Semi_OT:Market for Internet Calling, Once Tiny, Gets Crowded Fast Better Technology, Few Rules Spur Flood of Competition;
Pace of Change Is Dizzying Vonage Takes On 'Von-a-bees'
By SHAWN YOUNG
Staff Reporter of THE WALL STREET JOURNAL
August 26, 2005; Page A1
EDISON, N.J. -- In 2002, Vonage Holdings Corp., a tiny start-up with about 50 employees, sparked a revolution in the U.S. phone industry when it began offering an Internet-based telephone service at rates far below those for traditional phone calls. More than 800,000 subscribers signed up, and Vonage, which now counts 1,500 employees, is about to move to new headquarters and is planning an initial public offering that could raise as much as $600 million.
But its key selling point -- inexpensive phone service -- is no longer so special. Verizon Communications Inc. and AT&T Corp. have started their own Internet-based phone operations, as have a slew of cable companies and small start-ups. Within the next year, nearly every major player in the communications world will offer an equivalent service. Some rivals are already pitching prices below those of Vonage, and at one successful outfit, some calls are free.
After years of hype, Internet phone calling has finally caught on, but the technology's very success is threatening to turn the multibillion-dollar phone business into a cheap commodity. Ever since AT&T lost its monopoly in 1984, the industry has been plagued by falling prices. Now, using the Internet, companies don't need to own or even lease a telephone network to sell telephone services. It's a market governed by virtually no regulation. As a result, competition is flooding in like never before, driving prices to their lowest possible levels and threatening to send profits to near zero.
Even in an industry where change is the only constant, the rapid life-cycle of the Internet phone industry is dizzying. In three years, for example, Vonage has gone from being a miniscule start-up to the industry's star to being the established leader with a target on its back.
Driving the popularity of the service is the expansion of broadband Internet connections that can quickly handle music downloads, video and phone calls with minimal distortion. While about 40 million households still rely on dial-up connections, most new subscribers choose broadband, which now serves more than 36 million homes, according to TNS Telecoms, a Jenkintown, Pa., market-research firm.
By the end of 2005, about four million Americans will purchase local, long-distance and international telephone services through their Internet connections, a number that's expected to grow to about 17 million in the next three years, according to Jon Arnold, an independent analyst. Conventional household phone lines, by contrast, now numbering about 123 million, are declining steadily.
The rapidly expanding Internet-phone market has spurred brutal price competition. Last year, Vonage cut its prices by nearly 30%, twice undercutting the list price of AT&T's rival service, called CallVantage, while AT&T cut its prices twice in four months. Several cable companies have entered the phone business recently and some are offering promotional packages including telephone calls, television and Internet services at drastically reduced rates.
Internet technology even allows overseas companies to offer phone services in the U.S. to anyone connected to the Internet. Internet calling is already popular in other parts of the world, including Europe and Japan.
This downward spiral is reminiscent of the battles that beset the long-distance phone industry, where AT&T, MCI and dozens of start-ups fought each other by slashing prices. The eventual winners were large, regional phone companies that joined the long-distance battle at a late stage. They faced rivals that had largely bled each other dry. The long-distance companies couldn't match the Bells' sales packages of local, long-distance, Internet and wireless calls.
Similarly, many investors and industry insiders expect to see a shakeout among Internet-phone start-ups, while they say larger phone companies will have to find ways to offset falling prices. Companies with no other businesses to offset declining revenue could go belly up.
"If all we're doing is driving down price, we lose," says Jeff Pulver, an industry pioneer and promoter who helped start Vonage. He has since moved on to other projects including pulvermedia, which organizes trade shows, and an Internet-based calling service called Free World Dialup intended to help promote the industry.
Most of the latest Internet calling services are far more sophisticated than the early computer-to-computer options available a decade ago. In the U.S., early pioneers such as Net2Phone Inc. sold phone services that worked over dial-up Internet connections and required users to speak into microphones attached to their computers. Customers' slow Internet services couldn't handle the calls and the voice quality was too poor for the mass market.
Many of the current offerings use a more-sophisticated version of this technology, called voice over Internet protocol, or VOIP. But this time, it works through regular telephone handsets. The phone connects to an adapter that turns the conversation into bits of digital information, which are then sent in fragments over an Internet connection, and reassembled as sound at their destination.
Many VOIP services, including Vonage, are able to offer deep discounts because they don't have the expense of maintaining their own communications networks. That means, however, that calls may travel over the public Internet, where they jostle with Google searches, eBay bids, email and other random traffic. Since voice data are easily distorted by even small delays, Internet calls sometimes don't sound as good as standard calls. Some larger phone and cable companies, which own their own networks, can provide more consistent quality, though they typically don't offer the cheapest service.
Nonetheless, in recent years the quality of Internet calling has significantly improved. Many Internet phone services are so similar to standard services that some customers don't even realize they are using Internet technology.
What's more, many Internet calling services include free high-tech features, such as sending subscribers emails when they receive a voicemail. Vonage users can go to a personalized Web page and click on a link to hear the message. These advanced features also appeal to corporate phone users and many large businesses are working with their existing carriers, such as AT&T and MCI, to shift telephone calls onto their existing data networks.
Vonage began in 2001, led by Jeffrey Citron, 34 years old, the former chief executive of securities firm Datek Holdings Corp. and a veteran of the 1990s day-trading craze. Mr. Citron and several colleagues were accused of improperly trading on behalf of themselves and their firm using a system intended for small transactions by individual investors. In 2003, he paid $22.5 million to settle civil charges from the Securities and Exchange Commission and neither admitted nor denied wrongdoing. He declines to comment on the matter.
Ka-Ching!
In the early days, Vonage targeted a largely male clientele made up of hard-core technophiles. The competitive landscape was wide-open and customers kept on coming. The company set up an email alert that rang on employees' computers with a cash register's "ka-ching!" every time someone ordered the service.
"Sometimes you would wait four or five hours between rings," recalls Mr. Citron. Two years ago, he says, it started ringing constantly so "we had to switch the damn thing off."
To keep growth going, Mr. Citron put some of the $408 million raised from venture-capital investors into slapstick TV ads that emphasize the foolishness of overpaying for phone service. Vonage is also expanding into the United Kingdom and other countries. "We're really at a land-grab stage," says Chief Financial Officer John Rego.
At phone companies throughout the country, Vonage's success didn't go unnoticed. Mr. Citron made sure of that. He boasted in an interview earlier this year that he would drive traditional phone companies out of business. "We'll buy Verizon when it comes out of bankruptcy," he quipped. He has also joked about the high price rivals would have to pay to buy Vonage.
Mr. Citron and Mr. Rego decline to comment on the previously reported possibility that Vonage might seek an IPO. Vonage hasn't made any filings with the Securities and Exchange Commission on the matter.
While publicly dismissing Vonage and other start-ups as too small to be a serious threat, large phone companies began developing their own Internet-calling strategy. The first major player was AT&T. It launched an Internet calling plan in March 2004 at $40 a month -- $20 for the first six months -- covering all types of domestic calls.
Vonage nicknamed its rivals "Von-a-bees," but nonetheless responded swiftly, lowering its monthly rate to $30 from $35 in May 2004.
Three months later, the line between traditional phone companies and Internet start-ups blurred even more. Verizon, the largest U.S. phone company, launched VoiceWing, an Internet-based phone service. It now offers the service to all comers, even non-Verizon customers. Verizon's high-speed-Internet customers pay $30 a month for the first year; others pay $35.
By October, Vonage and AT&T cut their base rates again, followed by Verizon, which introduced a new, lower-cost plan with some restrictions. Promotional discounts offered to new customers of Cablevision Systems Corp., a New York cable company, make phone service essentially free for the first year.
The large phone and cable companies hope to use Internet calling as a base to build other businesses. Verizon, for example, plans to offer a combination of Internet-based phone service, Internet access and TV service over its privately managed network. Verizon says running one Internet-based network instead of multiple old-fashioned ones could cut its costs in this area by 40% or more.
"We all concluded that you're not going to stop the technology," said Michael Hassett, Verizon's senior vice president of voice services.
SBC Communications Inc., which earlier this year agreed to acquire AT&T, currently offers traditional local phone service in a 13-state region that includes Texas, California and Connecticut. It's planning to use AT&T's Internet-based CallVantage service to offer phone service to the rest of the country.
From Hype to Skype
Amid the enthusiasm, however, is the specter of relentlessly falling prices. One fast-growing start-up, privately held Skype Technologies SA, based in Luxembourg, offers free calls to its 51 million world-wide customers. The free element of the service works between personal computers and some specially adapted personal organizers and phones, provided both users are Skype subscribers.
Skype's main revenue source is the more than two million people who pay to make calls from their PCs to conventional telephones. Skype also charges for voice mail. Skype marked the first anniversary of its paid service by cutting rates to more than 30 countries by an average of 15%. Many of Skype's international calls to regular phones cost about two cents a minute.
Niklas Zennstrom, Skype's chief executive, says he's content to make just a handful of dollars a year from each of Skype's customers. "Google has $10 average revenue per user, per year," he says. "We want to be as good as Google or Yahoo." Skype is now exploring the possibility of selling itself and has hired investment bank Morgan Stanley & Co. to help outline its options, according to people familiar with the matter.
Another threat: free instant-messaging programs from Microsoft Corp.'s MSN unit, Yahoo Inc., Time Warner Inc.'s AOL and Google Inc. that allow PC users to talk to each other through their computers. AOL has already taken the next step and launched a full-service offer similar that of Vonage.
As more and more players enter the U.S. market, Vonage is expanding abroad. But the company is finding the effort difficult, with some markets already crowded. BT Group PLC in the U.K. and KPN NV in the Netherlands are among traditional telephone companies already offering such services to consumers.
In the U.K., Vonage has found it difficult to undercut calling plans offered by even traditional phone companies. Vonage offers unlimited calls to regular landlines for the equivalent of $18 a month, while Tele2 AB of Sweden, which resells airtime on BT's network, offers a similar package for $13.50 a month.
Amid these threats, Vonage is emphasizing quality, stability and features instead of price, all the arguments typically made by traditional phone companies. "It's not our desire to be the cheapest operator," says Mr. Citron, the company's chief executive. |
