A Web Phone Called ooma

With its quirky version of Internet phone calls, a startup hopes to succeed in a business where others have failed

The secret that was "ooma" is out. Over the past few years, the stealth startup had managed to raise $27 million in funding from Silicon Valley heavyweights like Draper Fisher Jurvetson and The Founders Fund—all without divulging what product or service it was developing.

And so the innovative new concept behind the hush-hush is…an Internet phone?

Ooma, whose name is meant to evoke simplicity and approachability, announced July 19 that its first product is a new device for Web-based calling. Starting this fall, ooma plans to compete head-on with the likes of Vonage (VG) and eBay's (EBAY) Skype, not to mention traditional phone and cable TV companies such as Verizon (VZ), Comcast (CMCSA), and AT&T (T).

Free Service for Life

The timing of the announcement is rather striking, coming just days after an online phone company named SunRocket flamed out of business. And that's not the only sign of darkness hanging over the business of providing phone calls using the technology known as Voice-over-Internet protocol, or VoIP. The longtime VoIP leader, Vonage, has seen its subscriber growth stumble, a slowdown that began even before the company's future was cast into doubt by a courtroom defeat in a patent dispute with Verizon (see BusinessWeek.com, 5/11/07, "Vonage Calls with Encouragement"). Vonage's customer base grew just 7% in the first quarter, compared with a 26% gain a year earlier.

To enter such a market now sounds a bit counterintuitive. Profits are elusive, as pure-play Internet phone providers are forced to compete on price against attractive bundles of phone, TV, and Internet service from the established phone and cable companies. And competition from wireless carriers, which are integrating cell phones with VoIP-based capabilities in the home, is on the rise as well (see BusinessWeek.com, 6/27/07, "T-Mobile's Triple Threat").

And yet, here's ooma, expecting customers to hand over $399 up-front for its device (most VoIP services provide equipment for free and charge a $25 monthly service fee). The pitch? Free unlimited phone service for life on all calls within the U.S. (Ooma says it will charge low, Skype-like, per-minute rates for international calls.)

Capitalizing on Rivals' Woes?

A great deal for sure, presuming ooma can guarantee it will survive a lifetime. After all, roughly 200,000 SunRocket users paid up-front for a great deal, and now they're out hundreds of dollars, looking for new phone companies. "People are going to be leery of prepaying for phone service after the SunRocket debacle," says Stephan Beckert, an analyst with consultancy TeleGeography.

But ooma may be betting the industry's woes will have exactly the opposite effect. "Vonage and SunRocket have come onto hard times, and you have subscribers looking for alternative services," says Patrick Monaghan, an analyst with consultancy the Yankee Group, which estimates the market for pure-play VoIP services will grow from 2.8 million subscribers at the end of 2006 to 6.4 million at the end of 2011.

Though an ooma user will be able to dial local calls as well as long distance, the company appears to be pinning its approach on the notion that customers will turn to ooma for long distance but keep paying for a traditional local phone line. That's because, somewhat like Skype, ooma is employing a peer-to-peer approach with which calls are connected directly between customers rather than through a central server operated by the service provider. Say, for example, you use ooma in Oregon to place a call to a non-ooma user in New York. Your ooma box will route the call over the Internet to an ooma in the New York area, which will then use that stranger's regular phone line to place a local call to the desired number.

Plenty of Style

This means the company needs to have ooma boxes strategically positioned across the country, preferably in the homes of people who plan to keep paying for regular local phone service that can be exploited by ooma for local calls. To "build" this national network, the company is distributing 2,000 boxes for free. But whenever an ooma is not available to facilitate a local call, ooma will need to eat the long-distance cost of completing the connection.

In addition to the ooma box, which looks like a typical answering machine, a user will need a broadband Internet connection. If customers want to use the service in more than one room, they will need to buy a $39 adapter, called a scout, for each additional phone jack. Whenever an ooma user dials someone, the call recipient will hear a different, ooma dial tone. The company hopes that the recipient will ask the ooma user about the tone, then get sold on the concept. Each customer gets a single home phone number, but one feature of ooma is an instant second phone line whenever it's needed.

The startup has plenty of high-powered supporters. Its board includes technology notables such as TiVo (TIVO) co-founder Mike Ramsay. The management team is studded with former executives from Apple (AAPL) and Yahoo! (YHOO). When he was 17, ooma CEO Andrew Frame was a star employee at Cisco (CSCO). The creative director is Ashton Kutcher, co-creator of the Punk'd reality show and husband of actress Demi Moore. The company says Kutcher, who helped design ooma's flower-like logo, is involved on a daily basis. In fact, Kutcher helped design ooma's unusual viral marketing campaign. Each of the 2,000 participants in the free trial will receive three invites, allowing three friends to get free oomas and enroll in the service. The trial is code-named White Rabbit after the creature that got Alice started on her adventures in Wonderland.

At the very least, in a grim period for the industry, "They've added some character and style to the VoIP market," says Yankee's Monaghan.

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