Domestic and international rates are dropping faster than ever, forcing computer-based telephone servicees to quickly develop new features to survive the competition.
Companies such as Net2Phone and Deltathree.com are furiously testing enhanced services such as unified messaging and e-commerce to differentiate themselves from telecom giants such as MCI Worldcom and AT&T.
Previously the cheaper alternatives to traditional long distance services, the upstart companies are getting squeezed in the price wars between long distance carriers. Executives say they have long anticipated that prices would fall, but the question remains whether they are prepared to deal with the sudden crunch.
"I think the recognition is that the Internet telephony carriers are not going to have a cost advantage for long," said Peter Nighswander, a telecommunications consultant at Strategis Group. "They need to go out and start marketing real high-end services and come up with other distribution channels such as calling cards and deals with retailers."
These firms are targeting an emerging market that is based on the expected growth of PCs as a primary communications device. Analysts believe that consumers will latch on to making calls over the Internet as companies improve call quality and offer unique services, such as video conferencing.
Yet the future of such companies is brought into question as they lose their pricing advantage, and still must grapple with technical issues, like poor phone call quality.
PC telephony firms have been able to take advantage of certain regulatory loopholes that allow them to avoid so-called access charges. Local phone companies charge long distance carriers an access charge to complete a call over a local network.
Yet regulatory authorities have reduced these access charges, allowing long distance carriers to cut their overall costs for providing service. As these firms pass these savings on to consumers, the gap between cheap telephony and rates offered by AT&T and MCI WorlCom has narrowed.
In August, AT&T became the latest to cut prices when it offered long distance calls for 7 cents per minute anytime. MCI WorldCom and Sprint already offer domestic calls for 5 cents a minute on weeknights and weekends. Qwest Communications International also offers 5-cent weekends and other specials.
Aside from the immediate pressure in the domestic long distance market, analysts expect these telephony firms to face new competition soon in the international arena. Net2Phone and Deltathree say international calls make up more than 65 percent of their total revenue, as their rates still significantly undercut per-minute costs from traditional long distance providers.
"The domestic U.S. market is not our market," said Deltathree spokeswoman Fara Hain, whose company charges 10 cents for long distance calls within the United States, with occasional promotions that offer 5 cents per minute.
"We could drop our rates, but there's not a lot of value in fighting with the big boys for half a cent," she said.
Net2Phone charges 4.9 cents per minute for domestic long distance calls. Net2Phone and Deltathree executives believe their international price advantage over can last another three to six years until international phone companies are completely deregulated and competition lowers prices.
"Bottom line, the most attractive part from a savings point of view is international calls--but, clearly, if pricing is your motivation, the price differential is getting smaller and smaller," said telecommunications analyst Jeffrey Kagan, of Kagan Telecom Associates.
A new game plan
In response, the computer telephony companies are developing a handful of new IP-based services. Deltathree and Net2Phone are diving into e-commerce by allowing consumers to click a button on retailers' Web sites to call a customer service representative to purchase goods or get advice.
Later this fall, the firms will offer unified messaging, which allows consumers to get their voice mail, faxes, and email on a Web site or over the phone.
"It's not about cheaper telephony in the United States. It's the vision of voice enabling the Web," said David Greenblatt, Net2Phone's chief operating officer.
Greenblatt said his company is also building video-conferencing software and a "universal phone number" that will bounce a call to a number of different sources to find a person, whether they be at the office, home, or on the road. Users can also have phone calls routed to their cell phones or voice mail at work, he said.
E-commerce also will be a large part of the company's future revenue, he said.
Deltathree's Hain said she also expects the majority of the company's revenue eventually to come from advanced services and less from long distance calls.
"The long-term prospect has got to be toward bundling services and bringing customers something other than low cost calling," said Brian Adamik, senior vice president for telecommunications research at The Yankee Group.