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FSA Case: American Online: Name Avantika Gupta Alok Dhawal Harsh Misra Deepthi Arumalla Ravi Jewani
FSA Case: American Online: Name Avantika Gupta Alok Dhawal Harsh Misra Deepthi Arumalla Ravi Jewani
FSA Case: American Online: Name Avantika Gupta Alok Dhawal Harsh Misra Deepthi Arumalla Ravi Jewani
Name
Avantika Gupta
Alok Dhawal
Harsh Misra
Deepthi Arumalla
Ravi Jewani
e: American Online
Roll No
2008a19
2008b28
2008c
2008a36
Prior to 1995, why was America online (AOL) so successful in the commercial onlin
The reasons for the success of AOL were manifold. Not only was it a pioneer in many new o
retain and capture customers. The following are a few reasons for the 4 million users it ha
1. AOL found ways to coordinate its pricing and compete on nonprice dimensions, such as inno
2. It also had the first mover advantage.
Supply a unique product or service at a cost that was easy to understand by the c
Superior product variety : AOL offered a lot of added services to the customers.
Superior customer service
Investment in brand image
American online was a leader in the development of new mass medium that encompassed
1. Online services
2. Internet
3. Multimedia and other interactive tecnologies
AOL pursued continuous investment in the following to position itself as a leader in the de
1. Growth of its existing online service and related businesses.
2. Ability to provide a full range of interactive services.
3. Technological flexibility.
neer in many new offerings to the customers, it also pursued aggressive marketing to
million users it had by the end of October 1995
ensions, such as innovation or brand image.
nderstand by the customer and at the same time the customer was ready to pay premium..
o the customers.
that encompassed
d and anticipate. Thus customers did not feel cheated when dealing with AOL
structures.
cheduled online events and conferences, online promotion of upcoming events
re programs.
to attract and retain customers. The co-marketing companies bundled the AOL
customers.
at the newest stars of cyberspace entered into contracts with them. AOL paid
ve contracts with them.
is attracted new as well as existing customers to AOL.
premium..
As of 1995, what are the key changes taking place in the commercial online industr
The commercial online industry was undergoing a change during 1995. The various facts about the in
1. Online consumer service industry represented $1.1 billion revenues in 1994 and the reve
2. Market leaders AOL, CompuServe and Prodigy served 8.5million of the existing subscribe
as middlemen till now.
3. Microsoft with MSN allowed all the content providers to be their own publisher. They char
rest to the content owners.
4. The coming up of the World Wide Web posed a major threat to AOL's customer base. He
everyone with a computer was his/her own publisher.
5. Content providers were becoming increasingly interested in these alternate distribution c
earn higher revenues
6. Products by different players were becoming more or less identical. Hence, bra
the earlier years now mattered less.
publisher. They charged only 30% from the site owners as commission and passed the
s customer base. Here the role of middlemen was shrunk further. On the internet
ternate distribution channels which gave them greater control over their products and
entical. Hence, brand name and services which were important to the customers in
. The existing competitors and the new enterants like MSN, and Internet
nies, had enhanced their service offerings. Internet directory services and
e online services and Internet markets, resulting in greater competition for AOL.
e of the original content owner as far as the original revenues are concerned.
higher investments in technology and heavy advertising and the increase in
the condition of AOL serious as it has a huge deferred customer acquisition costs balance in its books. As the fu
n its books. As the future becomes riskier and the company’s business will be more competitive.
Was AOL’s policy to capitalize subscriber acquisition costs justified prior to 1995?
AOL’s biggest expenditure was the cost of attracting new subscribers and maximize custom
1. Separate registration numbers and passwords were issued to customers that could be us
They cost more than $40 per new subscriber in 1994. A one time cost from which revenue/v
2. AOL aggressively marketed its online service both directly and indirectly. The company a
3. To retain new subscribers and increase customer loyalty & satisfaction, AOL invested in s
Analysis
a. It is not advisable for AOL to capitalize the marketing costs because in 1995 there were n
Web was being established. This would definitely impact the sales of the company and wou
b. Instead of amortizing the Acquisition Costs for 15 months, if we treat it as an expense, we
the Income statement shows a loss for the period. CompuServe, on the other hand,did not c
c. Capitalizing the expenditure for 2 years contained an implicit assumption that the custom
for the coming two years. This was unlikely with the online industry as it was in its growth s
had acquired most of its customers in the last 36 months, to anticipate that they would rem
d. Through these steps the management wanted to improve their earnings position so that
e. If these costs were not amortized over the years, their cash flows from operating activitie
As per accounting principles, capitalization for marketing expenditures was allowed. Compu
Prior to 1995, when AOL was writing off the marketing expense in 15 months looked justifie
ied prior to 1995?
ut 15 months. It was extended to 24 months from July 1, 1995. The reason for
mail marketing which had shown a longer response time.
of subscriber acquisition costs deferred & decided to expense certain subscriber
se in 1995 there were new enterants such as Microsoft and also the World Wide
f the company and would reflect in the Revenue Statement.
eat it as an expense, we find that for the period of 1993-1995
he other hand,did not capitalize these subscriber acquisitions costs.
umption that the customer acquired with that expense, would remain loyal to AOL
as it was in its growth stage and there were threats from the new entrants. AOL
ate that they would remain with the company for 24 months on an average was too optimistic.
rnings position so that the share price of AOL shares would shoot up in the market.
from operating activities would be affected adversely.
d had seen the trend that they do stick on for atleast 12 -15 months.
Given the changes discussed in question 2, do you think AOL should change its acc
view?
The industry was becoming increasingly cometitve. The various factors that pose
1. New entrants into the industry made customer retention u
2. Product pricing had to change, as there were more attrac
3. Decreased profitability likely to be experienced by AOL in
4. Diminishing leadership in the industry due to other compe
It does not look feasible for AOL to anticipate that customers would remain with them for a
match the amortization costs over those months. Hence, matching principle would fail and i
of accounting when competition grows in the industry.
AOL should probably shift from matching principle to conservative principle of accounting, a
A look at the following table tells us that there is a need for conservative account
The table shows that where the cash and cash equivalents for the company has grown by 3
deferred costs have risen over 100% and even 400%. This shows that the policy of the com
The company’s response is not consistent to our views. Instead of reducing the a
d change its accounting policy as of 1995? Is the company’s response consistent with your
ain with them for a period of 12-18 months and accrue revenue to them to
iple would fail and it appears to be prudent to follow conservative principle
ple of accounting, and expense the customer acquisitions costs as and when they are incurred.
advertising expenses should be reported as incurred on a conservative basis, rather than capitalized. This wou
, the company should reduce the goodwill amortization period.
this industry, so, the product development costs should also be capitalized for a shorter period.
be pessimistically forecasted due to increasing competition.
any has grown by 3.39%, the trade receivables, product development costs,
e policy of the company has to change and it cannot increase the period of deferment.
of reducing the amortization period from 12-18 months, AOL chose to increase the same to 24 mon
sistent with your
cost structure.
capitalized. This would have the impact of decreasing the assets and increasing the expenses.
Amount(1994)Amount(1993)
115,722 51,984
69,043 28,820
23,548 9,745
18,523 11,494
111,114 50,059
4,608 1,925
1,774 371
6,382 2,296
-3,832 -1,897
2,550 399
1,133
2,550 1,532
0.07 0.01
0.07 0.05
34,208 29,286
Amount(1994)
Amount(1993)
1994 1993
115,722 51,984
69,043 28,820
26,390 12,181 12,669 2,842 2,436
18,523 11,494
113,956 52,495
1,766 -511
1,774 371
3,540 -140
-3,832 -1,897
-292 -2,037
1,133
-292 -904
-0.01 -0.07
-0.01 -0.03
34,208 29,286
AOL expensed all the subscriber
AOL’s share price as of November 8, 1995 was $81.63. In October 1995, the compa
dollars per share). Its book value as of June 30, 1995 was $217.944 million. Assumi
share issue, compute AOL’s market to book ratio as November 8, 1995.
Due to the issue of fresh shares in October 2005, the book value of equity has increased. T
Particulars Amount
New shares issued in Oct 1.713
Total BV 100.000
BV per share 58.377
ity has increased. The total book value of equity can be calculated and also the book value per sha
on shares at $58.73
an due to the new
book value per share. Market to Book ratio has been calculated from the market price on Novembe
price on November 8 2005. The calculations are given in the following table:
Assuming a perpetual average growth rate in book value of 15% per year, calculate
its market to book ratio as of November 8, 1995.
er year, calculate the long-run average return on equity needed to be earned by AOL to jus
ned by AOL to justify
Based on your analysis in questions 1-5, do you think the return on equity and grow
From the following observations, we can conclude that ROE and growth rate assumptions
1. AOL amortized its customer acquisition and amortization expenses. Its competitors would
2. AOL amortized its software development costs over five years, which is unrealistic given
3. AOL capitalizes its product development costs, direct labor and related overhead for softw
So the growth projections seem to be doubtful. They are only based on the companies per
n equity and growth rates assumptions implied by AOL’s market to book ratio realistic?
the companies perception and accounting standards but not the reality and facts.
atio realistic?