Momentum Builds For VoIP Services

Momentum Builds For Hosted Voip Services

July 21, 2004

By Mark F. Whittier

After years of waiting and hoping for the technology to take off, Voip services are now gaining momentum in the U.S. marketplace.

Residential Voip service providers such as Vonage are adding nearly 20,000 new lines a month and other services such as AT&T’s CallVantage aim to have 1 million subscribers by the end of 2005. In July, Vonage activated its 200,000th line.

While there were only 114,000 U.S. broadband (DSL and cable modem) IP telephony subscribers at the end of 2003, according to In-Stat/MDR, lower service costs and compelling new communications features are driving service adoption. In fact, the research firm expects 10.3 percent of all broadband subscribers to use broadband IP telephony by the end of 2008.

This is a significant number, given that there were already close to 27 million U.S. business and residential broadband subscribers at the end of 2003, with one in every five U.S. households subscribing to a broadband service.

Another Voip high adoption market, where hosted Voip services originally entered the residential space, is the multiple dwelling unit (MDU) market. According to In-Stat/MDR, MDUs represent more than one-third of total households worldwide and are an enormous current and future market for broadband services. Moreover, the high-tech market research firm reports that while worldwide there will be just fewer than 1 million MDU in-building broadband subscribers by the end of 2004, these subscribers will grow tenfold by the end of 2008.

The increased momentum the industry has experienced for sales of hosted IP telephony services to residential users has been driven primarily by:

the increased market penetration of broadband residential services such as discussed above;
the appearance of aggressively priced service bundles offering flat-rate and/or low-cost long-distance services for residential customers with existing broadband services; and,
the availability of inexpensive IP telephony endpoints for the residential end user, such as 1-port/2-port residential Voip gateways for use with traditional analog phones and/or low-cost session initiation protocol (SIP) phones.

Keeping Above the Regulatory Muck

In addition, while the regulatory situation is getting bleaker for “traditional” competitive local exchange carriers (CLECs), recent developments likely will not affect Voip providers. As most of us know, the Supreme Court recently decided NOT to grant a stay sought by AT&T, MCI and an association of state utility regulators that would have potentially saved FCC regulations that would force carriers to share their networks with competitors at discounted rates. This decision definitely could hurt traditional CLECs, but it will not hurt Voip providers, leaving them free to compete – and actually giving them a leg up on “traditional” telephony competitors.

While incumbent local exchange carriers (ILECs) are protecting their front doors from traditional competitors through favorable regulation, competition has entered the back door in the form of Voip carriers such as Vonage. The world of telephony is changing dramatically.

And that has a lot of incumbent providers looking to Voip as either a means to fight back against competitors – or to become the competitors themselves by using an IP strategy to enter the markets of other incumbents.

Voip offers service providers several benefits. First, they can launch voice services on a regional or national basis without investing significant capital. They can invade each other’s territory and cherry-pick the most valued customers. They also gain the ability to add voice services to existing bundles, such as Internet and cable, while retaining second-line services that would otherwise be lost to competitive IP telephony providers. And they can accomplish all this rapidly, typically without requiring a truck roll to the customer premise.

Of course, the biggest benefit for service providers looking at IP is the compelling business case. The simple fact is that residential Voip based on a hosted platform – using existing infrastructure – can be highly profitable.

Consider this pricing model, which allows a service provider to realize a positive cash flow in 18 months: A one-time connect fee of $29.99 with a range of monthly fees: $14.99 per month for 500 minutes total bucket, $24.99 for a bucket of unlimited local minutes and 500 minutes long-distance, and $34.99 for unlimited local and long-distance minutes.

Based on the complete pricing model, service providers that sign up about 82,000 residential broadband Voip subscribers within two years will break even at about 18 months. If they grow their subscriber base to just over 500,000 in the fifth year, the service provider can generate a cumulative profit of more than $91million while seeing healthy profit margins up to 45%.

And these projections only estimate $2.50 per month for potential incremental revenue captured by offering traditional voice applications such as voicemail, caller ID and call waiting as well as advanced applications made possible by VoIP, which include find me/follow me, unified messaging, click-to-dial and many others.

The bottom line is that service providers can profitably attract new customers by offering integrated IP services at a reduced cost while leveraging existing broadband networks already in place.

The Hype is Residential…But the Long-Term Opportunity is Enterprise

The problem with the business model for a strictly residential offering can be summed up in one terrifying phrase: price erosion. The business model simply breaks down if there is too much price erosion, which we are already seeing in the Voip market. In May, Vonage dropped its Residential Premium Unlimited Plan from $34.99 per month to $29.99 per month. And in June, it dropped its Suggested Retail Price at Best Buy, Circuit City, Fry’s and RadioShack to $79.99 with a $50 mail-in rebate.

Using these reduced prices in the model used above still shows a strong business opportunity. However, such competitive pricing pressures are only likely to continue as the number of Voip service providers increase in number and as traditional ILECs introduce competitive products. Thus margins in pure voice-only residential Voip can be expected to erode. It could be the story of the long-distance market all over again.

And that obviously affects profits. In fact, if you double the price erosion from 10% to 20% annually in the 5-year business model outlined above for residential Voip service, it becomes an unprofitable endeavor. The bottom line is that residential IP telephony pure play services are highly susceptible to price pressure due to competition, which of course can reduce revenue significantly.

Service providers have a few key ways to fight against this, including bundling services and selling more advanced services. Perhaps the most effective way to avoid the residential-only trap is by staking a claim in the Voip enterprise market.

The Enterprise Advantage

Why is entering the Voip enterprise market a good move for service providers? Because enterprise services traditionally have greater margins, greater volume and tend to be less price elastic. More importantly, enterprises have a tendency to use a greater number of features, which means that the $2.50 collected for advanced features from residential users is likely to be a much higher number for enterprise users.

Best yet, service providers that choose their hosted IP telephony platform wisely can use the same platform to support both their residential and their enterprise Voip services. For example, NTT COMWARE in Japan is using the same application server to support both residential and enterprise customers for years.

Using just one platform, service providers can deliver residential Voip "must haves" such as caller ID, call waiting, and voice mail as well as advanced features such as conferencing, web-based click-to-dial, and find-me call routing – while also delivering a wide range of enhanced services such as more advanced conferencing and call center applications to enterprises. This allows service providers to gain economies of scale and spread their costs across a wider customer base. Of course, in order to support both residential and enterprise offerings, service providers must ensure that they select a highly scalable application platform, capable of growing as they grow.

Service providers should also look for an application server that does not require subscribers to give up their existing phones to enjoy the benefits of Voip communications – or, alternatively, allows them to choose from a wide variety of new IP phone models if they want to upgrade.

They should look for an application server that allows subscribers to use their computers in conjunction with their phones to manage their Voip services via a user-friendly Web portal to easily take advantage of advanced features. And they need an application server that meets all necessary regulatory requirements for home users, including local number portability, operator services, equal access, 911, and lawful intercept/CALEA.

By remaining flexible to serve both residential and enterprise users, Voip providers can ride the wave of residential Voip growth today while protecting their businesses from potential price erosion in the future.

Voip is finally becoming a force to reckon with in the telecom marketplace – it is up to savvy service providers to protect their businesses and improve their business models by remaining flexible enough to adapt to marketplace changes.