Taking the battle online

Sep 1st 2005
From The Economist Global Agenda

Microsoft has become the latest big technology company to make a move into telephony over the internet. The low cost of calls is attracting customers in ever-greater numbers and robbing traditional phone companies of business. How worried should they be?

WHEN occasion permits, it is salutary to remind oneself how the conduct of business and leisure has changed since the advent of the internet. Gathering information, written contact (through e-mail) and other tasks have been speeded up immeasurably thanks to the forward march of technology. One is often pressed to remember how people got by before the internet became widespread. In fact, many of the tasks taken up by the web were conducted over the telephone. And if Voice over the Internet Protocol (VOIP), a new type of web-based telephony, continues to takes off, we may one day ask how we made phone calls before the internet took that strain too.

Microsoft is the latest big technology firm to embrace VOIP. This week, the software giant announced that it had bought Teleo, an American VOIP-technology firm, for an undisclosed sum. Days earlier Google, a leading search engine, announced that it would launch Google Talk, an instant message and voice service, in competition with other leading web portals. In June, Yahoo! bought Dialpad, a firm offering the same sort of technology as Teleo.

At the moment, the technology giants generally only allow computer-to-computer voice services. But they may soon extend their offerings to compete with the likes of Vonage, Skype, 8X8 and a host of other new firms that concentrate on providing VOIP services. These companies allow customers to plug their phone into a gadget connected to the internet. By offering this service they have shown they want to compete directly with traditional telecoms firms and the cable companies that have recently joined the fray.

However, VOIP differs from the usual phone services in that it sends calls as digital packets of information over data networks rather than relying on a dedicated circuit-switched network. As a result, calls are charged at a much cheaper rate: long-distance and international calls can be made for the price of a local call and a home broadband-internet connection. Furthermore, a VOIP user can keep his old fixed-line phone number, which will work not only at home but anywhere in the world where he chooses to use the device (as long as a broadband connection is available).

Not surprisingly, consumers have shown more than a little interest in the new technology. TeleGeography, a research firm, estimates that VOIP providers offering similar services to traditional telecoms firms in America had amassed over 1.8m subscribers by the first quarter of 2005. This number is set to grow to over 7m by the end of 2006 and 17.5m by 2010 (see chart). These figures do not take account of the growth of Skype, whose software permits free calls between computers. The Luxembourg-based firm says it already has 51m registered users and a further 2m that have signed up for paid services, such as voicemail and connections to landlines and mobile phones. Skype claims to carry 45% of all American VOIP traffic.

Despite the relatively modest size of the market for VOIP at present, its quick advances and potential for growth have forced traditional phone companies and cable firms on to the defensive. Fixed-line operators in America have suffered a torrid few years as cable firms and mobile operators have eaten away at their business. Revenues at America’s fixed-line local and long-distance carriers have fallen back since peaking in 2000, and forecasts suggest that revenues will slip further over the next few years partly as VOIP providers grab their business. The number of fixed lines in America has been declining as consumers switch to mobile telephony. One estimate suggests that revenues at fixed-line firms may fall by another 25% between now and 2010.

The appearance of new VOIP providers in the past two years has come amid a battle for customers between traditional telecoms firms and cable operators. The latter have built fibre-optic networks across many countries and can offer not only telephones but broadband connections and television too. Many traditional telecoms firms are upgrading their lines to offer the same services and may also be in a position to add mobile telephony to the bundle. And both the telecoms firms and their cable rivals are aggressively, though somewhat reluctantly, offering VOIP telephony. Profits are slimmer for VOIP—the service yields up to $10 less monthly revenue per customer for traditional phone companies, according to some estimates. But telecoms firms reckon it is better to cannibalise revenues than to lose a customer altogether.

Some analysts reckon that the inability of pure VOIP firms to offer the bundled services that telecoms and cable companies can provide (which include the all-important broadband link) may limit the appeal of internet telephony. Other problems also beset VOIP. America’s Federal Communications Commission has insisted that some VOIP phones are made able to access America’s emergency services. The expense of complying with this and the possible imposition of other regulations that govern traditional telecoms providers could add to the costs of VOIP firms and eat into their competitive advantage. And customers may balk at relying wholly on phones that are affected by power cuts, not to mention the viruses that trouble the internet.

Despite these concerns, VOIP's rapid growth is set to continue for the foreseeable future. And mobile operators have as much to fear from it as fixed-line firms do, thanks to the roll-out of WiMax or other forms of wireless broadband delivered over the airwaves, which will offer mobile VOIP across many countries. As a result, the more established mobile operators, still trying to recoup the vast sums spent on third-generation (3G) licences, could see revenues fall.

It is too soon to sound the death knell for traditional fixed-line telephones. The ability of wires to deliver a variety of services, and the drawbacks of VOIP, should keep fixed-line firms in business for some time. But the coming of VOIP will provide cheaper calls for customers and help to keep fixed-line prices down. The consumer with a far-flung network of friends or business contacts may soon wonder how he paid the bills before the internet brought the cost of calls crashing down.

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