Why VoIP Telephony is Quickly Coming of Age

vonage-forum.com/images/media/logo_financialtimes.gif">

Why VoIP Telephony is Quickly Coming of Age

September 9, 2005

By Michiyo Nakamoto, Mark Odell, Paul Taylor and Richard Waters

One of the pioneers of internet telephony this week reached a milestone. Vonage Holdings, a New Jersey-based start-up, announced that, less than two-and-a-half years after it launched its consumer services, it had signed up its millionth paying customer. Jeffrey Citron, Vonage's chief executive, talked of its having created "a tidal wave of change" in a dormant telecommunications industry.

In the hyperbole-prone technology world, such claims might be easily dismissed. But most analysts agree that the recent dramatic growth of residential services and subscriber numbers using VoIP (Voice over Internet Protocol) - albeit from a relatively small base - points to a big future for the technology.

Vonage is far from the only company involved: from the traditional incumbents in the telecoms sector to internet and media groups, a host of companies believe that VoIP will revolutionise the way people communicate. "VoIP's time has come," says Michael Arden of ABI Research. "Consumer VoIP is going to continue to grow."

In its less developed days VoIP was for early-adopting "techies". The latest wave of converts, by contrast, are mainstream telephone users eager to capitalise on the low cost of internet telephony and the improved features that it allows, such as the chance to have calls directed to multiple lines.

Unlike most traditional phone calls, calls based on VoIP technology are digitised, chopped up into tiny electronic packets and then sent to their destination over the public internet. That translates into more efficient use of bandwidth and lower costs for VoIP service providers. This, coupled with light-touch regulation - for example the designation of VoIP as an "information service" in the US exempts internet telephony from many of the taxes, fees, charges and regulations associated with traditional telecoms - means cheaper services and smaller bills for consumers.

In the US alone, internet telephony services are expected to have about 4m subscribers by the end of this year. That is expected to grow to about 17m over the next few years, according to Jon Arnold, an independent VoIP analyst. In contrast, the number of traditional "circuit switched" phone lines, currently about 125m, is declining steadily in part because of wireless and VoIP substitution.

Mark Main, an analyst at Ovum, a consultancy, predicts that within two years the US will overtake Japan, the world's largest VoIP market with 8.3m subscribers, where the entry of Softbank, the broadband services group, in 2002 drove rapid take-up. But it has been the accomplishments of Vonage and other independent VoIP pioneers, such as the UK-based Skype Technologies, that have grabbed attention as they internationalise their businesses. Their success has sent shivers down the spines of some of the biggest telecommunications industry incumbents.

It has also encouraged cable companies on both sides of the Atlantic to begin to offer versions of internet telephony. In the US, cable companies believe this will drive growth by allowing them to offer consumers a knockout "triple play" package of voice, video and high speed internet services. Time Warner, the second largest US cable TV group, added 242,000 internet telephony subscribers in the second quarter. Comcast, the largest US cable operator, plans to add 250,000 subscribers in the fourth quarter and 1m next year.

Across the Atlantic, cable operators in the Netherlands, where levels of cable and broadband penetration are among Europe's highest, have rolled out VoIP services aggressively. Within a year of the roll-out, all five cable suppliers have undercut KPN, the incumbent phone company, on call packages or line rental. KPN's subscriber losses have doubled within the year and Dresdner Kleinwort Benson estimates cable operators could gain 20 per cent of the voice market by 2008, up from 4 per cent today.

Also exploring VoIP are some of the internet world's biggest names, such as Microsoft, Google and Yahoo. This month Microsoft bought Teleo, a company with technology that will allow anyone who uses Microsoft's MSN instant messaging service to make internet phone calls. A week earlier Google, Microsoft's arch-rival, introduced Google Talk, a service that lets users of its web-based e-mail service talk to one another using a microphone and speaker. Yahoo's purchase in June of Dialpad Communications, a VoIP provider, will enable it to offer an internet telephony service. Meanwhile Skype is understood to be in early talks with eBay.

Uptake of broadband, which most VoIP services require, has been a bottleneck for VoIP. But the global broadband internet market is forecast to pass 190m subscribers by the end of next year and will approach 440m by the end of 2010, according to Informa Telecoms & Media, a market research firm and consultancy. Niklas ZennÃ‚Âstrom, the founder and chief executive of Skype, says broadband growth drives take-up of VoIP. "Over the next five to 10 years all traffic will migrate to VoIP. This is a function of internet penetration with broadband becoming ubiquitous," he says.

Many of the incumbents that formerly dominated national telephony markets - and are these days under intense pressure from traditional voice competitors, mobile operators and regulators - are only just dipping their toe in the water with VoIP. Most face declining revenues in their fixed-line business as competition and the take-up of broadband, with its flat-fee model, eats into their traditional per- second charging.

At the same time, most of the incumbent telephone operators are engaged in upgrading their ageing "public switched" telephone networks (PSTN) to IP technology, driven by the promise of huge cost savings. In the UK, for example, BT plans "21CN", a project to replace its entire analogue network with IP by the end of the decade - which inevitably means VoIP will take centre stage. "As we move to deploy 21CN and offer better and better products . . . we will be effectively replacing PSTN with VoIP services," says Wendy McMillan-Turner, acting general manager of voice at BT.

Most incumbents are trying to manage the transition and at the same time offset the resulting revenue loss by developing the premium services that IP technology allows. "PSTN revenues per user are going to decline but we don't know at what pace. We are developing new services and customers will progressively benefit from broadband services instead," says Olivier Sichel, head of France Telecom's fixed- line business.

Vonage and other VoIP providers say subscribers value features such as call logs, "follow me" call transfer and automatic call blocking. In addition, Mr Arden says, the quality of VoIP service, a constant source of complaint, has improved markedly over the past 18 months. Such improvements make it increasingly difficult for traditional telephony providers to dismiss VoIP services as inferior or second-class.

Nevertheless, VoIP providers still have to counter some negative perceptions. In particular, broadband internet phones are vulnerable to power outages, unlike ordinary phone lines, which carry their own power. In the US the FCC has required VoIP providers to make it possible for emergency services quickly to identify the location of a VoIP caller - something that early VoIP services lacked.

These limitations are cited by some traditional telecoms companies as reasons why they do not offer stand-alone VoIP services. Others suggest that the incumbents in this radically changing industry are loath to embrace VoIP until they have to. "Many traditional carriers have yet to fully depreciate all their investments in (circuit-switched) equipment and do not want to start offering VoIP yet," says Mr Arden.

Time may be running out - and Mr Main at Ovum believes the incumbents will emerge weakened from the expected huge transformation.

"It is likely that, in 10 to 15 years' time, PSTN as we know it won't exist and it will be (internet telephony) in some form or other. It is hard to say what the market will look like but I think the incumbents will still be there, albeit weaker, and you will see the ISPs, like Yahoo, coming in with a number of other players on the horizon. It is all to play for."