The Future of Pure-Play VoIP

Can Companies Like Vonage Compete in the Long Term?

A federal appeals court has given Vonage Holdings Corp. permission to keep adding customers following its high-profile patent infringement case with Verizon Communications Inc. But the battle isn’t over yet. And this battle, along with Vonage’s other struggles, has the industry and its investors wondering about the future both of Vonage and of pure-play VoIP providers at large.

After all, margins for voice services have been thin for some time, driven down at least in part by VoIP itself, and plenty of cablecos and telcos bundle voice with larger packages that severely challenge the competition in terms of price and functionality.

“I don’t see how far it can go — there is no future,” Stéphane Téral, principal analyst for Infonetics Research, says of the VoIP pure-play model. “They really need to come up with something new that has nothing to do anymore with who they were in the past.”

Sally Cohen, an analyst who covers consumer VoIP and broadband for Forrester Research, says consumers are not really interested in a pure-play solution. Despite the mountains of money Vonage has spent on advertising to evangelize VoIP services to the nation, Cohen’s recently released report, “VoIP Marketers: Price And Features Slowly Win Over Consumers,” finds 3 percent of online consumers in 2004 paid for pure-play VoIP and that’s only risen two percentage points since then. That slow growth illustrates Cohen’s opinion that Vonage is “marketing to a disinterested public.”

So, the writing is on the wall. And, like the rest of us, Vonage also sees it. “Vonage is definitely looking at getting into new offerings” such as mobility and content, says Brooke Schultz, senior vice president of corporate communications for Vonage. For example, the company hopes to unveil a dual-mode phone by year’s end. It also has rolled out 700-number services, which subscribers can call to receive and forward news headlines and weather information.

Additionally, EarthLink resells Vonage services, a partnership Cohen deems “advantageous” for the troubled IP telephony provider. Whether Vonage will get the chance to see these new service plans win or lose in the marketplace depends upon the outcome of the patent infringement suit brought by Verizon.

In March, a jury found Vonage guilty of infringing — although not willfully — on three Verizon patents, which have to do with connecting VoIP calls to the PSTN. Vonage contests Verizon’s assertion that the three patents are specific and valid. Nonetheless, Vonage was ordered to pay Verizon $58 million plus 5.5 percent royalty fees on all of its future revenue. District Judge Claude Hilton then barred Vonage from using the Verizon technology and adding new customers. However, an appeals court overturned that decision, allowing Vonage the right to continue adding new customers.

The companies will present oral arguments on June 25 to a federal appeals court. The judges then will decide whether to grant Vonage’s request for a new trial, a process that could take a year.

On May 1, Vonage, citing a favorable Supreme Court ruling in a major patent case, asked the appeals court to throw out the case against it and requested a new trial. Verizon protested and on May 3, judges rejected Vonage’s request.

If Vonage loses its appeal, “it’s the end of a company that’s certainly done a lot to increase the profile of the voice-over-IP market, and that would be tragic,” says Lynda Starr, a senior analyst for Frost & Sullivan.

Of course, the patent case holds implications beyond determining Vonage’s future. The suit could unleash a torrent of copycat patent infringement accusations.

Going Beyond the Call

While many questions about the future of pure-play VoIP have focused on Vonage Holdings Corp., the IP telephony pioneer isn’t the only pure-play company out there. Other prominent providers include Skype and SunRocket Inc. However, these companies are different from Vonage.

First, neither companies’ services connects directly to the PSTN, a factor that largely shields them from patent lawsuits such as the one Vonage lost.

Second, these companies have been aggressive in looking beyond plain old VoIP and bringing their subscribers into the new generation of communications.

Peer-to-peer VoIP provider Skype, which has more than 171 million users and is owned by eBay Inc., recognizes the need to go beyond the call. For example, Skype already has expanded into commerce services. Skype subscribers now can send money through the service provider’s Send Money capability, enabled by PayPal. Skype CEO and founder Niklas Zennström introduced the feature at VON, noting that many Skype users have friends and family “on the other side of the planet.” Send Money is an ideal service for them, he said. “It takes communications one step further by adding transactions and sending money,” he added.

Zennström also discussed Skype Prime at VON. Skype Prime lets users sell their services — anything from IT support to foreign language tutoring — to one another.

Meanwhile, Skype Find is a search engine of sorts aimed at local business listings, with an integrated click-to-call VoIP option.

And because there are so many Skype users today, more application developers are interested in targeting them. That’s why the company recently launched Skype Extras, an ecosystem for third-party developers. More than 7 million Extras already have been downloaded.

SunRocket, a consumer VoIP service provider that launched in November 2004, also understands the importance of expanding beyond pure voice services. SunRocket CTO Mark Fedor says the company aims to introduce enhanced applications — such as multimedia emergency calling and possibly video — sometime this year.

Know Your Audience

Forrester’s Sally Cohen

Expanding beyond VoIP to new services such as money transfer seems like a good idea to reach early-adopter types. Still, Vonage Holdings Corp. could learn a thing or two from incumbent network operators such as cable companies in appealing to the rest of the population.

Stéphane Téral, principal analyst for Infonetics Research, says cablecos typically cloak their VoIP services in the phrase “digital voice” so as not to confuse consumers or threaten to upend their landline familiarity.

Subscribers moving to VoIP also want to retain basic PSTN-like features including consistent availability, operator access, 911 and directory assistance. Most VoIP companies now offer at least some of those features, but the fact that many VoIP services are not line-powered makes them much less reliable than PSTN services.

Infonetics’ Stéphane Téral

Nonetheless, Vonage continues spending big on marketing in its quest to convert approximately 180 million PSTN lines in the United States to VoIP. But, despite Vonage’s Herculean efforts, Forrester Research analyst Sally Cohen says, “It’s not going to be these pure-play providers who bring VoIP into the mainstream marketplace.”

Still, Cohen continues, even though bundling appears the best bet for most providers, there is a place for selling targeted services to customers who don’t want to buy in bulk. That includes the opportunity to cater to the millions of immigrants who make international calls and need an inexpensive option for doing so.

Indeed, immigrant populations were — and continue to be — early adopters of VoIP for just this application. And this seems to be the audience to which Skype is appealing with its new money-transfer service.

Cohen says one way a VoIP provider could enhance the attractiveness of such a targeted offer would be to partner with a Web video broadcaster, such as JumpTV out of Canada. JumpTV streams content from Asia, Africa, Europe, Latin America and the Middle East. Theoretically, Cohen says, someone could “make calls to Pakistan and watch a cricket match,” she says.

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