Why NTT Is Running Scared

The giant is losing business fast to Internet telephony

A scuffle over telephone interconnection fees might sound like the sort of arcane dispute that gets regulators and phone companies hot under the collar but makes consumers yawn. In Japan, though, a proposed increase in such charges may be worth getting excited about. Why? Nippon Telegraph & Telephone Corp. is lobbying hard to increase fees--by 8% to 13%--to swat down purveyors of Internet phone service, which it sees as a threat to its dominant position in Japan's $40 billion fixed-line phone business.

NTT has reason to be worried. Japan is emerging as the world's fastest-growing market for Net telephony. More than 6 million homes now have high-speed Internet connections that can also accommodate phone calls. And with broadband rates as low as $25 a month --compared with $40 or $50 for similar services in the U.S.--hundreds of thousands more are signing up every month. Worse--for NTT, at least--2.4 million broadband subscribers have opted for cut-rate phone service on their broadband lines, according to Yano Research Institute. By 2005, that number is expected to grow to at least 6.5 million, or 10% of all phone subscribers. "We're forcing down calling rates," boasts Masayoshi Son, CEO of Softbank Group, which owns Yahoo!BB, Japan's leading broadband provider. "No one can keep up with us."

Those are fighting words to NTT, which is determined to perk up its wilting phone business. Its weapon of choice is the long-distance interconnection fee--what NTT charges carriers such as Softbank to complete calls that travel over the Internet but then connect to the conventional phone network to reach their destination. After wooing politicians and regulators, NTT is expected to get the go-ahead in the next month or so from the Telecommunications Ministry to boost its interconnection charges.

Why is this fight so important to NTT? Internet telephony can destroy the traditional economics of the phone business. Conventional phone systems, called circuit-switched networks, create an electronic link between two phones that remains intact as long as a call is connected. Internet phone systems, by contrast, chop calls up into tiny pieces of data that flow through the network via various routes--just as e-mail messages do--before being reassembled at the far end. That flexible routing is far cheaper than the dedicated circuits of older systems. For instance, NTT charges 68 cents for a three-minute call from Tokyo to Osaka, while three minutes anywhere in Japan costs 6 cents on Softbank's BB Phone system.

One reason more Japanese are signing up is that quality concerns are largely a thing of the past. In early Net phone technology, bits of conversations often didn't make it to their destination in the right order. These days, call quality is almost indistinguishable from that of circuit-switched networks. Furthermore, while Internet calling once required hookups through a computer, callers now can use handsets that look like regular phones.

With prices plummeting and quality improving, soon there will be little reason for Japanese with broadband links to pay NTT's higher prices. NTT has already seen fixed-line voice traffic fall by nearly 20% over the past two years. That's mainly due to growing use of cell phones. But in the next few years, Internet telephony could siphon off nearly half of voice traffic, predicts Tadashi Onodera, president of KDDI, Japan's No. 2 phone company, which is planning its own Net phone service.

NTT's rivals fear that the new fees will slow the spread of an important new technology. For instance, Fusion Communications, which provides 2 million corporate clients with Internet phone service, may be forced to slow its expansion. "It will be hard for us to compete in this market if NTT raises access fees," says Katsuya Shishido, general manager for services at Fusion. KDDI's plans to push into Net phones could suffer, too, says Sobee Shinohara, KDDI's senior manager in charge of regulatory affairs. "Higher access fees will hit us where it hurts--in our profits," he says. Officials should pay heed: If the fees stifle innovation as well as profits, they're likely to hurt the entire country.

By Irene M. Kunii in Tokyo

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