Vonage: Spending As Fast As It Can

CEO Jeff Citron aims to keep the Internet telephony startup a step ahead of the giants now in hot pursuit

Enticing customers to switch from their tried-and-true phone service to a newfangled brand costs loads of money, and Jeffrey A. Citron is on one heck of a spending spree. Citron, the 34-year-old chief executive of telecom startup Vonage Holdings Corp., has been burning millions in venture funding to market Vonage's Net-based phone service. His message is simple: Users with broadband connections can save on their bills by hitching their phone to the Net -- through a Vonage hookup. It's called Voice over Internet Protocol, or VoIP, and customers like the economics. Vonage subscriptions have jumped 63% this year, to 700,000. Some 15,000 more jump on board every week.

The trouble for Vonage? Big cable players such as Time Warner (TWX ), Cablevision Systems, and Comcast are starting to gain traction in the same market. And they're chipping away at Vonage's industry-leading share, which was 37.5% in the first quarter, according to Halpern Capital. What's more, telecom giant Verizon Communications (VZ )just launched its own VoIP service, and SBC Communications (SBC ) is expected to plunge into the market in coming months, once its merger with AT&T (T ) is final. By yearend, the total VoIP market is expected to top 3 million. By 2008 it'll be 19 million, according to researcher IDC.

With such powerhouse competition emerging, Vonage has its work cut out to remain on top in VoIP. Most industry executives and analysts see the company becoming a niche player focusing on voice alternatives, while its competitors bundle everything from cell-phone to TV service. But Citron isn't ready to relinquish his bold vision -- not without a big roll of the dice. To increase market share, he has been dishing out some $200 for every new subscriber. And that number could rise. At a recent board meeting, he recalls asking what was limiting Vonage's growth. The answer: capital. "So," he says, "we set out to raise some money."

Oh, how he succeeded. On May 9 the four-year-old Vonage nearly doubled its venture funding with a fresh $200 million, led by Bain Capital. That's the largest single funding in a telecommunications venture since the Internet bubble burst in 2000. And Citron is racing to put it to work. In May, Vonage spent an estimated $21.8 million on Internet advertising, according to TNS Media Intelligence. Chief Financial Officer John S. Rego admits that Vonage, which charges customers an average of $30 per month, continues to burn cash as it races to grow. But success, he says, "is all about scale."

Win or lose, Vonage's dash for customers is shaking an entire industry. Like other Net-based upstarts -- TiVo Inc. (TVO ) and Netflix Inc., to name two -- Vonage wields outsize influence. It's pushing larger competitors to embrace the Net and to slash their rates. And once those rivals take the plunge, they hurry to generate sales with other services, from e-mail access over the phone to new TV hookups.

Citron, no newcomer to long shots, has long shown a readiness to take big chances and stretch limits -- sometimes taking it too far. As a trader at Datek Securities, he made his first million by age 21. In 1998, he took over Datek Online -- and quickly got into hot water. The Securities & Exchange Commission investigated charges that Datek had made illegal trades and generated rich profits by manipulating systems designed for small investors. Citron resigned in 1999 and sold most of his stake for $225 million. In a settlement four years later, the SEC banned him permanently from "associating with any broker or dealer," according to documents. Citron agreed to pay $22.5 million in penalties, but did not admit to any wrongdoing.


Citron founded Vonage in 2001, when his reputation was under siege and Internet telephony was still associated with the dot-com splatter. Nonetheless, he pulled it off. "I wouldn't have guessed early on that we'd be in this position today," says J. Sanford Miller, a senior partner at investor 3i. "But Jeffrey predicted it."

Now he faces rivals who are promising smorgasbords of digital offerings. The cable companies can bundle their voice service with video, broadband, and soon, wireless phone service. And phone companies are racing into TV.

Citron knows he can't match these offerings. So his goal is to hammer out partnerships with a variety of wireless providers and leave the TV service to others. The trouble is that the mobile industry has consolidated so much that the few big cellular players left are already competing with Vonage.

This could push Citron to the margins of the industry. He's starting in the wilds of Wi-Fi, the wireless Net connections available in so-called hot spots found everywhere from Starbucks to hotels. His plan is to forge enough partnerships with Wi-Fi hot spot providers to allow Vonage subscribers to make calls as they roam. But most analysts doubt that Vonage can survive on voice service alone -- wireless or not. "In the long run, Vonage can't afford to be just about cheap phone calls," says William Markey, president and general partner of telecom consultants RelevantC Business Group.

Why? Even a successful network of hot spots is a long way from the seamless connections the phone giants are promising. SBC, for example, predicts that within two years, customers will be able to walk into the house while on a cellular call and switch the call instantly to the in-house Wi-Fi network. Then users could transfer the call to a PC or instant message chat box on the TV so they could shoot the breeze as they, say, compete in a video game or watch the World Series.

While Vonage doesn't own networks, it has one towering advantage over its larger foes: a proven record as an innovator. Its genius was in developing components to carry phone calls through a broadband connection owned by the phone or cable company, and to transmit them over public Internet lines. It worked. And the voice quality surpassed expectations. It also developed technology that lets customers pick up their voice mail online, from anywhere.

As richer competitors attack the VoIP market, they're quick to predict Vonage's demise. "Unfortunately, sometimes the pioneers get trampled by all the stagecoaches that follow," says Rian J. Wren, general manager of Comcast Corp.'s (CMCSA ) Voice Services business.

Citron still has big plans. Coming soon will be the F-1000 UT Starcom Wi-Fi phone, giving customers more freedom to roam. And Vonage expects to expand to Asia and Continental Europe within the next 12 months. If Vonage is destined to become a niche player, Citron hasn't gotten the message yet. And his drive to build a giant -- whatever the result -- is transforming an entire industry.

By Roger O. Crockett

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