Free ride over for VoIP?

A cheap, Internet-based alternative to traditional telephone service is facing a sudden regulatory backlash that could slow adoption of the fast-growing technology, raise prices and put financially shaky start-ups out of business.

Two weeks ago, Minnesota drew first blood. It ordered so-called VoIP (voice over IP) provider Vonage Holdings to file for a telephone operator's license. Many see the move, the first attempt by a state public utilities commission to regulate an Internet telephony provider, as the beginning of a new regulatory framework for Internet telephone operators in the state.

Telephone regulators in Alabama, North Carolina, Michigan, Colorado, Illinois, Virginia, Pennsylvania and Ohio are all at various stages of drafting some IP telephony regulations. The Federal Communications Commission could also adopt new rules for VoIP operators soon, signaling the end of the honeymoon for an industry that's operated to date with no official oversight.

"If it's a company operating as a phone company, then there are requirements they must follow," said Beth Bosch, a spokeswoman for the Illinois Commerce Commission, which, along with other states, has raised concerns over VoIP emergency 911 services.

This is a 180-degree swing in thinking by the nation's telephone regulators. State and federal officials were once happy to Net telephony providers such as Net2Phone, deltrathree and Packet8 operate outside of ordinary telephone regulations.

After all, the young companies had a tough enough task selling a little-known but promising new technology to make phone calls over the Internet. They didn't need regulations--or the extra costs and technical problems that go with them.

But as U.S. IP telephony subscribers near the 2.5 million mark, and some 10 percent of all calls are VoIP generated, a growing number of states and the FCC have begun exploring whether to put VoIP providers on their regulatory radar. Analyst group In-Stat/MDR believes there will be 7 million VoIP phones in circulation by 2007.

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The regulatory activity has Internet telephony's earliest supporters believing the Wild West days are over now that the technology has progressed from its early 1990s geek-chic reputation to a mainstream service, although its use is still relatively tiny by comparison with traditional phone dialing. Although regulations may finally force VoIP providers to offer essential services such as 911, many VoIP operators say consumers should brace themselves for higher prices, slower introductions of new Internet telephony services and the demise of some of the same start-ups that are just beginning to win customers.

Michigan has gone so far as to begin demanding that Internet service providers, which sell the broadband connections VoIP dialers use, pay the same property taxes charged to telephone companies, a move being battled by most ISPs in the state.

IP telephony providers are digging in their heels to fight the trend toward regulation, but they face an uphill effort against the well-oiled lobbying machines of the local-telephone companies.

Vonage recently indicated it will fight the Minnesota decision. "We believe the Minnesota PUC (public utilities commission) is incorrect in its findings," Vonage attorney Bill Wilhelm said.

Michigan Web provider Gateway Online is among those fighting the state's taxation effort.

"Not that the amount that my company pays is going to break the local budget," Chief Financial Officer David DeFord wrote in an e-mail. "But if you combine my tax bill with the tax bill of all of the other ISPs and other nontelephone-company telecommunications providers in the state, there is likely a several-million-dollar shift."

The FCC is moving much slower than the states are, although it too has begun investigating the regulation question. FCC staffers recently met with various major telephone and VoIP providers, a sign that the commission has "begun to more seriously consider" applying its decades-old telephone regulations to VoIP newcomers, said Jeff Pulver, founder of Net telephony provider Free World Dial-Up, who attended some of the meetings.

In addition, the FBI has recently put pressure on regulators to seek rules requiring VoIP and broadband ISPs to ensure the ability of law enforcement to conduct wiretaps on VoIP subscribers.

Dialing in some surprising partners
The ongoing efforts have divided the telecommunications industry along predictable lines, but with two surprising twists.

Among those supporting state and federal regulations are, unsurprisingly, major phone companies Verizon Communications, BellSouth and SBC Communications, which have the most to lose from VoIP's success. Because VoIP calls use the Internet, dialers can avoid paying for access to the toll roads of a telephone network.

VoIP services "are plainly telecommunications," Verizon told the FCC.

The three phone companies argue that it's time for regulators to level the competitive landscape, especially now that cable providers are taking serious steps toward launching VoIP telephone services and are considered a major challenge to the dominance of phone companies.

"Do you think if we took a lot of Verizon's traffic the FCC wouldn't say it's time for regulation?" said Sarah Hofstetter, a senior vice president with VoIP provider Net2Phone.

But one of the nation's top four phone companies, Qwest Communications International, has broken ranks with the other Bells. It still wants Net telephony to be regulated but believes the FCC should draft separate, lighter rules for the upstart services compared with what traditional telephone companies must follow. In a recent FCC filing, the company argued that the agency should "balance the competing interests of fostering a nascent technology and creating a level playing field among all providers of voice transmission."

This fractured front line might actually be helping VoIP providers, according to Michael Smith of the University of Maryland Graduate School of Management and Technology. The major phone companies "are not united behind a single position," he wrote in a report on VoIP regulation earlier this year.

Meanwhile, those against Internet telephony regulations include the growing number of VoIP providers, which have begun winning converts to their cheaper dialing plans. Networking-gear manufacturer Cisco Systems, which makes a converter that's needed to turn traditional landline phones into VoIP dialers, is also against imposing regulations.

Pulver counts long-distance provider AT&T among those rallying against VoIP regulations as well, a second major phone company to break ranks.

In 2002, AT&T asked the FCC to decide whether "phone to phone" calls using the Internet are exempt from access charges AT&T would normally have to pay.

"With so many issues and petitions simmering, the FCC may just let the petitions simply sit in the docket," Smith writes. "That in itself is a decision because it continues the regulatory limbo."