Microsoft: Your Next Phone Company?

It's keeping mum, but the giant has already introduced software that could turn into the killer phone application

On Feb. 12, the Federal Communications Commission ruled that a voice communication between two people using PCs is more like an e-mail than a phone call. This decision on a petition brought by Jeff Pulver, the entrepreneur behind the Free World Dialup Internet phone service, meant that the hundreds of thousands of people who now use broadband connections for voice conversations can continue to do so unmolested by the tariffs that are levied on traditional phone calls to support 911 service and universal access to the phone network.

While Pulver was jubilant, and the operators of a handful of increasingly popular PC telephony services such as Skype sighed with relief, most of the technology and telecom world yawned. Phone calls between PCs remain rare in the grand scope of the telecom universe. Few businesses use these systems, which remain far less developed than cutting-edge corporate-communications systems sold by the likes of Avaya (AV ) and Cisco (CSCO ). Those employ Internet protocol to route calls over data connections, but they rarely use the PC as an origination or termination point.

Replace Pulver, whose system now has 175,000 users, with Microsoft (MSFT ), however, and the FCC ruling could have enormous significance. The software king has for years made noises about augmenting the voice-communication capabilities in its operating system to allow any two Windows PCs to create a voice link over the Net.


  "The Pulver petition becomes important for the market when Microsoft pushes a voice product," say Blair Levin, an analyst with Legg Mason and former chief of staff at the FCC under William Kennard during the Clinton Presidency. "If you can turn each Windows PC into a voice device, you suddenly have a whole new phone network that never touches the public switched telephone."

He's clearly not the only one to think that. In April, 2002, a software engineer named Larry Pearson took the stand to testify against Microsoft on behalf of his employer, SBC Communications (SBC ). As one of the seven Baby Bells that emerged from the 1984 breakup of AT&T (T ), SBC was one of the largest communications companies in America, with a near monopoly on local phone service in chunks of 13 states across the West, Southwest, and Midwest.

Yet Pearson claimed that Microsoft, with its dominant position in PC operating systems, might one day use that power to short-circuit SBC's efforts to create a unified messaging service that would make it possible to retrieve voice, e-mail, fax, and other communications over the same platform.


  At the time, these concerns seemed premature. Few corporations were using desktop PCs for anything beyond e-mail and instant messaging. And not many consumers had the broadband connections required for voice calls made from PC to PC via the Net -- also called voice over Internet protocol (VoIP). Without broadband, call quality was inferior, and even with broadband it lagged behind the clarity of traditional phone networks.

What's more, Microsoft didn't even have a product similar to what SBC was planning. "It's unusual for someone with close to dominant market share [to argue] to a court that a party with 0% market share in the relevant market of voice should nonetheless be forced to submit to stiff penalties," says Levin.

Fast forward two years, however, and broadband is now in 50 million U.S. households and is spreading at a 50% annual clip, according to Nielsen/NetRatings. On the job, 75% of U.S. workers have a broadband connection. At the same time, VoIP technology has improved enough to entice every major U.S. cable-TV company to offer some sort of phone service to their customers. Not that the average Net surfers needs help turning an Internet connection into a voice connection.


  As of Feb. 27, nearly 8 million Web surfers had downloaded software from free Internet calling network Skype. Founded by Niklas Zennstrom, who created the popular file-swapping KaZaA application, Skype has built a peer-to-peer community around a high-quality VoIP application that's easy to use (see BW Online 1/6/04, "Skype: Net Telephony as File-Trading"). The latest version even works well over fast dial-up connections.

All of the major instant-messenger software programs from America Online (TWX ), Yahoo! (YHOO ), and Microsoft now boast voice capabilities. And software companies that are building more secure corporate versions of instant messaging have also rolled audio communications into their products.

Against this landscape, SBC's fears of Microsoft look far more relevant than they did a couple of years ago. Over the course of the typical five-year replacement cycle for PCs, the Redmond (Wash.) software giant could distribute such capabilities to the vast majority of computer owners with minimal added cost.


  For instance, the Windows XP operating system already contains so-called session initiation protocol (SIP) software. SIP is an industry-standard technology that defines how computers interact with the public phone network, instant-messaging software, and Internet telephony networks and applications. The Pulver decision effectively clears the way for Microsoft to move forward on these initiatives without worrying about getting tapped to pay charges and fees levied by on regular phone companies and wireless carriers -- and possibly in the future on VoIP providers that don't use direct PC-to-PC connections.

In an effort to start tying these loose ends together, last August Microsoft launched its Live Communications Server (LCS). This piece of software could turn into the killer phone application that SBC feared. Aimed at big corporations seeking to leverage their PCs to create unified communication systems on the desktop, LCS can perform a wide variety of tasks, from creating secure instant-messaging connections to alerting members of a workgroup that a key document has been posted to a virtual whiteboard.

Perhaps most important, LCS, which hooks into both Microsoft Office and Windows Messenger, can be customized to create on-the-fly audio connections between PCs and even groups of PCs.


  That has allowed one LCS customer, Siemens, to start supplanting conference phone calls with LCS-based conferences. The German tech company claims that it can save $95 per four-person conference call and 30 minutes of work by eliminating the need to set up a bridge, distribute call-in numbers, or secure online collaboration tools to allow participants to look at Web presentations together. All of those can be handled by LCS. Microsoft, which declined to comment for this article, is keeping a relatively low public profile on LCS and related products.

Should Microsoft move more strongly into the business telephony market before other VoIP providers get big, however, it might yet attract the FCC's attention. Gates & Co. have so far avoided that by laying low and playing nice with the standards bodies that are setting up common protocols to be used in SIP communications. Still, Microsoft will need to convince its customers to upgrade to Office 2003, which is required to get the full communications capabilities of LCS.

"I think the embedding of collaboration tools in Office 2003 is compelling. The question is to what extent can they convince the enterprise that this is worth it," says Nick Shelness, a consultant with messaging and collaboration research firm Ferris Research.


  When Microsoft does make a big move for a major share of the Internet phone pie, it will likely face some potent competitors. Leading VoIP gearmakers Cisco and Avaya have staked out strong positions in the field, and Cisco is backing a different technology for VoIP calls, albeit one that cannot connect as easily to PCs and instant-messaging services as SIP can.

So what could develop is a form of "coopetition," where Microsoft partners with system integrators and software providers that distribute LCS, while at the same time competing with them for sales and consulting gigs. Microsoft will also have to consider IBM (IBM ), which has the biggest market share in the so-called corporate-collaboration market and will certainly fight hard to hang onto that lead.

Furthermore, most corporate customers aren't quite ready for Microsoft's vision of a PC-centric communications future. "No one is saying, 'We want to replace our entire telephony infrastructure with Microsoft gear,'" says Jorge Blanco, a vice-president for marketing at Avaya. Blanco sees a future where Microsoft helps provide some of the key technologies but doesn't run the systems.

Things could play out that way. But it's also worth remembering that Microsoft didn't win the browser wars by cozying up to the competition. So don't be surprised if the desktop phone business turns out the same way.

By Alex Salkever, Technology editor for BusinessWeek Online

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