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With iChat, Who Needs a Phone?

By Alex Salkever Give Steve Jobs credit. For a man who heads a comparatively small technology company, he sure knows how to alter the tech landscape. The exuberant and often exasperating CEO of Apple Computer (AAPL) gave the music industry its groove back in April when he introduced a powerful one-two punch of iTunes and the online Apple Music Store. With 99-cent downloads, Jobs also handed music lovers what they wanted: high-quality downloads, a fair price, a good selection, and the right to do what they see fit with their music. With 5 million paid downloads in two months and a version for Microsoft (MSFT) Windows users on the way, it's easy to see why music industry execs are dancing in their boardrooms.

While the record labels have been a lucky benefactor of Jobsian innovation, the phone companies are about to get whacked by Jobs's quest to give Apple users something else they want. I'm talking about the latest beta version of iChat. Released in late June at Apple's World Wide Developers Conference, the new version lets iChat users go beyond typed text messaging to actual voice conversations over the Net.

All you need is a Mac running OS X, a decent external microphone, and a connection of 28 kilobits per second or so. A broadband link isn't necessary. (This version also lets iChat users establish on-the-fly video calls with others on the iChat system, but the video isn't nearly as impressive as the voice capability.) I tried talking to someone in Amsterdam who was on a narrowband connection. He couldn't do much else on the computer when he was talking, but the iChat connection held up very well. On all broadband links, iChat has worked without a hitch for me.

TWO-WAY TRAFFIC. In fact, I feel iChat has several insanely great things going for it. Installation is painless, in the Apple tradition. Also very Apple-like, the system works flawlessly right off the bat. And it coexists easily with a popular existing function, instant text messaging. The voice quality is just a notch below regular phone service and several notches above cell-phone connections.

Unlike most other software designed to let people speak directly to each other over the Net, iChat is "duplexed." That means if two people talk at the same time, they can still hear what the other is saying because the connection can handle traffic going in both directions simultaneously.

I was also highly impressed with iChat's ability to carry streaming traffic through not one but two firewalls that guard my connection. These beauties keep the hackers out, but they often disrupt streaming-media services. Apple has built a neat work-around that lets my system instruct the iChat servers about which ports are open on my firewalls and allow streaming voice traffic to go in and out.

NO COSTLY BELLS. Best of all, iChat lets me bypass the phone company. For the few people on my instant-messaging buddy list who have iChat, I don't pick up the phone anymore to talk to them. I simply look to see if they're available and, if they are, I click on the voice connection button in iChat. A few seconds later, I have the equivalent of a phone line. If everyone on my IM list had the new version of iChat, I would think very seriously about dumping my wireline phone service. Just give me a cordless headset to connect to my Mac, and my IM will supplant the phone almost entirely.

Take this one step further, and it's not so farfetched to imagine that the various IM systems from America Online (AOL), Microsoft (MSFT) and Yahoo! (YHOO), among others, will quickly morph into major competitors against the lumbering telecoms. And it will hasten the day when Internet users can set up their own phone service, or at least something that functions as phone service does today. All they'll need is a dumb pipe connected to the Internet with no costly bells and whistles attached.

Everyone agrees that communications using packets of data typified by the Internet will ultimately replace the circuit-based system used by the legacy phone network. All the big telecom providers are busily switching from networks built largely to handle dedicated circuits for voice calls to vastly more efficient and flexible networks that handle voice traffic in bits and bytes, just like data. But their efforts presuppose a paradigm where they'll continue their role as the middlemen who route all calls.

VOICE OR DATA? Already the Baby Bells and long-distance companies are seeking to consolidate their hold on that role with fierce lobbying efforts aimed at regulating so-called voice-over-IP communications, like iChat. Upstart companies, such as New Jersey-based Vonage, have the audacity to tap into the phone system the cheap way. Rather than pay stiff interconnection fees to complete long-distance calls or costly tariffs to rent high-capacity local circuits, Vonage and others others sell specially equipped phones that can turn any home broadband connection into a phone hook up. The voice traffic flowing over these users' broadband connections is virtually indistinguishable from data traffic. On the Net, surfing to and phoning grandma can be one and the same.

Vonage charges a flat monthly fee $40 for local and long-distance calls inside the U.S., and calls to foreign countries are a rather cheap 5 cents or 6 cents per minute. This development fulfills the often-made prophecy that voice communications, both local and long-distance, will become another flat-fee service. The Baby Bells and long-distance companies know this, too: MCI (WCOEQ) offers a flat-fee local and long-distance plan to millions of U.S. subscribers. The Baby Bells, most notably Verizon (VZ), have also begun experimenting with such packages (see BW Online, 6/6/03, "Phone Companies Find Bundles of Joy").

500 MILLION USERS. Still, all of this presupposes a phone network and a system designed specifically to move voice traffic. Now, though, there's no longer any need for someone to sell voice service. Consumers can piece together their own phone networks over the Internet, thanks to the rising tide of iChat-like technology. Since most Internet traffic still travels over dial-up connections, that part of the phone network will still be necessary, and users will continue paying for connections to the Net. But there would be no reason to pay special fees, such as long-distance charges, for antiquated, dedicated voice phone service.

Let's do the numbers. America Online (AOL) alone has 350 million users on its two IM services, AOL Instant Messenger and ICQ. Several technologists have told me that what Apple has done, while technologically sophisticated, wouldn't be hard for other IM services to replicate. In fact, iChat and AOL IM are already compatible. iChat users show up on the buddy lists of AOL IM users and vice versa. Give all those users an iChat-like voice capability, and all of a sudden you have a phone network with more than 350 million users.

These number don't include Yahoo and MSN's IM customers. If at some point those two interconnect with AOL's dominant IM network, the tally would likely eclipse 500 million. And once word gets out that you can have free phone service simply by signing up for IM, I guarantee millions more people will come aboard.

YEARS, NOT MONTHS. The net effect on the telecoms would be nothing short of catastrophic. The rise of IM as a viable mechanism for voice communication would undermine the pricing power of flat-rate voice plans by virtue of being even cheaper than Vonage, which mails out phones that it sells below cost. A desktop microphone suitable for iChat costs $15.

It will also eliminate the need for a middleman to mind the huge chunk of the phone networks used for interconnecting dedicated voice calls and the services associated with those calls. Everyone will be able to connect directly. That would hasten the decrease in the value and utility of legacy phone networks, which rely on massive penetration and use to make money.

Granted, none of this could happen overnight. Big shifts in technology take shape over years, not months. Although Apple is making a big splash, it remains a bit player in the grand scheme, without enough users to shift markets.

CELLUAR LIFELINES. Further, traditional phone service carries all sorts of regulatory baggage that makes replacing it with IM tricky. For example, voice-over-IP won't work if someone can't afford to buy a computer. Likewise, the phone goes down if power or the Internet connection goes down. That would be a serious problem because the legacy phone system remains a lifeline, although cell phones are a potential replacement here, too.

After all, most users find their cell phones as reliable as local phone connections because no one buys a cell with a coverage plan that doesn't work in their own home and neighborhood. Further, cell networks have proven more resilient. Witness the aftermath of September 11, when mobile networks held up while Lower Manhattan's wireline circuits remained dark for days.

In the past, Apple has contributed to big technological shifts such as introducing the graphical user interface to consumers and, more recently, creating a viable platform for digital music sales online. If past is prologue, then Jobs's latest innovation could hasten a coming age when anyone who wants to can use their PC to bypass traditional phone services.

They could do this using simple connectivity, cheap hardware, and free software that's familiar to and widely accepted by hundreds of millions of Net users. That's bound to feel like a phone book dropping on the Baby Bells' heads. Salkever, Technology editor for BusinessWeek Online, is alternating with Charles Haddad on Byte of the Apple

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