VIRAL VoIP:

The Spread of Residential IP Telephony

“Consumers are looking at VoIP service as a replacement for their primary phone line, not as a secondary backup,” says John Barrett, a research analyst at Parks Associates. “VoIP could also serve as a lure for new broadband subscribers, given the strong interest among narrowband households. The market is still searching for a ‘killer’ broadband application.Wouldn’t it be ironic if it turned out to be telephone service?”

Market research and consulting firm Parks Associates, which forecasts there will be 4.5 million residential VoIP subscribers in the United States by 2007, reports that 50 percent of households with Internet access are interested in VoIP telephone services — whether these households use dial-up or broadband to connect to the Internet. The study, which sampled 3,300 households, goes on to report that interest in these VoIP services is disproportionately among subscribers with high monthly phone bills, and cost savings is the primary driver.

Of course, fees for VoIP vary by provider, but in general, Barrett says, IP telephony services including unlimited local and long-distance calling within the United States and Canada typically sell for around $40 per month. “One provider doing it for closer to $20 is Packet8,” he adds. And 200-minute packages usually go for between $12 and $15, he continues.

Of course, many of the “virtual providers” like Packet8 and Vonage Holdings Corp. don’t offer the broadband connection, Barrett says, so that costs extra and requires a second service provider. But customers may already have or want to get broadband for high-speed Internet access, so they might not necessarily consider that extra $40 or so for the broadband link as an added cost for voice.

However, other VoIP upstarts like Phonom — which as of late January had about 100 VoIP lines in operation — can provide both the voice service and the broadband connection if the customer desires.

Phonom, which offers residential VoIP service in the mid-Atlantic states, sells unlimited local and long-distance voice services for $34.99 per month. But it can also deliver ADSL2-based broadband connectivity plus unlimited local and long-distance Internetbased calling for $64.99 a month.

Brad Evans, founder and president of Phonom, explains the company gets the ADSL2 line, which provides a maximum connection of 8mbps downstream and 1mbps upstream, from CLEC Cavalier Telephone.

In fact, Cavalier Telephone is providing much of the infrastructure on which the Phonom service is based, enabling Phonom to deliver a service meant as “a total replacement for existing telephone service,” and including E911, transparent dialing (meaning dialing that’s the same as would be used to make PSTN calls), support for CALEA and more, says Evans. The only major difference in reliability between the Phonom service and PSTN voice is that if power to a home goes out, telephone service will not work “so we recommend you have a cell phone or a backup if there is a power outage,” says Evans. “But in today’s world, cell phones are so prevalent,” he says. He adds that even in the PSTN — with the DLCs and other electronics Verizon, SBC and BellSouth use — when there’s a prolonged power outage, there are outages on the PSTN.

Phonom’s service is based on a Class 5 switch owned and operated by Cavalier, combined with gateways, which the companies have not yet decided who will operate in the long run, says Evans. The Lucent Technologies Inc. 5ESS switch provides the features, CALEA support and network connectivity. The TDM switch interfaces with a Lucent Accelerate IP gateway for IP-based transport and to give customers the flexibility to take their phones with them wherever they go, he says.

Many of the investors in Cavalier are also investors in Phonom, but beyond that Evans would not provide details on the relationship between the two companies. Of course, a key reason for keeping Phonom separate from Cavalier, rather than have it operate as a business unit or subsidiary of Cavalier, is to draw a clear line between the established CLEC and Phonom, whose Internet-based offering is considered by regulators to be an information service and is therefore not subject to the same taxes and fees as traditional voice services, concedes Evans.

“The tax savings are enormous,” Evans says, referring to the benefits of having an offer that is considered an information service. “There is a $17 tax savings per month per residential user. So there’s a total savings of $32 a month for somebody with unlimited [service].”

That’s why Phonom is able to offer both broadband and unlimited VoIP service for just $34.99 while Verizon Long Distance and The Neighborhood offer just unlimited phone service — without broadband — for $49.99, he says.

Of course, that fact is not lost on the RBOCs and long-time IXCs, which are also moving into residential VoIP services.

At a company event in January, Qwest Chairman and CEO Dick Notebaert — referring toFCC Chairman Michael Powell’s recent statement that the agency would not regulate VoIP — said he doesn’t expect regulators “to step in” and begin to put new requirements on VoIP service. Notebaert said that once state and federal regulators start regulating VoIP, they will have no choice but to regulate wireless, by adding universal service and other obligations, and cable. No one would do that, he added, especially in an election year.

That’s probably why Notebaert has publicly stated on more than one occasion that he wants Qwest to deliver VoIP for the mass market nationally. “We have been evasive about what we are doing,” he says, adding, “but if you’ve got the network, hello, you almost have to do it.”

In December, Qwest launched a small, free trial of residential local IP voice service in the Minneapolis/St. Paul area — where startup service provider Vonage is already offering VoIP services. (A federal court recently ruled Minnesota regulators do not have the authority to treat Internet telephone companies, such as Vonage, the same as traditional phone companies.) Between 100 and 200 subscribers will receive the service for free, Claire Maledon, spokeswoman for Qwest, told xchange.

Joe Glynn, vice president of product strategy at Qwest, says the company’s residential VoIP service includes a “very rich” Web browser that enables customers to control and monitor their communications by checking a call log of call attempts and recent calls, viewing voicemail via PC and more. “Some of our early customers have found this very valuable,” particularly those that work out of their homes, he says.

“The interesting thing with Qwest will be how they do the packaging and bundling so people want to use their services instead of Vonage’s,” says Barrett of Parks Associates. “Will they give you a substantial savings? It will be interesting to see how distinct it will be from Qwest’s regular telephone service.”

Although Qwest says it isn’t using the new Lucent equipment for the current VoIP service in the Twin Cities, and won’t say what infrastructure it is supporting the service with, Qwest recently announced plans to use Lucent’s 5E-XC switches to replace older technology, consolidate endoffices and lay the groundwork for migration of its network to VoIP. Following lab and field trials this year, Lucent says, Qwest plans to deploy the new Intelligent Media Gateway that will eventually connect existing customers to VoIP networks. Lucent says this will position Qwest for a smooth transition of its 5E-XC network to softswitch control and effectively transform its entire local network to VoIP in the future.

Additionally, Cliff Holtz, executive vice president of Qwest’s business markets group, says Qwest’s Allegiance Telecom acquisition, which was expected to be completed last month, will make Qwest a national local provider with interconnection agreements in place to facilitate nationwide VoIP within 18 months.

“We are not doing [VoIP] as a regulatory dodge,” Notebaert says, explaining that in the mid-’90s, data exceeded voice in the company’s Class 4 switches, requiring the carrier to build a data network overlay to the voice network, but now there needs to be a voice network overlay to the data network. “There is no choice about the migration [to VoIP]; it doesn’t matter what the regulators do.”

Indeed. Just after the turn of the year, Verizon Communications said in 2004 it will dramatically accelerate the evolution of its nationwide wireline network to packet-switching technology and selected Nortel Networks as its VoIP equipment provider. Verizon’s initial service deployment as a result is scheduled for mid-2004 and is expected to include hosted VoIP and multimedia services for businesses and consumers. The company has said Verizon’s residential customers will see a complete suite of bundled services, including local and long-distance VoIP service, as well as Internet access, all via a single broadband connection. As of press time in late January, Verizon hadn’t provided any details about the timing, geographical availability or pricing of its planned residential VoIP service.

Meanwhile, AT&T has been running a trial of VoIP services since October in three states to test market a residential VoIP offering including advancedcall-management capabilities and various Webbased features. In December, AT&T announced that it will roll out its residential broadband VoIP offer in major cities across the United States in 2004, beginning in select metropolitan markets in the first quarter.

Like Phonom, AT&T is positioning its residential VoIP as a primary line replacement. In line with that, the company recently announced an agreement with Intrado Inc. to develop an emergency calling solution for the AT&T residential broadband VoIP service.

And, of course, the cable companies are again beginning to attack VoIP in a serious way. According to a new report from Kagan World Media, the cable VoIP sector will leverage the fledgling voice-over-Internet technology at a pace of 4.2 million new subscribers per year, yielding a $5.4 billion business for cable system operators by the end of 2008.

Barrett of Parks Associates says although there’s a lot of interest in VoIP, there are not a lot of consumers using these services. As a result, service providers, he says, face a challenge in gaining consumer trust and confidence in the service. “A lot of people don’t know you can sign up with Vonage and sign up for an unlimited number of calls,” he says. “Some people might think it won’t work.”

Of course, that’ll be less of an issue for incumbent service providers, which already have the embedded base of customers and the marketing clout to overcome such barriers.

And many believe that clout — and in-house broadband services — of the incumbent telcos and cable companies position these telecom giants to be the most successful with VoIP.

How that success is measured remains to be seen because if service providers and customers think VoIP services are low cost now, Barrett says, just wait. As competition for VoIP services heats up in the near term, it appears likely it will only continue to drive down voice pricing.

Residential VoIP Types

According to Parks Associates, there are four general categories of consumer VoIP services.

Category 1: This is where long-distance providers convert a normal phone call into packets, transmit it internationally and reconvert it before handing it off to the PSTN for call termination. The PSTN is thus used on both sides of the call. The long-distance provider could be the consumer’s default provider, a provider that offers service via a prepaid calling card or a 10-10 number. In any case, the consumer may or may not be aware that his or her call has utilized VoIP technology. For Category 1 calls, tariffs are comparable to traditional long distance or slightly cheaper. Notably, MCI announced in 2003 plans to migrate all of its voice traffic to a VoIP core network by 2005.

Category 2: Category 2 calls completely bypass the PSTN. Through a software package, Category 2 calls are made with an Internet-connected PC that has an attachable microphone. The software package converts the consumer’s voice into VoIP packets and then transmits them via the Internet. This method presents a key problem, however: there is nobody on the other side to reassemble the packets and connect the call to the PSTN. Thus, a PC-generated call is usually made only to another PC that also has the requisite software and hardware. For this reason, several peer-to-peer (P2P) networks have been created to help callers find each other and connect. They include Free World Dialup, Microsoft Messenger and Skype, a venture of the infamous music-swapping network KaZaA. These P2P networks function similar to, and are sometimes integrated with, instant-messaging software.

While PC-to-PC calling is inconvenient and limited in application, it is cheap. Software packages are available for free, PC headsets are inexpensive ($20) and there are no additional costs beyond the price of the Internet access. Consumers can also purchase phones that plug into the computer, making the experience nearly identical to a traditional phone call.

Category 3: Category 3 is very similar to Category 2. The consumer uses the same kind of PC software and hardware to make the call, but a third party connects it to the PSTN on the other side. This process allows consumers to call any telephone number from their PCs for a perminute fee (typically 5 cents to 8 cents). Net2Phone is the most prominent Category 3 service provider.

Category 4: Another VoIP variant utilizes a piece of stand-alone hardware that is connected to both the Internet and a traditional telephone. These devices, usually referred to as analog terminal adapters, allow the consumer to pick up an adaptor-connected phone and dial the same way as they would with circuit-switched telephony. The call is sent across the Internet to a third party that essentially functions as a long-distance provider, reconverting the call to an analog signal and connecting it to the PSTN. For consumers, the net effect is a standard telephone call made without using their computers.

Analog terminal adapters also allow incoming calls to function in the traditional way. Each adapter has its own phone number, which needs not correspond to local area codes. In fact, these adapters can have multiple phone numbers (even for differing area codes) which allow “local” calls to be made from many different areas.When the number is called, any phone connected to the adapter will ring regardless of location. Consumers can thus receive calls wherever their adapters are connected to the Internet — a convenient feature to have when traveling.

Category 4 services are substantially cheaper than traditional voice telephony. A consumer can typically make unlimited domestic long-distance calls for a flat fee of $35 per month. International long-distance calls to most developed countries typically cost 5 cents per minute.

Category 4 service providers include Vonage, Packet8, Time Warner and Cablevision. Qwest, Verizon and other telcos and cable MSOs are poised to join the fray. Given that these VoIP adapters can be integrated into DSL/cable modems or residential gateways, VoIP is attractive to broadband ISPs that already ship modems to subscribers because it opens the door for further revenue growth.

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