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For Whom the VoIP Bell Tolls

Bob Johnson is one of the people who are about to turn the phone industry upside down. The director of telecommunications and network services at Dartmouth College, Johnson has contracted with a traditional telco for years to provide the school with phone service. When his current contract expires in March, though, Johnson expects to switch to one of the hot VoIP (voice over Internet protocol) outfits that are lining up to steal customers from traditional carriers.

Making phone calls via the Net will slash Dartmouth's annual phone bill by 25% to 40%, Johnson figures. And though some established carriers offer VoIP service, Johnson expects the startups to be cheaper. Muayyad Al-Chalabi, an analyst with telecom consultancy RHK in San Francisco, thinks the newcomers will charge as much as 30% less.

WAVE OF DEFECTORS. That's a potentially huge problem for the U.S. telecom industry. Based on its recent survey of 270 corporations, tech consultancy Meta Group in Stamford, Conn., estimates that nearly 30% of U.S. businesses may move to VoIP within two years. Consumers won't be far behind: By 2009, the Net will carry 40% of calls made in the U.S., estimates the New Millennium Research Council in a December report. People will be using the technology to make regular as well as some cell-phone calls.

As this shift occurs, VoIP may give phone companies' competitors their first real chance at success in years. Unlike traditional phone service, VoIP isn't regulated -- at least for now. And many of the new providers -- including Time Warner Cable, a subsidiary of Time Warner (TWX), Comcast (CMCSA), and Cox Communications (COX) -- have the marketing muscle and sophisticated networks needed to compete with established phone companies.

To these cable guys, VoIP looks irresistible, since it has the potential to generate as much as $300 per year in extra revenue per subscriber, says Andrei Jezierski, a partner at tech consultancy i2 Partners in New York. By including VoIP into their bundle of other services, cable operators can also reduce customer turnover by more than 50%, estimates Bryan Wiener, president of global services at VoIP service provider Net2Phone (NTOP).

VULNERABLE BELLS. If they play their cards right, cable outfits could grab 5% to 20% of the $200 billion phone-services pie within 10 years, according to various estimates. The winners and losers will start to become apparent as early as 2005, says Chris Finn, a partner at IT consultancy IBM Global Services. He believes that eventually a majority of consumers could end up making their calls via cable. He adds that a few well-positioned traditional carriers -- such as AT&T (T), which has its own Internet protocol network and is already running trials of VoIP services in three states -- might dominate the corporate market.

Likely losers could include phone companies that hold off on offering VoIP. That's because customers soon will expect VoIP to be a basic component of Internet access, says Vinton Cerf, a senior vice-president at MCI and the co-inventor of the Internet protocol, the technology standard for sending and retrieving data over the Web that VoIP uses. Eventually, wireless service providers could be affected by VoIP as well, but that's farther in the future, say experts.

Particularly vulnerable to this new competition could be carriers that primarily serve local markets, including Verizon (VZ), SBC Communications (SBC), and BellSouth (BLS). About 30% of their revenue comes from fees paid by other telcos for the use of their networks to complete calls, estimates RHK's Al-Chalabi. As calling via the Internet spreads, the usefulness of such arrangements will decline. What's more, the established outfits are accustomed to moving slowly -- a problem when dealing with a technology that could start eating into their businesses within six months, says Finn.

"WE'RE VERY SERIOUS". The telcos believe their expertise in phone services won't be easily acquired by rivals and will, in the end, save their business. "Providing voice services of high quality and reliability isn't an easy thing to do," says David Young, director of technology policies at the nation's biggest telecom, Verizon.

Even the incumbents that react nimbly will suffer, however: As competition intensifies, monthly charges could fall as much as 30% over the next two years, estimates Al-Chalabi. Thus, the established carriers' revenue growth could flatten and their profit margins compress as newcomers take more business.

Cable outfits may be the primary threat. Already, two out of three broadband customers in the U.S. get their Internet service from cable providers, for whom VoIP is rapidly becoming a top priority. "We're very serious," says Gerry Campbell, Time Warner's senior vice-president for voice. "Our CEO is clearly focused on this." Time Warner will roll out its VoIP service across most markets in 2004, making it available in a bundle with cable subscriptions at a discount, Campbell says.

CORPORATE INVASION. Pure-play VoIP concerns will also provide competition. Though some analysts question their staying power, these businesses are signing up subscribers quickly. Privately held Vonage in Edison, N.J., has attracted 85,000 customers since its launch three years ago -- and says it's adding 10,000 more per month. Its VoIP plans range from $14.99 to $34.99 a month, with the latter including an unlimited bucket of anywhere minutes -- nearly a 30% discount to fees of traditional players.

Vonage also offers features such as a virtual phone number that works in any of 180 area codes, says Chairman and CEO Jeffrey Citron. For an extra $4.95 a month, a customer in California who constantly calls New York can now dial the East Coast as a local number. So far, the established carriers that offer VoIP mainly offer a few basic features, such as voice mail and caller ID -- and those only in a few states.

The phone companies' grip on corporate accounts could also be threatened -- by both their own customers and by telecom-equipment makers. In the past, large customers have set up PBXs (private branch exchanges) -- internal phone networks managed by a telco. As corporations switch to VoIP, they'll realize that they can manage their own phone system using a voice-over-IP PBX, says Elizabeth Ussher, a Villa Park (Calif.) analyst with Meta Group. VoIP PBXs, supplied by the likes of Cisco Systems (CSCO) and Alcatel (ALA), started to gain significant market share just before the economic downturn.

PBX SHAKEOUT. Many corporate tech departments now have experience in working with advanced technology such as high-speed Wi-Fi (wireless fidelity) networks. Plus, the latest PBXs for Internet protocol are easier to manage than the older gear. Most upgrades can be simply done via reprogamming, without any changes to the physical infrastructure. Dartmouth College's Johnson figures that a VoIP PBX will cost half as much to maintain as the $500,000 needed annually to run a traditional, campus-size PBX.

As sales of VoIP PBXs ramp up, some equipment makers could even compete with phone carriers to provide PBX management services. Some analysts believe that networking king Cisco could enter this business, though it denies any such plans, according to Don Proctor, vice-president and general manager of Cisco's voice-technology group.

In the $14 billion PBX business, makers of the VoIP variety will make life tough for traditional telecom-equipment makers such as Nortel Networks (NT) and Lucent Technologies (LU), say analysts. Cisco's Internet protocol product sales are growing at double the industry rate, say analysts. And startups such as Cedar Point Communications, privately held and based in Derry, N.H., have found customers such as Comcast for their switching equipment, says David Spear, an executive vice-president at Cedar Point.

NOT CUT OUT -- YET. The incumbent equipment makers are responding by increasing their efforts to supply the VoIP market. About a month ago, Lucent announced a special strategy and products for VoIP, including various switches and software. It believes its long-standing relationships with phone carriers will give it an advantage in retaining business, says Roger Heinz, vice-president for convergence solutions at Lucent.

The advent of VoIP isn't the end of the world for the traditional phone carriers. Today, the U.S. has more than 180 million regular phone lines vs. fewer than 30 million broadband lines (a prerequisite for quality VoIP). For the foreseeable future, moreover, cable operators and other VoIP newcomers will need the telcos' help to route calls to their customers who aren't on IP networks.

Even so, U.S. broadband adoption is growing at 40% a year, according to RHK, so the threat to the phone companies could grow rapidly. That means the established carriers will have to hop onto the VoIP bandwagon fast -- or be left behind. If nothing else, VoIP offers them an opportunity to recoup some of the estimated 12% in annual revenues they're losing as customers disconnect their second phone lines when opting for broadband, estimates i2 Partners' Jezierski. (With broadband, consumers can make calls and surf the Web at the same time, over the same line.)

"PLANETS ARE ALIGNING". Some incumbents might acquire companies with VoIP expertise. In December, local phone company Qwest (Q) bid for most assets of bankrupt Allegiance Telecom as the basis for its IP network (see BW Online, 12/18/03, "Qwest Opens the War for Allegiance"). Others might build their own networks, thus raising the ante for VoIP competitors, all of which are still losing money, though some expect to turn a profit in 2004.

Cable outfits, meantime, may be distracted by that other war for customers they have to fight -- against satellite TV systems. It may not help that in surveys consumers tend to associate cable companies with constantly rising rates, says Cathy Martine, senior vice-president in charge of VoIP efforts at AT&T.

Who has the best chance of success in VoIP will also be determined in part by regulations covering call-transfer fees and other issues that the Federal Communications Commission is expected to release within the next year or so. But many experts believe the FCC will take a light-handed approach -- leaving the established phone companies to largely fend for themselves.

Whatever else happens, it's obvious that "the planets are aligning for VoIP in 2004," says Joe Glynn, Qwest's vice-president for product strategy. "This is clearly the way the industry is going." And the players that don't get up to speed fast could lose out. By Olga Kharif in Portland, Ore.

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