $15 a month! Get free, unlimited e-mail and pay no extra charges for long-distance communications! As if to balance those good things, the Net has more than its share of congestion and service disruptions.

These offers and problems aren't simply the results of rapid growth, loss-leaders, free-rider syndrome or even the short-lived dreams of some altruistic souls. They are symptoms of the interaction of a physical infrastructure poorly matched to the pricing models, architecture and regulatory environment of the superstrate evolving above it.

Some physical resources are mispriced, which leads to bottlenecks. Other resources are used in new ways, creating repercussions through the system. Pricing tends to move faster than physical supply, but in the long run supply adjusts to eliminate bottlenecks and pricing reflects supply. Things keep moving....

So writes Jerry Michalski in Release 1., a leading computer industry newsletter. NNI's next report, "Access Wars", the second study in the Inter...Notª series examines the fight what NNI believes is inevitable and has already started. For example, proposals for a "Modem tax", billing for Internet services on a per minute basis, or the banning of "Internet Phone", a software package that allows an audio conversation over the net, are now all be heatedly discussed by the Telephone industry.

NNI contends that the computer industry and the Internet are in a collision course with the wishes of the telephone industry. In a lively debate, NNI present's Release 1.'s view of the computer industry's proposed future, while NNI examines the Telephone companies' position.