Monday September 18 05:00 PM EDT
Net2Phone shift raises warning flags for
industry
By John Borland and Corey Grice, CNET News.com
Internet telephony pioneer Net2Phone is shifting strategic gears, a sign that
the price pressures pummeling the long-distance calling industry also are
being felt in the young Net calling sector.
As expected, Net2Phone said today it would
start a new joint venture, with a minority
investment from Cisco Systems, aimed at selling
Internet phone-system software similar to what it
uses for its own service.
The company, which is among the most
high-profile Net phone firms, hopes to move away from relying on service
charges for connecting calls to sustain its business. Call charges now make up
about 95 percent of the company's revenue, but the company hopes that the
new software venture will make up about 50 percent of its revenue stream in
just two years.
Net2Phone says it is trying to "diversify" its revenue streams, in the face of a
market where profit margins are falling rapidly as a result of new competition
and telecommunications deregulation.
Analysts say the industry as a whole has to look at falling per-minute charges
with some concern, taking the near-crisis in the traditional long-distance
telephone business as a warning. But that point hasn't yet come, they add.
"Being a tollbooth is still a great business," said Mark Winther, a
telecommunications analyst with International Data Corp. "Net2Phone has a
pretty solid balance sheet and cash flow."
The Net calling business, which languished for years as the province of
hobbyists and early-adopters, finally has begun approaching something like a
mainstream business over the last year.
Net2Phone itself has served as the most dramatic example of this trend. The
company now counts Yahoo and America Online among its investors, and
recently giant AT&T took its own stake, snagging nearly a third of the
company.
Another recent deal, with Microsoft, saw the company's service packaged
into a free-calling feature in Microsoft's instant messaging software.
But it is exactly these types of deals that have helped put a quick squeeze on
the industry's profit margins. A host of companies like PhoneFree or Dialpad
have sprung up that offer free, ad-supported calling over the Net, at least
within the United States. This has quickly instilled the idea among many
consumers that calling online should be free--making it harder to make a
profit.
"We believe a tremendous differentiating factor between Net2Phone and
other players in the voice-over-IP services business is the underlying
platforms and technologies that power our networks and services,"
Net2Phone chief executive Howie Balter said in a conference call today.
"We've announced today a process of 'productizing' that technology."
Spinning out gold?
Net2Phone still charges for its international calls, where considerable money
can be made by undercutting the high prices charged by traditional telephone
companies. Analysts say this will be a profitable market until international
telecommunications deregulation flattens out the traditional calling prices.
But Net2Phone also is in a unique situation among Net phone providers. The
technology it uses internally is strong and could be applied to other networks,
analysts say. Its decision to spin this software out as a separate subsidiary
likely marks as much of an attempt to gain revenue from this asset as a
genuine shift in business.
"I'm not sure that this is a result of weakness in the service business. It may
be more of the other way around," said Ofer Gneezy, chief executive of
iBasis, an international business-oriented IP telephony company. "Their
minute business is very strong."
Moreover, by partnering with Cisco, Net2Phone gains one of the most
valuable distribution tools available, because Cisco is among the most
powerful suppliers of Internet equipment in the business.
"We're not giving up any piece of the business by a long shot," said Sarah
Hofstetter, Net2Phone's spokeswoman. "But with AT&T, AOL and
Microsoft using our software...we have a good chance of being the de facto
standard for voice-over-IP in the industry."
The companies aren't saying how much each party will own of the new
venture. But Cisco is a minority partner, and Net2Phone says it expects 50
percent of its revenues will come from this software sector two years out.
On the service side, companies--including Net2Phone--must struggle to find
a way to support the free-calling model they've developed in the last year.
Advertising is helping, but all of them are moving into additional services,
hoping to tap into their subscribers' wallets by offering things like voice mail,
one-stop in-boxes and other services.
"I think (Net2Phone) had trouble revising their business model due to the fact
that these services are being offered for free in a lot of cases," said Jan
Horsfall, chief executive officer at PhoneFree, a competing consumer
Net-based long distance provider. "You've got to take that mass of users and up sell them to other
opportunities...If you're an advertising-only model you've got problems."
Horsfall said PhoneFree, Net2Phone and the others are looking for new ways to generate revenue, which could
be reflective of Net2Phone's new spinoff.
"The real opportunity isn't to make a fraction of a penny on a call," he said. "The opportunity is to use the
low-cost structure of the Internet and reformat your revenue streams…"
Gneezy agreed. "There's tremendous growth on the free, advertising-supported long-distance services. But at
some point that growth will stop when the level of advertising-based revenue slows. They'll all branch out into
unified messaging and other premium full-featured services. They'll move up the food chain to create more
revenue sources." |
