Yahoo! Inc. (YHOO): AOL, Inc. (AOL)’s Fundamentally Flawed Strategy

In my opinion, AOL, Inc. (NYSE:AOL) will eventually end up in bankruptcy, or selling off its parts as scrap. Its business strategy is seriously flawed. The plan at AOL, Inc. (NYSE:AOL) is to milk the declining cash flow from dial-up subscribers to invest in Internet brands and content, which can be monetized via advertising.

In particular, the company is focused on local Internet content. If you have a high tolerance for corporate-speak, you can watch CEO Tim Armstrong describe the strategy to Bloomberg in 2010. And despite years of mediocre results, the strategy has not changed — it’s all about content, advertising, and local. The problem is, selling advertising around Internet content is brutally competitive, and the economics of local content don’t work. If you have any doubt of this, just look at AOL, Inc. (NYSE:AOL)’s recent results — after huge investments, its content business is unprofitable.

AOL, Inc. (NYSE:AOL)Content-driven Internet advertising is a brutal industry
There are virtually no barriers to entry to create content on the Internet. With a little sweat equity and tech savvy, anyone can create content on the Internet. The costs, if any, are minimal.

It’s an amazing feature of the Internet, and it’s been a vast boon to consumers. There are blogs and websites for every niche, and it’s an incredible outlet for creative individuals — many of whom do it for free as a hobby. This has created a major supply-and-demand imbalance in the Internet content business.

There’s lots of people willing and able to supply content and draw an audience, but the supply of businesses willing to pay for advertising hasn’t grown nearly as fast. It’s economics 101 — as supply outstrips demand, prices fall until they reach the cost of production. That’s the economics of making content for the Internet.

Most will fail and, at best, the goal is to scrape by with fleeting attempts at brand development, innovation, superior operations, or lower cost structure. The companies that have thrived on Internet advertising haven’t been content producers — they’ve been platforms. The best example is, of course, Google, but even Yahoo! Inc. (NASDAQ:YHOO) has stayed afloat is based on its platforms like Yahoo! Inc. (NASDAQ:YHOO) Finance or Yahoo! Inc. (NASDAQ:YHOO) Sports — not its content.

The goal of becoming “the world’s largest online content company” is foolhardy. AOL, Inc. (NYSE:AOL) will never get an adequate return on all the money that it has invested in developing online content.

The economics of local content do not work
Leveraging the Internet to enable local content has been a Holy Grail for media and technology entrepreneurs for decades. It’s been tried and failed so many times that’s its probably worth admitting defeat, at least for AOL, Inc. (NYSE:AOL). Local ad-based content doesn’t work because audiences are so small that it’s not possible to cover the cost of content production. It’s a noble vision, and it might happen some day. But AOL, Inc. (NYSE:AOL) probably isn’t going to be the company that cracks the code.