Voice over Internet Protocol; Wall Street Week
July 16, 2004
pbs.org
GEOFF COLVIN: How would you like to make unlimited phone calls, local and long distance, for a flat fee of just $30 a month? Or how about unlimited calls plus high-speed internet access plus digital cable TV, all for just $90 a month? If you haven't received such an offer yet you probably will soon, and it could come from your phone company or your cable TV company or even your electric power utility -- or from all three.
The business of connecting you to the world is turning upside down, and your head is probably spinning. Who wins? Who loses? And what should investors do now? Susan Kalla covers the industry for Friedman Billings Ramsey. Barron's dubbed her Dr. Doom when she predicted a major downturn a few years ago, but she turned out to be right; and by the way, she started her career as an engineer for PBS. Scott Cleland is founder and chief executive of Precursor, an independent research firm. He's also a top telecom analyst who spotted WorldCom's problems long before they made headlines.
Okay, unlimited calling for a flat monthly fee. The technology is called VoIP, voice over Internet protocol. It used to be the sort of clunky, geeky technology. Now Michael Powell, chairman of the FCC, says it is "the most significant paradigm shift in the entire history of modern communications since the invention of the telephone"
Susan, is Michael Powell exaggerating?
SUSAN KALLA: No, he's very right. It's a clear technology evolution, and it's the change from circuit switching to packet switching. Packet switching allows you to cram much more data onto the same bandwidth, onto the same channel as you could when you were doing circuit switching, which made you have individual channels for individual phone calls. This way you can aggregate phone calls, and it's much cheaper and more efficient to combine phone calls and combine phone calls with Internet information and sent it all over the same pipe.
COLVIN: Scott, is Michael Powell exaggerating?
SCOTT CLELAND: No, I don't think he is. The way circuit telecom is done is it connects one person with another, and if you want to do a conference call, it connects one, another, and another. What VoIP does is it makes it very, very easy. It is like having a voice browser, that when you want to call one or many people, you click a button and it instantly creates a phone call with those people. It could be a video conference call. It could be having a power point presentation next to your video conferencing. So it is essentially allowing the personalization of a lot of the technology that you have on this show and that we think are high tech, it's being brought to the individual consumer.
COLVIN: Can anybody under, or let's say anybody over the age of 22 do this? Because it sounds like, I mean do you have to be young and grew up with the Internet, or can my grandmother do this?
CLELAND: Well, what I think is interesting is that VoIP makes many of these things very, very simple. Just like point and click got simple and we all have grandparents and great grandparents who are on the Internet and they can understand the intuitive feel of pointing and clicking. And they'll bring the same intuitive, easy feel to voice applications. That's what's revolutionary, is right now we have a chaos of all different devices. We have your home phone, your cell phone, maybe a BlackBerry, maybe a pager, all these different things in different locations. And what VoIP does is allow unification in an organized way where you personally can choose how you want to organize it.
COLVIN: Scott, the phone companies used to regard VoIP as competition. It was evil incarnate. Now they're selling it. How come?
CLELAND: Well, you want to cannibalize yourself before somebody else does, and so it is a mortal threat to the Bells because it is a cheaper and better way to do voice communications. And so what they're trying to do is offer a VoIP light first so that they entice and lock in consumers before they see what real VoIP can do and the price that real VoIP can be offered to them.
COLVIN: Which is a very low price. And we should point out, by the way, that nobody calls it VoIP when they sell it, right. They come up with some friendlier name than that, but that's what it is. Now you say real VoIP. You mean that offered by companies like what?
CLELAND: Vonage is a real VoIP player, because all you need to be a VoIP provider is a server, essentially a server. It can be anywhere in the world, as long as it has a connection to bandwidth.
COLVIN: As long as you can connect to it from your house.
CLELAND: Yes.
COLVIN: Well, it is simple. I mean people don't understand, but we have it here. This is from Vonage. This is their modem, which looks like any other kind of cable modem you might have, and it's got one wire that goes into the wall and one wire that goes to your telephone. This one apparently was used previously for connecting with the Kremlin, but it's a normal telephone. And that's it, right? You can pick up the phone and make calls.
CLELAND: Yes, it's much simpler than it has ever been before.
COLVIN: Now this looks to me like one big war of attrition. The phone companies and the cable companies investing billions of dollars to put in new cable, new fiber and stuff, at the same time trying to undercut one another on price. They're just beating the daylights out of each other. How does one company win in an atmosphere like that?
KALLA: They don't. You know, the telephone companies and the cable companies are facing Vietnam, but fortunately they both generate an enormous amount of cash flow and they both have huge networks, so they're armed and dangerous and they're about to go to battle.
COLVIN: And they're about to go to battle. But continue with that thought, because what is the future for the big phone companies and the big cable companies?
KALLA: Their cash flow diminishes as their prices go down, because they have a big fixed cost to cover, and that's their network. This is the same problem that the airlines industry has that they go in and out of bankruptcy every five years, simply because for some reason the passengers don't show up or the fuel costs go up and it's more than they expect, and then they can't cover it.
COLVIN: Scott, what's the future for the big phone companies and the big cable companies?
CLELAND: Well, I would agree with Susan in the long term, but over the next few years and most people's investment horizons, I think there's a winner and a loser. And I think the Bells are the losers and cable are the winners. And the reason I think cable is going to do fine for the next few years is they have the best consumer IP network, period. They invested tens of billions of dollars over the last several years.
COLVIN: IP meaning Internet.
CLELAND: Internet protocol. They have over 750 times the bandwidth that a telephone company has. They can offer many, many services, everything from VoIP, home networking, home medical monitoring, all sorts of different services, easily and cheaply over it. The other thing people don't appreciate is there's not a price war going on right now. Cable, most of cable's revenue still has pricing power. An investor must like pricing power.
COLVIN: Now there are other aspects of the business that are interesting. We've got some cool new cell phones here. This is the latest from Nokia, the N-Gage model, the latest model, which is big on gaming, a lot of those features. Here's another one from Sony Ericsson, which is cool in that you can play videos and you can send videos back and forth with this one. This one's from Motorola. This is particularly tiny, and it has the smallest camera I think I've ever seen. That little tiny circle there is the lens for the camera. Now two questions: One, can the phone companies, the cellular service providers, make money selling these extra features like sending videos and sending pictures and so forth? And two, what's the outlook for the companies that make these things?
CLELAND: Well, wireless, the wireless trend and the wireless trend towards broadband which enables those services, is not necessarily a good one for the people that are offering cell phone service. And the reason is, is when you move to broadband, it allows companies like Vonage and others, whether it be 7-Eleven or whatever company, to get in front of the cell phone provider and the customer. And so wireless, when you move to broadband, what happens is disintermediation, or essentially it allows a customer, a competitor to step in front of your customer relationship and take your pricing power and your relationship away from you. So all of these neat services are going to be a boon for consumers, but they're very troublesome for suppliers.
COLVIN: Broadband over power lines? This is something I've heard about for a long time. It never came to anything. Now it seems to be amounting to something?
CLELAND: Yes, I've been watching it for over 8 ½ years and been one of the biggest skeptics waiting, it's almost like waiting for Godot for it to get right. And I'm convinced that it's at least now in the mix. They have solved the technological problems, and I think people are going to see and hear about it increasingly.
COLVIN: There's an old saying that times of revolution is when fortunes are made. We seem to be in a real revolution. Who's going to make a fortune?
CLELAND: It's going to be the new areas of converged services. Just like the Internet launched companies like eBay and Amazon and Yahoo and there were some big winners, there's going to be some big winners as voice converges in the technology area. And the underlying technology that is allowing this all to occur is something called session initiation protocol, which is what enables VoIP. And that, the people that master that new interface are going to be the ones that have the most upside. There will be Yahoos and eBays of the new VoIP world.
COLVIN: Is there any inkling yet of who they might be?
CLELAND: I think it's still too early.
COLVIN: One other aspect of this. What about the old idea of making your money in a gold rush by selling the picks and shovels, the companies that sell the equipment to all of these big phone companies and cable companies that may themselves have a hard time but the equipment sellers?
KALLA: Well, this is very similar to constant themes of investment. If you see the war coming and you can't figure out who the winners are going to be, if it's not self evident, then you're much better defaulting on the whole thing and investing in the arms suppliers. So all of these companies are going to have to invest in their networks to lower their cost bases so they can compete on price, and the only way that you can compete on price is replacing labor with capital. So you automate functions and bring down the cost floor, and then you have the flexibility to decrease your prices. So that's typical of the commodity business, and that's the business that telecom is clearly headed into.
COLVIN: And so who are those companies going to be?
KALLA: Oh, anyone that's a major supplier. So it would be niche suppliers that do innovative different kinds of equipment, a lot of private companies in the optical and networking space. And then the large companies, the Lucents, the Nortels.
COLVIN: Cisco?
KALLA: Certainly the Ciscos, the Junipers, you know, CIENA, the optical players. There's lots of different niches that all of the Bells are at least upgrading their access network, so that's the far reaches of the network to go broadband. And so anyone that has networking gear and optical gear would be a beneficiary of that trend.
COLVIN: Scott, suppliers who might do well?
CLELAND: One of the ones that we think is in the right place at the right time is Avaya, in the sense that they have a lot of the installed base of equipment that will be converted, the corporations will convert to go to VoIP, and the voice over IP, the VoIP providers are targeting the big company market first. So that's one.
And we think in the router space that much more than Cisco, Juniper is the one that is probably going to benefit the most from this trend.
COLVIN: It is really a revolution, and you have brought us up to speed very considerably. Thanks for your insights, Susan, Scott.
KALLA: Thank you. |
