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Vonage Shakes Up Old Phone System - Brings Service To Remote Parts Of U.S.

Vonage In Print News

Universal Battle In Tiny Towns
New Call Options Shake Up An Old Phone System
Rivals, Technology Threaten Program Bringing Service To Remote Parts Of U.S.

February 22, 2005

By Anne Marie Squeo

Mr. Smith's $10 Lifelines

Until recently, Westhope, N.D., a windswept town six miles from the Canadian border, had 533 people, one bank, one bar, one gas station -- and one federally subsidized phone service.

But seven months ago, Cassidy Sivertson, a 27-year-old who runs a computer business out of his home here, bailed out of the subsidized plan, which was costing him about $165 a month. Instead, he signed up for a new Internet-based service from Vonage Holdings Inc. Now, the subsidy-free Vonage phone service, a high-speed Internet connection and an additional toll-free line cost just $60 a month. "It surprises me we can have this type of service out here," says Mr. Sivertson, who says several of his friends have made a similar change thanks to him.

Mr. Sivertson's new setup illustrates how competition and technology are threatening a big shake-up in a program that has played a major role in the phone business for nearly a century. Today dubbed the federal Universal Service Fund, the $6.4 billion program assesses all phone customers a monthly surcharge to help cover the higher cost of providing service in thousands of isolated places like Westhope. The overriding goal is to make sure phone service is "universal," so that everyone in the country has access to it -- no matter where they live.

Critics say the program is a throwback to a time before satellites, cellphone towers and other high-tech gear made it possible to provide phone and Internet service to far-flung towns. Technological changes are also slowly starving the fund. Since it doesn't apply to new Internet-based phone services that most major companies are rolling out, people like Mr. Sivertson aren't required to kick in anything toward the fund. When it released its budget this month, the Bush administration disclosed that the USF will incur $200 million more in obligations than it expects to take in during the fiscal year ending Sept. 30.

As Congress begins working on a rewrite of telecom laws, the future of the fund -- and the goal of universal service in a competitive marketplace -- are central to the debate.

Some argue that, with 94% of U.S. households equipped with phone service, and strong alternatives to traditional telephone providers from cable, Internet and wireless companies, a program focused squarely on traditional land-line telephone service no longer makes sense.

The highly fluid situation promises a high-stakes free-for-all, pitting rural interests against cities, tiny phone companies against giants, and purveyors of high-tech communications services against traditional players.

Internet-phone services like Vonage say that broadband lines should be subsidized. Cable companies would prefer not to pay into the fund or take anything out for phone services they're rolling out. Regional Bell companies such as Qwest Communications International Inc. complain their customers in western states like Montana and North Dakota aren't receiving as much funding as those in southern states like Mississippi and Alabama. Wireless companies want more USF funding for rural areas, while local rural companies and cooperatives say their wireless counterparts should get less because of their lower cost structure.

"We've had this whole regime set up to subsidize and support areas that needed it, but it hasn't changed given the new technological abilities," says Tony Clark, chairman of the North Dakota Public Utility Commission. "We've finally reached a tipping point."

The sparring has already begun on Capitol Hill. Rep. Joe Barton, the Texas Republican who is chairman of the House Energy and Commerce Committee, recently quipped that one way to fix the USF "is to just repeal it." At the very least, he said, it needs to be scaled back. Senate Commerce Committee Chairman Ted Stevens of Alaska, a defender of rural interests, suggested Mr. Barton visit the remote villages in his state to see the fund in action. Sen. Stevens wants to expand the USF to subsidize broadband.

The notion of universal phone service dates back to the early 1900s. Theodore Vail, then president of American Telephone & Telegraph Co., convinced President Woodrow Wilson the newly invented telephone would catch on quicker if the country adopted a nationwide system similar to the one used for mail. At the time, a number of companies were building phone networks around the country, but the systems weren't connected. Allowing one company to consolidate these networks as part of a government-sanctioned monopoly would create uniformity, Mr. Vail argued. He declared his vision "one system, one policy, universal service."

'Geographic Averaging'

In doing so, AT&T created a system dubbed "geographic averaging" that charged city dwellers and businesses more so rural customers could pay below-cost rates. Consumers weren't really aware of this since the company wasn't required to disclose the adjustments. The system largely stayed in place even after the 1984 breakup of AT&T as the seven resulting Bell monopolies continued to make such offsets out of public view.

In the Telecommunications Act of 1996, Congress scrapped the remaining phone monopolies in favor of competition. But lawmakers also codified the idea of universal service for the first time. The law creating the Universal Service Fund mandated it be based on a percentage of long-distance revenue, and required it be disclosed as a separate entry on monthly phone bills. Besides subsidizing rural phone service, the fund also helps pay for Internet connections for schools, libraries and rural hospitals as well as phone service for the poor.

The fund paid out about $3.4 billion in rural phone subsidies in fiscal 2004, largely to small phone companies unrecognizable to those outside their service areas.

Despite rounds of consolidation among the industry's biggest players, there are still hundreds of these small phone companies. Some have as few as 48 phone customers, such as Absaraka Cooperative Telephone Co. in North Dakota.

These companies get about one-third of their annual revenue from the USF. Another third comes from the access fees charged to connect other companies' calls to their customers, while the remainder comes from customers. They submit their costs quarterly to the Universal Service Administrative Corp., an independent, nonprofit corporation that oversees the fund, and are reimbursed their costs plus 11.25%.

Big political contributors with strong ties to legislators from their states, these companies have successfully blocked major changes to their business structure repeatedly in recent years. Passage of the 1996 telecom law was stalled by rural legislators until Congress agreed to free these smaller companies from many of the changes in the new legislation. And a recent recommendation by a joint federal-state board to limit the USF funding to just one phone line per customer -- instead of the unlimited number allowed now -- was thwarted by rural senators, who quashed such an effort in a massive government-spending bill last fall.

As consumers switch to new technologies, the USF program is slowly losing revenue. E-mail and instant messaging are replacing some phone calls and flat-rate calling plans allow for unlimited conversation at one price. Millions of consumers are going completely wireless, lured by buckets of minutes and free evening and weekend calls.

As a result, total U.S. long-distance revenue fell 21% to $52.3 billion in 2004 from $66.4 billion in 2001, according to data collected by consulting firm Yankee Group. And that number is expected to drop to $39.4 billion by 2008, the group says. To keep the fund out of the red, the amount consumers pay each month has nearly doubled, jumping to 10.7% of monthly long-distance charges today from 5.9% in 2000.

With phone giants like Verizon Communications Inc. and SBC Communications Inc. expected to roll out Internet-based phone services in coming years, the squeeze on the USF is expected to increase. The new technology -- which breaks voice communication down into digitized packets that are rapidly zapped around the Internet and reassembled into conversation -- make it virtually impossible to distinguish between local and long-distance calls. Even if these new services were made to pay into the fund, contributions would need to be based on something other than long-distance.

Some areas of the country are still completely dependent on subsidized phone service. In Ovando, Mont., which has just 50 or so residents and is 70 miles away from the nearest city, there's no cellphone or cable service. The only provider of phone and Internet connections for Steve Smith and his wife, Alayne Marker, is the Blackfoot Telephone Cooperative.

Mr. Smith and Ms. Marker run small marketing and legal firms from their home, as well as the nonprofit Rolling Dog Ranch to care for sick or disabled animals. Although it costs Blackfoot about $60 a month to provide and maintain a single phone line, the couple pays just $10 a month for each of the six lines they have installed to help run their various businesses. The USF covers the difference. "Our low phone rates allow us to shrink distance," says Mr. Smith.

Disjointed System

The telecom landscape also has spawned a disjointed system to determine who pays what into the USF. Wireless companies, for example, say they can't figure out when a call is long-distance, so cellphone customers pay a 28.5% flat rate to the fund based on total monthly charges. This is likely lower than the actual revenues received by the companies for long-distance calls, government officials say, citing the companies' willingness to agree to the amount. Cable companies pay into the fund when they offer phone service over copper wires, but not if it's Internet-based.

At the same time, distributions by the fund are on the rise. In the coming year, the USF will spend some $3.6 billion subsidizing the price of phone service to rural areas where the cost is high. That amount is increasing in part because wireless companies are seeking more disbursements from the fund as they push into rural areas.

While wireless companies paid about $1.8 billion into the USF in 2003, according to John Stanton, chief executive of cellular provider Western Wireless Corp., the industry received only about $175 million out of it. But that number jumped to $323 million in 2004 as some 144 wireless companies became eligible for government subsidies for service offered to rural customers. That number is expected to exceed $440 million in 2005, FCC officials say.

Rural companies contend such payments are a major tax on the fund because wireless companies are being reimbursed based on the cost of running actual wires to homes in a particular region, not on the much lower cost of putting up a few cellphone towers. What's more, the rural phone companies say they bear the responsibility of being the phone provider of last resort in their geographic areas, meaning whether or not a customer wants their service they have to be able to provide it. Wireless and Internet companies don't carry the same requirements currently.

One possible solution: Assess a USF charge on every phone number, no matter what technology it's based on. "You have to divorce the goal of universal service -- ubiquity and affordability -- from a particular mechanism," says outgoing Federal Communications Commission Chairman Michael Powell. That way, "everyone pays a really tiny amount" instead of certain types of customers bearing the brunt of the costs.

But that still leaves open the question of who should receive payouts. Vonage Chief Executive Jeffrey Citron thinks broadband connections should get some federal funding so emerging Internet-phone technologies aren't disadvantaged against traditional ones. Especially since, "we are actually delivering a service that's cheaper," Mr. Citron says.

In Westhope, N.D., Mr. Sivertson has the proof. His old phone bills, despite being subsidized, were steep. Though USF keeps the cost of the basic local-phone line down, just about every call outside of town was billed at a per-minute rate. Not only did he and his wife frequently call family back in Binghamton, N.Y., but calls elsewhere in North Dakota cost between eight cents and 12 cents a minute.

With Vonage, that's no longer an issue. Mr. Sivertson now pays $30 a month for an unlimited Vonage calling plan and a toll-free number, plus an extra $30 for a high-speed Internet connection that his old phone company, SRT Communications Inc., provides. And he can talk for as long as he wants.

"We were on the phone for about six hours on Christmas Day" with family in Binghamton, says Mr. Sivertson. "That would've cost a small fortune through our old phone company."

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†AK and HI residents pay $29.95 shipping. ††Limited time offer. Valid for residents of the United States (&DC), 18 years or older, who open new accounts. Offer good while supplies last and only on new account activations. One kit per account/household. Offer cannot be combined with any other discounts, promotions or plans and is not applicable to past purchases. Good while supplies last. Allow up to 2 weeks for shipping. Other restrictions may apply.

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