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Behind VoIP's renaissance

Declared dead just a few years ago, Internet telephony is now all the rage. Knowledge@Wharton provides a reality check on how big this technology will become.

    Behind VoIP's renaissance
    From Knowledge@Wharton
    Special to CNET News.com
    January 17, 2004, 6:00 AM PST

    Declared dead just a few years ago, voice over Internet Protocol (VoIP)--or the ability to make phone calls over the Internet--is back, bearing all the markings of a Next Big Thing.

    Just a few weeks into 2004, signs of VoIP's quickening pulse are everywhere. Phone carriers are practically tripping over each other to announce aggressive VoIP strategies aimed at both consumers and businesses. Not to be outdone, Time Warner Cable, Cox Communications and Comcast have trumpeted their own forays into the VoIP market.

    Comcast's decision alone, says Gerald Faulhaber, Wharton professor of business and public policy, is a clear signal that the resurrection is for real: "Comcast never does anything tricky but takes cautious and measured steps. That they are getting into this is a signal that the technology, which they will roll out slowly, is a big deal."

    In its new incarnation, VoIP is not free, as it was back in the 1990s, but even so, its charms are undeniable:


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    Unlimited local and long-distance calling, and voice mail and caller ID for as little as $20 a month.

    Analysts like Daryl Schoolar, a senior analyst at In-Stat/MDR, a Scottsdale, Ariz., research firm, expect that even those low fees will generate some $4 billion in revenue for providers by 2007. The move to VoIP will benefit equipment vendors as well. Light Reading, which keeps an eye on the communications network business, reports that the market for all VoIP equipment, about $1 billion in 2002, is likely to reach almost $4.3 billion in 2006.

    But despite all the signs that VoIP is back for good, it is also evident that VoIP will not soon replace the traditional telephone.

    Schoolar points out, for example, that three years down the road, there are likely to be some 4 million VoIP subscribers. That is an impressive increase over the 378,000 who are expected to sign up for VoIP in 2004, but those 4 million pioneers will still represent a tiny fraction of the 113 million households where the traditional phone call will still hold sway.

    The move to universal VoIP service, especially within the home, is likely to be slow; one that will have to make its way past some important roadblocks. As anxious as they are to take customers away from the phone companies, the cable providers that are committed to providing VoIP service are themselves not completely convinced that the technology is ready, according to CNET News.com.

    "Cable companies are worried that current VoIP equipment has not been proven on the kind of large scale that would be typical in any nationwide service," the online news service concluded, after interviewing cable operators and analyzing white papers the providers had drawn up on the topic.

    In addition, VoIP in the immediate future is likely to remain a computer-based application--rather than a service that can be accessed directly with special phones--which means that the base of potential VoIP customers will be somewhat restricted. "We live in a country where PC penetration is only 65 percent of the households," Faulhaber points out.

    But for bandwidth
    And then there is the bandwidth issue.

    VoIP succumbed to an undignified death in the late 1990s, because most computers were connected to the Internet over conventional phone lines, via 56K modems. Making a phone call on the Internet was free, but because the primitive technology was incapable of providing the steady, uninterrupted channel required by voice communications, callers got exactly the kind of service they paid for.

    The move to universal VoIP service, especially within the home, is likely to be slow; one that will have to make its way past some important roadblocks.
    The advent of cable and digital subscriber line (DSL) modems, which offer the sort of bandwidth that makes for smooth and clear transmission of voice calls, has been one of the key drivers behind the renewed effort to make VoIP a player in telephone communications.

    Yet even today, only about 20 percent of U.S households have broadband connections, another limitation on how fast the consumer market for VoIP can grow. Nor are matters likely to get dramatically better quickly. By 2007, fewer than 40 percent of American households will have broadband connections, according to Schoolar. "The VoIP market," he points out, "will be a subset of that."

    Wrangling over regulatory issues may also put a drag on the speed at which VoIP spreads.

    Internet and VoIP advocates are adamant that federal and state bureaucrats keep their hands off VoIP, just as they kept their hands off the Internet. "The Internet has succeeded in large part precisely because government regulators have agreed to hold off on regulation," VoIP expert Jeff Pulver, president and CEO of Pulver.com, which calls itself the "Voice of IP communications," recently wrote in a CNET News.com Perspectives column. "The FCC owes it to consumers to continue that policy, when it comes to something with as much unfulfilled potential as Internet voice communications."

    But there is no doubt that federal as well as state officials see VoIP as a service they may well have to take in hand. Law enforcement officials want to make sure that they will be able to use wiretaps on VoIP calls as readily as they use them on conventional phone conversations. On a broader scale, state and federal officials concerned with utilities worry that if VoIP gets too popular, conventional phone line networks will atrophy, phone companies will no longer offer universal access, and services such as 911 will suffer.

    Some experts think that the complexities inherent in VoIP service will themselves slow the ability of regulators to devise ways of controlling the service. Says Schoolar: "IP changes the rules. If you subscribe to Vonage (a small VoIP provider) you can get 212 area code service, live in Florida and go to Minnesota for three months to avoid the heat.

    If VoIP is here to stay, which industry--cable or telephone--will benefit the most? The answer seems to be both.
    Who regulates your service? And if here in Scottsdale, I call Phoenix, five miles away, to order lunch. Part of the call might go through Utah. How do you regulate that?"

    For his part, Faulhaber thinks that VoIP regulation could well turn into a hot political issue in this election year, with Democrats supporting regulation and Republicans opposing it. "My guess is that we will see deregulation winning," Faulhaber says, but he speculates that if VoIP turns into a populist issue, the proponents of regulation may well win out. "When (FCC chairman) Michael Powell tried to ease media ownership rules, he got smacked around."

    Boon to cost cutters
    Lingering doubts about the technological issues and the controversy over regulation notwithstanding, experts are convinced that VoIP will survive in this second incarnation.

    Many businesses are already sold on VoIP as a communications technology. During the years VoIP was thought to be dead, a host of companies were adopting the technology, especially those with international operations. VoIP took a big bite out of the cost of keeping in touch with overseas divisions.

    "The price of country-to-country phone calls was a lot higher than it is today and especially high compared to domestic calls," says Lisa Pierce, vice president at Forrester Research. VoIP reduced the cost of those calls from 54 cents a minute to 4 cents a minute.

    Now that VoIP is being publicly acknowledged as a viable communications technology, the business sector is even more poised to adopt it, especially as its providers find a way to marry it with traditional PBX (private branch exchange) systems. Besides, Faulhaber points out, VoIP will probably make its greatest inroads among businesses, because they are the most likely to have the fat pipelines to the Internet that are a prerequisite for VoIP. And, although phone service within the United States is relatively inexpensive, businesses are always looking for ways to cut costs. VoIP providers promising to cut phone bills in half will find a receptive audience among corporate financial officers, Faulhaber believes.

    If VoIP is here to stay, which industry--cable or telephone--will benefit the most? The answer seems to be both.

    In the home market, says Faulhaber, the cable companies are likely to do well, because they have done a far better job of introducing broadband services to the consumer than phone companies have. Moreover, cable providers that sell VoIP to their subscribers, other experts say, add revenues to their bottom lines, because every new phone service customer will bring new dollars.

    By contrast, phone companies that sell VoIP may, in a way, be cannibalizing themselves, because their new VoIP clients will be the old customers taking advantage of the lower VoIP prices for service.

    But phone companies are also likely to reap advantages from VoIP, especially if they build on their existing strengths. AT&T, with its massive national footprint and huge business customer base, Faulhaber adds, is in the best position to dominate the business market. VoIP "could be a tremendous shot" for the ailing phone giant, he says.

    And even if VoIP does not add new revenues to the phone companies' bottom line, it is likely to help them compete, because the technology is being integrated into the communications infrastructure independently of its usefulness as a saleable service. In early January, for example, Verizon announced that it will use Nortel VoIP soft switches, media servers and gateways, rather than more traditional switches, in both local and long-distance networks.

    Schoolar says that the Verizons of the world are changing to VoIP equipment, even in their conventional networks, because far fewer technicians are required to run and maintain a VoIP-based network, reducing operational costs.

    Adds Lisa Pierce: "A VoIP infrastructure will be less expensive over time to build, to maintain and to support customers. We will see a bottom-line improvement, making (the phone companies) more profitable."

     
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