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Analysts Debate Merit of Free VOIP Telephone Calls


By Hal Plotkin
Silicon Valley Correspondent

I’ve been talking to my old college buddy, David, who lives in New Zealand, a lot these days. Since I live in California, that may sound like good news for my long distance carrier, AT&T, which charges $2.85 plus tax per minute for such calls.

But it isn’t. In fact, some experts say people like me may be the long distance carriers’ worst nightmare.

Traditionally, firms such as AT&T {T}, Sprint {FON}, and WorldCom Inc. {WCOM} have derived a lion’s share of their revenue from high-margin overseas calls.


52-week stock comparison among AT&T, Sprint and WorldCom

But I haven’t paid a dime for any of my dozens of calls to New Zealand in recent months. That’s because my friend David and I have been using Microsoft’s NetMeeting software, which is available for free at the Microsoft web site.

The number of people taking advantage of the Internet to make free phone calls is exploding. Even so, most analysts following the telecommunications sector are only now beginning to turn their attention to what this trend might mean over the long term for the big established long distance firms.

“It doesn’t surprise me that we don’t hear much about this on Wall Street yet,” says Mark Winther, group vice president for worldwide telecom at International Data Corporation, based in New York. “Most Wall Street analysts are not really that forward looking, they’re usually more focused on what’s happening next week, or maybe next quarter.”

Winther says several IP telephony developments are coming together that are an unprecedented threat to the business models of the leading long distance carriers.

“The long distance companies are absolutely paralyzed,” he says. “They haven’t got a clue what they should do. Nobody’s making money in long distance right now. In fact, they’re all hemorrhaging money. And now they have to compete with companies that are giving away what they’re trying to sell.”

At present, most telecom analysts say IP telephony’s drawbacks still outweigh its advantages for the typical consumer, who is accustomed to simply picking up a phone and dialing.

The most significant threat to carriers could emerge in the next few years, as the increasingly broadband Internet combines with powerful, handheld wireless Internet devices.

These devices could largely replace the proprietary circuit-switched telecommunications network that has traditionally been the long distance companies’ cash cow.

“When voice over IP was still relegated mostly to PC to PC calls, it had a very small niche and was not that much of a threat,” says Dylan Brooks, an analyst with Jupiter Communications, based in New York. “But the newer services, which let you use your PC to call a [conventional] phone, are bringing it a little more into the mainstream.”

Hackensack, N.J.-based Net2Phone Inc. {NTOP} for example, does just that, charging from between one to four cents a minute for most domestic long distance calls. AT&T recently invested $1.4 billion in the company in exchange for a 39 percent stake.

A more dramatic example can be found at privately held, Silicon Valley-based Dialpad.com Inc., which offers entirely free net-to-phone calls. Launched last October, Dialpad’s 9 million registered users make the advertiser supported offering the fastest growing consumer telecommunications service in history.

“Dialpad is now growing faster than either ICQ [an instant messaging service] or Hotmail [a leading free email service],” says Winther. “They’ve got nine million users today, a year from now its what, maybe 40 or 50 million users? It’s really explosive. A free proposition is a very compelling proposition.”

Not everyone agrees.

In fact, the current consensus among many analysts is that most consumers will balk at the lower quality of net phone calls, particularly given current congestion on the Internet, which often causes drop outs, echoes and other audio problems.

What’s more, they point out that long distance carriers are already moving quickly to use IP telephone systems in their own networks, which lets them pass those cost savings on to consumers in the form of lower prices.

“Five years ago, if you were paying 25 cents a minute for long distance that was a pretty good deal,” says Clay Ryder, vice president and chief analyst at Zona Research in Redwood City, California. “We’re now paying something like 2.5 cents a minute in our office, and the cost is continuing to go down.”

“The quality of service is very inconsistent in an unmanaged network [such as the Internet],” says Elizabeth Herrell, an analyst at the Giga Information Group, based in San Jose, California. “I don’t think it will see serious improvement for several years. It’s going to be a while before the Internet gets to the level of quality needed for this function.”

Herrell points out, for example, that fewer than 10 percent of all PC users currently have microphones attached to their PCs despite their low cost and ease of installation.

Ryder of Zona Research adds that the downward price pressure created by deregulation, lower local access fees paid to incumbent carriers, and the advent of IP telephony have turned the once-lucrative long-distance sector into a low-margin commodity business.

“It’s already more like selling salt now,” he says. “They’re going to have to make up the difference selling value-added services.”

Essentially, the analysts say today’s long distance companies must make a transition from selling access to the toll roads they long controlled and instead make their money from whatever lemonade stands they can set up on those roads.

“I’m certainly not counting out the AT&T’s and Verizon’s” says Winther, of International Data Corporation. “They’ve got a broadband play. But there is no doubt the IP telephony companies are reinventing the world. The long distance companies have a difficult road ahead of them, but the IP phone companies, as a group, are going to grow very fast.”

Winther says he thinks the movement toward IP telephony is taking place quicker than many other analysts realize.

“We’ve been dealing with poor quality on our cell phones for a while now,” he says. “It hasn’t stopped anyone from using them. Consumers have already shown they are willing to sacrifice quality for convenience and lower costs.”

What’s more, in the years ahead, wireless Internet-connected broadband devices will allow consumers to use IP telephony software, such as NetMeeting, wherever they are, a development that could make those devices virtually indistinguishable from a cell phone as the Internet’s carrying capacity increases.

Winther says the long-distance companies have, in a way, set the stage for the problems they’re now facing.

“They’re only reaping what they have sown,” he says. “For years, they told us long distance calling was a price sale with the goal being to find the cheapest price. That’s been their entire marketing campaign. And when you’re talking about low prices, it’s going to be hard to beat zero.”

As a reporter, I can’t say how the argument between the analysts over IP telephony will turn out.

But as a consumer, I can tell you one thing:

My friend David and I will be on the phone again later this week.

Given the cost savings, neither one of us would ever dream of placing the call through a conventional long distance company.

Now, that’s not advice from a Wall Street analyst. But it might just tell you something.

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