Line Goes Dead for a Web Caller

Does the abrupt demise of SunRocket spell trouble for Vonage and other VoIP players? Cable companies continue to gobble up market share

Convinced he was getting a bargain, Andrew Mitry signed up for SunRocket's Web-based phone service in November, 2006. "It was great. I had gotten a promotional offer for $200 for two years of service," says Mitry. He even persuaded his mother to sign up. Now the deal isn't looking so great.

SunRocket, which launched service in late 2004, shut down on July 16 without warning its 200,000 or so customers—marking the first failure of a prominent Internet phone company in a business that was already looking shaky. While the technology behind Web calling, known as Voice over Internet Protocol, or VoIP, continues to thrive and reshape the telecommunications industry, SunRocket's crash adds doubt to the question of whether a business can survive by VoIP alone.

"I'd assume that sooner or later the same thing will happen to Vonage," says Alan Breznick, a senior analyst at Heavy Reading, an industry consulting firm. Breznick notes that independent VoIP providers face mounting competition from cable TV companies such as Time Warner (TWC) and Comcast (CMCSA), whose bundles of video, voice, and broadband Internet services are gaining traction. "People who sign up for multiple services from a cable company very rarely leave," says Breznick.

The cable industry is encroaching so rapidly that Vonage (VG), the biggest pure-play VoIP company, recently surrendered the lead in market share. At the end of 2006, there were 9.5 million VoIP subscribers, with 22% served by Vonage, followed by Comcast and Time Warner at 20% apiece, according to consultant TeleGeography. But by the end of March, Comcast had overtaken Vonage for first place, with a 22% share of the market, which had grown to 10.9 million subscribers.

Apples and Oranges?

Naturally, Vonage doesn't agree that the company is doomed, and it doesn't want to be lumped in with SunRocket. "The difference between Vonage and SunRocket is huge," says spokesperson Charlie Sahner, noting that Vonage has 2.4 million customers, a well-known brand, and ample resources to compete. "Even if the customer has cable, many don't like bundles, and people are finding they're paying more and getting less," he says.

It's probably a stretch to compare Vonage too closely with SunRocket, a minor player that captured just 2% of the market. Yet with traditional phone providers AT&T (T) and Verizon Communications (VZ) aggressively launching their own cable TV services, the competition from bundling is intensifying. And cable companies, which can pitch phone service to their tens of millions of subscriber households, hold another distinct advantage, notes TeleGeography's research director, Stephan Beckert: It's easier and cheaper to run TV commercials for your phone service when you own the cable system.

In contrast, Vonage and SunRocket have spent a great deal to sign up and serve subscribers. From start to finish, SunRocket raised about $80 million from BlueRun Ventures (formerly Nokia Venture Partners), Mayfield Fund, Doll Capital Management and Anthem Capital Management. That $80 million delivered only about 200,000 customers. "I'm baffled how they went through so much money so quickly," says Beckert. "They don't have a lot to show for it."

Vonage, which has lavished hundreds of millions on advertising, recently cut back on marketing to stretch its dwindling cash. Until recently, Vonage had been spending nearly $275 on marketing for each new customer that signed up for a service that costs the company $114 a year to provide. That's a total expense of nearly $390 for an account that will generate about $340 in revenue the first year.


Compounding that mathematical challenge is the fact that there are no service contracts for VoIP, as there are in the cell-phone market, to ensure that customers stay long enough for the company to recoup its investment, says Jon Arnold, a principal at J Arnold & Associates, an industry consulting firm. SunRocket attempted to address that problem by offering customers a great deal but forcing them to pay up front for one or two years of service, a financial commitment that's now come to haunt its subscribers.

While SunRocket's Web site is still running, calls to the customer support center are answered with an automated message that says: "We are no longer taking customer service or sales calls. Goodbye." Phone calls and e-mail messages attempting to reach SunRocket executives were not returned.

Despite his experience with SunRocket, Andrew Mitry isn't hanging up on VoIP, though he says he picked his new provider more carefully. He chose Lingo, which charges just $22 a month for unlimited domestic calling. Because Lingo is a subsidiary of a larger company, Primus Telecommunications (PRTL), Mitry says he's comfortable that it won't suddenly fold like SunRocket. Mitry briefly considered cable provider Cox Communications and Verizon, but found their services, which cost about $40 a month, too expensive.

It's never been a question of demand. No doubt there are many more people like Mitry willing to take a risk for the savings that come with VoIP. But with SunRocket's failure, it's a little less clear how a VoIP company can turn a profit while offering those savings.