Patch.com, a network of small-town news sites owned by AOL Inc., has emerged at the center of a tug of war over the Internet company's future.
The high cost of running the local-news sites has fueled a campaign by dissident investor Starboard Value LP against the AOL Chief Executive's strategy of investing heavily in online content.
Starboard, which is waging a proxy battle to win several seats on AOL's board at next month's annual meeting, says that Patch should be closed, sold or put into a joint venture, with a partner sharing the cost.
Inside AOL, Patch is also a flash point. The creator of Huffington Post, who took charge of Patch and AOL's other news and entertainment sites after AOL acquired her Huffington Post last year, distanced herself from the business after disagreements over how it should be run.
The AOL CEO, has held his ground in defending Patch, which he co-founded in 2007 before he joined AOL, but he recently promised to make it profitable by next year. In a small step toward that goal, Patch said Tuesday it will cut around 20 jobs, or less than 2% of its workforce. The cuts will come from merging the management of its eastern and southern regional reporting operations.
Whether he can make Patch a success could determine his fate at AOL. As the ad-supported network has expanded to more than 850 towns from 30 in the past two years, its annual loss has widened sharply to more than $100 million in 2011, analysts say.
The main problem: It is tough to sell enough online ads to cover the cost of producing local news, especially while maintaining a local reporting staff and a local advertising sales force.
Several big media companies, including Washington Post Co., Politico parent Allbritton Communications, New York Times Co. and Gannett Co., have given up on similar experiments after failing to wrest a profit from online local news.
Others are still trying. Examiner.com, backed by a billionaire, draws roughly the same traffic as Patch, according to comScore, but its approach differs from Patch's.
The website has a full-time editorial staff of fewer than 30 people, who organize articles, photos and other media submitted by more than 85,000 freelance local "examiners." These examiners write about topics ranging from restaurants to running. Patch, by contrast, employs nearly 1,000 full-time journalists
The AOL CEO thinks Patch is on the right track, and just needs time to hit its stride.
Frustrated by the lack of local online news about his hometown of Greenwich, Conn., Mr. Armstrong developed the business model for Patch with Jon Brod, the former president and chief operating officer of his private investment group.
The idea was to target wealthy small communities that generated about $20 million a year in advertising though TV, radio, newspaper and direct marketing.
Patch has fallen well short of that target. AOL says the business is on track to bring in between $40 million and $50 million in revenue this year. That translates to an average of $50,000 for each of its 850 local sites. But the average Patch site costs between $150,000 and $200,000 a year to operate, or a total of $160 million.
The recent withdrawal from overseeing Patch highlights internal divisions over the operation. Following Huffington Post's acquisition last spring, Ms. Huffington set about integrating Patch with the Huffington Post.
She recruited the founder of a successful network of hyperlocal blogs in the New York borough of Brooklyn, to improve Patch's ties to its local communities, and Patch quickly adopted a blogging platform modeled on the Huffington Post's.
The blogging platform attracted more than 20,000 local bloggers within a year, pleasing Patch's local and regional editors. The sites also got a traffic boost when their local scoops were linked by the Huffington Post.
But they sometimes chafed at top-down directives, called "fire drills," that required Patch journalists to pitch in with reporting for national trend stories in the Huffington Post, draining resources from their local mission, according to several people familiar with the matter.
The creator of Huffington Post also ruffled feathers by promising local editors they could each hire associate editors to help with their workload, even though salaries for such posts weren't part of the website's business model, according to people familiar with the matter.
People familiar with her plan said the associate editors would have been paid for with savings in freelance costs.
Within six months of AOL's merger with the Huffington Post, the involvement in Patch had waned, according to several people familiar with the situation. In May, she announced that she was scaling back her portfolio to focus on her namesake news site.
The good news for Patch is that its traffic has grown sharply, swelling to 10.3 million visitors in April from 6.9 million a year earlier, according to comScore. Patch attributes the improvement largely to growth at its established sites.
In addition, more than a third of Patch's content now is generated by users uploading announcements, photos and other content, helping Patch shrink its budget for freelancers.
As well as relying even more on content from the public, Patch is planning to move beyond advertising and into local commerce, and to look for new sources of revenue in partnerships.
Last week it began a partnership with WPIX, a New York TV station owned by Tribune Co., in which a Patch correspondent delivers the area's top local news stories from Patch headquarters during the evening news.