Who Pays For "Free" Net Calls?

For now, ooma isn't paying big carriers to use their networks


The staggering variety of free stuff available on the Internet sometimes seems to have repealed the first law of economics: There's no such thing as a free lunch. But as so often happens, the dismal science actually has it right. When it looks like you're getting something for nothing, somebody is paying, and it's often instructive to know who that is.

I've been testing a new phone service called ooma that provides an interesting case in point. Once you pay $399 up front for a box called the ooma Hub and connect it to your phone and the Internet via your home network, you are promised free, unlimited phone calls over two lines, plus voice mail. Boxes called Scouts let you plug in additional phones for a one-time payment of $40 each. The system works fine and is simple to set up.

When a voice-over-Internet call has to go to a regular phone number, a service such as ooma usually has to pay a "termination fee" to a carrier such as Verizon. Skype (EBAY ), for example, charges 2 cents per minute for calls outside the Skype network. But ooma avoids this by using some of its customers—those who have kept regular phone lines—to serve as gateways onto the local phone network at no charge. To make sure this would work from the beginning, ooma launched by giving away free Hubs to 1,500 testers who agreed to maintain landlines.

WHEN YOU WANT TO CALL OUTSIDE the ooma network, the call moves from your Hub over the Internet to a second landline-connected Hub within the destination's local calling area. The Hub dials the target number and patches the call through. In effect, ooma customers with landlines pay to keep the whole system going. You don't even notice if your landline is being used because your own phone calls go out over your broadband connection, with your flat-rate monthly phone bill covering the ooma traffic. In fact, this improves the efficiency of the phone system by putting idle lines to work. But if ooma ever gains real traction, I expect a legal assault from big phone companies, which are losing income from termination fees.

Web services do take advantage of genuine economies. The phone network is more expensive than the Net. And a carrier like Vonage, promising a "best effort" to provide service, has lower costs than an AT&T, (T ) which is committed to 99.999% uptime.

Lots of Net players build on these advantages. Skype relies on selected users who act, often without their knowledge, as "supernodes" to manage the system. FreeConference.com provides calls by taking advantage of regulatory quirks —namely, the stiff termination fees long-distance carriers must pay to certain rural phone companies that handle calls into their territory. FreeConference puts its equipment in rural Iowa. Then, when calls come in over AT&T (T ), Verizon Communications (VZ ), or Qwest Communications (Q ) circuits, these carriers must pay the local phone companies, who share the money with FreeConference. In effect, the free conferences are subsidized by customers and shareholders of the long-distance carriers.

Not all free Net services game the system. Many sites make money by selling premium services such as photo printing. Then there's the time-honored method of giving away your product while burning through your investors' cash. When outfits that do that finally have to make money, they often face resistance from customers. (It's still not clear how Google (GOOG ) or Yahoo! (YHOO ) plan to use the oceans of personal data they archive—a concern for some free Gmail and Yahoo! Mail users.)

You may as well enjoy free calls while you can. But it's always a good idea to read the fine print. If it isn't obvious who's paying for a free service, it might well be you.

For past columns and online-only reviews, go to Tech Maven at www.businessweek.com/technology/wildstrom.htm

By Stephen H. Wildstrom

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