John McKinley, chief technology officer and president, AOL Technologies, recalls vividly the afternoon in late december 1998 when Charles Schwab Corp.s market valuation reached $25.5 billion, surpassing merrill lynch & co. Inc. For the first time. The upstart brokerage—a pioneer in discount brokerage and online trading—had trumped the much larger and established company, which many years earlier had been equally revolutionary in its relentless ambition to bring wall street to main street. “It was a gray day; there was a lot of angst,” says McKinley, the cto of merrill at the time. “People wanted to jump out of windows.” But McKinley, who had been hired by Merrill just months earlier to upgrade the giant brokerages dusty technology and put it in a position to compete for the onslaught of online trading activity that companies like Schwab, E*Trade Financial Corp. and Ameritrade Inc. were getting fat on, wasnt moved by the Schwab coup.
McKinley had a plan—a step-by-step approach that wouldnt transform Merrill into a day-trading hothouse but instead would offer customers inexpensive electronic transactions, self-directed, Web-based portfolio management, and online consultation as part of a set of services that included traditional broker-client relationships at a higher fee. His online blueprint, and the companys internal efforts to integrate and revamp its isolated pockets of disparate technology platforms, was a radical undertaking. It had its share of skeptics in the media and inside the company, too many of whom assumed the lethargic Merrill was doomed to remain a step behind the New Economy.
In the end, though, McKinleys strategy won out. Now a much more efficient, streamlined and modern organization with a full range of online and offline products, Merrill is back on relatively sound financial footing, with net earnings for the first nine months of 2003 higher than its earnings for all of 2002. Meanwhile, online brokers, some in the red, struggle to squeeze transactions out of a shrinking customer base. Ironically, Schwab has tried to stimulate growth by becoming more like Merrill, providing more product offerings and consultative services for higher-end clients. That hasnt swayed fickle investors: Five years after topping Merrill, Schwabs market cap has dropped to less than $16 billion, while Merrills has ballooned to more than $50 billion.
Achieving a similar turnaround at AOL—a company that McKinley says has “a lot of analog to the challenges faced by Merrill” in the 1990s—wont be easy. McKinley left Merrill in February, just before David Komansky, his mentor at the brokerage, stepped down as chairman. When he arrived at AOL in July, the Internet company was at its lowest point in a decade. Still smarting from the turmoil of the Time Warner acquisition, a Securities and Exchange Commission investigation into advertising practices, and the departure of founder Steve Case, AOLs revenue in the third quarter of 2003 fell 5 percent compared with the same period in 2002, while its operating income dropped 7 percent. Much of this is the result of AOLs inability to attract broadband customers, who so far have resisted paying an extra $14.95 a month, on top of their DSL or cable modem fees, for AOLs content. With its fortunes tied to a contracting group of dial-up customers, AOL had 24.7 million U.S. subscribers as of Sept. 30, 2003, a drop of 2 million in 12 months. Fewer than 2.6 million subscribers have signed up for AOLs broadband service, compared with nearly 4.8 million high-speed cable-modem customers for Comcast Corp.
McKinley is optimistic that the downturn will be short-lived and AOL will solve its severe broadband problems. He says he has a technology strategy, based loosely on what he did at Merrill, to get AOL on solid footing again. The plan, McKinley says, is to “never give you a reason not to use AOL. We want to live through an entire Internet life cycle with our customers, regardless of where they are in their lives. Just like Merrill does with financial products.”
CIO Insight Contributing Editor Jeffrey Rothfeder recently sat down with McKinley in his office at AOLs headquarters in Dulles, Va., to discuss his successes at Merrill and his new challenges at AOL.
CIO Insight: Looking back at your Merrill experience, how did you formulate a strategy to overcome the significant challenges the company faced?
McKinley: We had world-class competitors; the emergence of a variety of value propositions—all types of discounted online trading plans—being offered to consumers, with technology playing a huge role, and time was not on our side. Exactly like the situation at AOL. We had to respond quickly, but as importantly, we had to respond well. The most essential thing for us was to get the business model right, then put the world-class technology under it to support it. At Merrill, that meant not doing what people expected. If you look back historically to 1999, there were an awful lot of people who said it was manifest destiny for the E*Trade or Schwab model to be the brokerage of the future, and Old Economy players just didnt get it. But you should never do strategy by consensus.
As we saw it—and this was a collective vision of the key business partners at Merrill—in a bull market where all boats were rising with the tide, there was a lot of forgiveness in terms of the consumer not being given rich advice. People were obsessively focused on one thing—to pay the least they could per trade. But when the market got dicey, we knew investors would need help in making decisions. The tagline was, “Never mistake intelligence for a bull market.” And we knew we could offer the entire experience—support when you needed it and none when you didnt. It became apparent to us that it is a lot easier to provide great technology—as our competitors did—than to replicate a great consultative, advice-giving, advisory force, which Merrill had. It took Merrill years to build and it is a tremendous franchise. So our perspective, when we looked across our customer base, was not “Lets create a discount self-service online market like everyone else for a small group of customers.” It was, “Lets give all our client segments—ultra-high net worth, high net worth, mass affluent, emerging wealth—a great technology experience.”
And thats what we did. As a customer, you have a choice: You can choose which portion of your financial management you need more help with and which you can handle alone. You can go online to trade, analyze your holdings, do portfolio analysis, migrate funds between accounts and offerings, pay bills, download research and access other advice. Or you can go offline and ask for specific advice on which transactions to do next. Even after Schwab topped us in market cap, we understood the event horizon that it was going to take to implement what we needed to do, and we were relentless about sticking to our commitment to our business model. But we didnt do what was expected.
What was the customer response?
We had tremendous success penetrating our customer base with the online system. A majority of clients use the system for some purpose. Funny thing is, given the choice, those who opted specifically for the self-directed trading channel—the product that everybody said we had to have or wed never survive—were very few.
Merrill was known for having many different technology silos that were hindering its ability to operate efficiently and be innovative. What did you do about that?
We had to migrate from a whole raft of bespoke systems to a fewer number of strategic platforms. Thats a multiyear journey for an organization serving that many geographies and discrete lines of business. Youre not going to flash-cut to a future state in one year. You have to have a vision of where you want to go and be committed to it. For me, that meant convincing people to integrate technology that could be used throughout the organization into their business plans. I had to preach consistency and also working with commercial partners. We made a lot of progress—for instance, the integration of global trading platforms and the partnership with Thomson Financial (to jointly develop Wealth Management Workstation for Merrill advisers and clients, which combines market data, news and portfolio management tools).
Why He Left Merrill
Why did you leave Merrill and take the job at AOL?
Ultimately, you get to a point where you want to take the next hill. I really wanted to get back to a role in a technology organization. Technology has been, and always will be, my one true passion professionally.
And when you decide to move on, you should look for an organization with a couple of critical attributes. One is key strengths. For AOL, that means a well-known brand and tremendous reach—111 million unique visitors viewed the AOL core service or Web properties like Mapquest. Another is that the organization must fit with you personally and culturally. You want to find a place where, because of your skills, you can make an impact. Responding aggressively to threats posed by other technology-enabled competitors, ensuring that our technology strategy addresses the unique needs of a wide continuum of consumers, and running a high-volume operation with zero tolerance for downtime—these are AOLs primary challenges for a technologist. And Ive succeeded at them before, most prominently at Merrill.
It could be argued that AOL is in much worse shape than Merrill was when you got there, because at least Merrills overall business was still growing at the time, even if it faced aggressive competition. How do you fix a company thats losing its primary customer base the way AOL is?
I would argue that the subscription numbers dont tell the whole story. You have to consider all of our properties, and when you do, you see significant growth in usage: Mapquest is up 34 percent this year, theres continuing growth in IM activity, and the same goes for other AOL sites. With 111 million users across all properties, we have a great opportunity to leverage every touchpoint with consumers and to be a central participant in technology shifts such as the emergence of broadband and the wireless Web.
The challenge for us as the executive team is to shift from historically viewing AOL as a mono-line company—as a single destination—to viewing it as a more complex multiproduct, multibrand and multichannel environment. Its about providing choice, and thats the key analog to Merrill. We should be an option for Internet users to do whatever they want to do on the Web from wherever they want to do it—whether theyre high-volume, high-literate Internet users or not—so they dont have to go to other companies for individual aspects of their Internet experience. Its a big transition as a business model and will add many more cylinders to AOL.
In broadband, we want to be the first organization to define the category of streaming broadband, bringing relevant content and relevant programming into the broadband household. We want to let people search for the video and music they want to view and listen to. We plan to build on our initiatives with antivirus programs and expand on voice mail to provide other voice services. We helped define categories like instant messaging, chat, discussion boards and e-mail, and we have to continue to be thought leaders in social software. We want to provide other à la carte and premium services, such as being a place for people to store pictures, documents and e-mails they create or receive while theyre on the Web. It makes sense. What you want is all your assets available all the time, regardless of where you are. This is especially important for our multichannel users, who will be a larger and larger portion of our customer base. Part of the day, people will need to access us from their laptops or at home on high-speed DSL or cable, or a smart phone or communication-enabled PDA.
And your hope is that with all of these products and services, customers will be willing to pay the extra money to subscribe to AOL, even though many seem to feel that their DSL and cable modem bills are already too high?
Were giving them a lot—a soup-to-nuts experience. You have to pay more to get it. But what were finding is that for some, there is already broadband buyers remorse. Just getting the additional communication capability isnt a transformative event for them. Delivering the first draft of truly broadband-enabled applications to them is a transformative event, and thats at the core of our strategy. Were already seeing that applications like “Youve got pictures,” where people can store their digital photographs and create online albums and share them with family and friends instantly, are gaining traction. What people want is a seamless Web experience. That has value to them. AOL is one of the only companies that have ever delivered rich, managed content to the retail consumer profitably. Thats part of our gene code and positions us to achieve our business model.
Its a huge strategic gamble and it must be an enormous technology undertaking. What are your technology plans?
Were putting together the road map right now to deliver all of this content and all of these services. But as always, it starts with getting the basics right—connectivity, security, privacy, communications infrastructure. Thats the price of poker: They all have to work perfectly, with no glitches, so you have a strong foundation to build on. Were going to have to become a best-in-class integrator of both captive technology and externally provided technology. The world is moving quickly into new channels and new applications, so leveraging a broader set of partners allows us to bring better value to our members. We currently have 16-plus different vendors of technology whose products are integrated as part of the core AOL experience. But that will have to expand and that will put a lot of strain on our organization to provide an experience in which the user doesnt have any notion that hes moved from one vendors products to another.
Having a world-class power plant is also essential. We peak out across our varying AOL properties at about 8 million-plus concurrent users on a hot night. We have to do better. Its a huge challenge to present a great experience with that level of scale, and were working to leverage best-practice thinking around application switching, next-generation networking and next-generation middleware. Currently, we have about 10,000 Linux servers in place, and the evolution of the overall technology environment will include high-performance Layer 7 switching (to speed up traffic management) to XML-based presentation services. And then we have to come to some decisions about greatly expanding storage management if were going to offer the network as the logical location for maintaining a subscribers personal digital assets.
Whether you succeed or not, youre making AOL sound alive again. Thats a far cry from the perception of the company recently. Has something changed?
Its a re-energized organization. Theres a reaffirmed commitment, a new management team on the field. Positioning the brand and regaining trust are all smart things for us to do and those are the litmus tests for any decisions we make. Now, we have to be able to recognize emerging trends and stake out our role in them before they take hold among consumers. The overall success of this business long-term will be our ability to integrate best-in-class technology and programming and create compelling value for each of our targeted customer segments. As a technologist, could you ask for a better role? Every decision matters.