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NetZero's black-and-white TV commercials, which evoke images of the Red Scare era, tout the company as a champion of the free Internet. Last week, however, the company succumbed to the Red Ink Scare.

Chronically unprofitable and with its stock price languishing below a dollar, the Westlake Village, California-based company said it was scaling back the amount of service it would give away. Rather than free Internet access 24/7/365, NetZero is giving away just 10 hours a month. Go over that and the meter starts ticking.

NetZero, which unveiled plans to merge with competitor Juno Online Services earlier this year, isn't the first free Internet service provider to scale back once-ambitious plans to bring the Web to anyone with a computer and a telephone line. Bluelight.com, part owned by retail giant Kmart, will phase out its free Internet service by August 29, replacing it with an $8.95-per-month pay service.

Even profitable AOL Time Warner has raised connection fees to increase revenue.

Making Money

Free ISPs were premised on a simple idea: Give away the service and make money on advertising. During the heady go-go days of the Internet boom, the plan made sense. But in the post-bubble era, the appeal of that idea has dried up along with the advertising market.

The free ISP boom emerged when free e-mail provider Juno began offering Internet access in December 1999. Soon scores of free services were popping up to compete for a part of this seemingly lucrative market.

Free ISPs tried to keep their costs low. Their business plans relied on word-of-mouth promotion and the sharing of their software among users. They brought in some money by helping retailers form ISP services for their shoppers. But mostly, they tried to sell advertising that would be displayed to their captive users.

The advertising revenues never materialized.

Small Companies Collapse

Smaller companies felt the pain first. 1stUp.com and Spinway.com, which was funded by Japanese Internet conglomerate Softbank, went under in late 2000. Their collapse brought down a passel of affiliated services they had created with retailers.

Bigger free ISPs relied on their IPO riches to carry them through hard times. Juno didn't have enough cash to last long, but seemed to be getting healthier as it pushed billable services and dramatically cut costs. The company narrowed its net loss from $47.6 million in the first quarter of 2000 to $9.6 million in first quarter 2001.

NetZero had deeper pockets, but quickly dug into them. NetZero's first quarter 2001 advertising revenue was less than $11 million, down from $16.6 million a year earlier. Unlike Juno, NetZero initially resisted paid services. And even after the two announced their merger, which will create the second-largest ISP in the United States, investors lost faith in its approach to profitability.

Free ISPs flailed to find profitability. They introduced more banner and pop-up ads to drive revenue. They tiered their products, offering premium service to paying customers. But the efforts didn't stem the losses. Ultimately, they had to become what they had initially fought: paid services.

Paying the Price

The problem is that the transition ended up costing them more than just customers; they had to pay to ship their software and to install billing systems. Their new revenue didn't offset their new costs.

"If they had started from day one with the idea that the free service is to get you in the door and the paid service comes later, they may have had a better shot," says Joe Laszlo, an analyst at Jupiter Media Metrix.

Steven Harris, an analyst at IDC, says that even with the changes, NetZero's free service will likely be abandoned by 2003.

NetZero Chair and Chief Executive Officer Mark Goldston disagrees. The merger with Juno, he says, will produce a company, United Online, with more than $100 million in cash, 7 million monthly active users, and more than 1 million monthly paid users. Becoming lean and profitable is its number one goal, he says. (The company's TV spots say keeping the Internet free is its priority.)

The company also has cut its marketing efforts, such as its sponsorship of professional basketball and cutting loose an unprofitable division, Goldston says. And he says that the new pricing plan keeps the Internet free for light users, while providing a value over pricier services, such as AOL and EarthLink, for heavier users.

"We are the Southwest Airlines of the Internet," says Goldston. "Our free service [is] equivalent to their low regional rates and our $9.95 service as equivalent to their transcontinental flights."

Whether NetZero can remain a symbol of freedom, like Southwest, remains to be seen.

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