Time Warner (TWX): How AOL Blew Q2


Based on further research, this is our current understanding of what happened last quarter, when AOL missed its advertising targets.  As with our previous piece on the coming AOL layoffs, none of this has been confirmed by the company:

By mid-May, AOL’s quarter was already tight.  Most analysts were looking for ad growth of 25%-40% (versus Q1 growth of 40%).  AOL had already reduced its internal targets to 20%, but this was not communicated to Wall Street (or possibly even Time Warner corporate).  Time Warner execs remained bullish about AOL’s ad business through early summer–even when missing the Street’s expectations was all but guaranteed.

One of new COO Ron Grant’s early initiatives was to make AOL executives justify everything they were doing that was different from what Google and Yahoo were doing.  The layout on AOL’s search pages, for example, was different than Google’s, and Grant did not find the search team’s justification for this layout compelling.  The search team warned Grant that a change to a more “Google-like” design–no sponsored links above results, etc.–would result in fewer clicks and a sharp revenue drop.  In late May, Grant ordered that the change be made anyway.  (Former AOL CTO John McKinley describes some of the logic that may have persuaded Grant that this was a good idea here.)

Search revenue immediately tanked, putting the company on track to miss its internal target.  In prior quarters, search had been the company’s go-to business, the product you turned to when you needed to save the quarter.  Now it was the cause of the trouble.  Grant and the search team tried to fix the problem, but instead of just rolling back to the prior layout, they employed half-measures–for example, adding back one sponsored link above the organic results. 

Meanwhile, in an attempt to goose search revenue, AOL began promoting search results on the service’s main pages.  This accelerated clicks (and revenue), but also had other consequences.  Most notably, it resulted in a torrent of unqualified leads–users who hadn’t really been interested in searching for products–suddenly clicking on sponsored search links.  As a result, traffic to advertisers’ sites did not deliver the expected ROIs.  The rise in clicks also quickly blew through advertiser search budgets, causing advertisers to complain to Google (Google serves AOL’s search results).  And Google, in turn, complained to AOL. 

By this time, the falloff in search revenue had blown the quarter. Again, however, this information was not immediately communicated upstream to Wayne Pace (Time Warner CFO) and others in Time Warner corporate.  This lack of communication may be one cause of the conflicting explanations that Time Warner CEO Dick Parsons and AOL President Falco ultimately gave about the quarter’s miss.

AOL blamed the miss on Mike Kelly, who was responsible for display advertising.  Our understanding is that the display business actually missed its target by less than the search business. Kelly is now history.  Grant’s reputation outside the company remains largely unscathed.

Internally, however, the credibility of Falco and Grant has been damaged.  Falco and Grant walked into a tough situation, but many at AOL had hopes that they would shoot straight and develop a clear, winning strategy.  The perception in Dulles now is that they have made poor decisions and not been straighforward about the depth of the coming layoffs.  This has further demoralized AOL staff, who feel that Time Warner corporate regards the division as little more than a cost centre.