Posted: 11/1999
Quiet Crusade
VoIP Wins Converts in Wholesale Markets Around the World
By Khali Henderson
As carriers scramble to compete in the hyper-competitive long distance markets internationally and domestically, voice over Internet protocol (VoIP)--its promise of cheaper transport and, so far, its lack of regulatory oversight--has become a panacea, enabling them to improve margins instantly in popular commercial centers and enter new, deregulating markets where margins are still high. Eager to take advantage of VoIP's benefits, many carriers--startups and veterans alike--are building out IP networks capable of carrying voice traffic. Greater still are the numbers that are lining up to resell their services to experience the advantages without the investment of capital or time to build their own networks.
In fact, according to an August study by International Data Corp. (IDC), Framingham, Mass., wholesale will be the fastest growth market for IP telephony through 2000 as networks continue to be deployed and quality is proven to retailers and consumers. IDC researchers predict wholesale IP telephony minutes will increase 300 percent between 1999 and 2000, jumping from 600 million minutes to 2.4 billion minutes per year. Revenues from wholesale IP telephony traffic for the same period are expected to grow from $90 million to $310 million. By 2004, IDC analysts say wholesale traffic will account for about $2 billion of the total IP telephony market, which they expect to grow to $19 billion (see tables, below).
Graph: IP Telephony Minutes of Use by Market Segment
Graph: Wholesale IP Telephony Revenue Forecast
This gain likely will come at the expense of circuit-switched providers, which IP telephony wholesalers say are the ones they meet in the market, rarely ever finding themselves bidding against other VoIP providers for a carrier's business. Very often they find themselves at the tops of carriers' least-cost routing (LCR) tables with their more costly circuit-switched brethren in the fallback position.
"Since we sell real-time voice and fax, we compete with anyone who sells that. We are undifferentiated in the market," says Gordon Vander-Brug, executive vice president of iBasis, Burlington, Mass. iBasis, formerly VIP Calling Inc., is an international wholesale-only provider of IP telephony services.
"We look just like a circuit-switched carrier [from a coverage standpoint]. But we offer them a different value proposition," explains Bob Freinberg, vice president of sales and marketing for Networks Telephony Corp. (NTC), El Segundo, Calif., a VoIP carrier's carrier serving wholesale customers in North America and Europe. NTC's service uses the private managed global network run by Infonet Services Corp., El Segundo, Calif., a 28-year-old data services company. NTC has a presence in more than 40 countries and offers call termination to more than 200 countries.
A pure wholesaler, NTC is focused on providing the necessary back-office support its resellers need as well as value-added services, such as VoIP phone cards and PIN-access (cardless) calling. However, like most of VoIP wholesalers, NTC's primary value proposition for the time being is low-cost transport made possible by the efficiencies of the packet-based network, which allows for greater compression ratios and silence suppression. (One carrier says it can improve its transmission efficiency by 40 percent just by inserting packets in the spaces created by periods of silence in voice calls.) This is particularly relevant in international markets where arbitrage provides a stable income for dozens of international carriers and prepaid card providers.
International Arbitrage
Not surprisingly, the international market is the primary playground for IP telephony wholesalers. International minutes (retail) represented 88 percent of the IP telephony market in 1999, and it is expected to comprise the bulk of the traffic (75 percent) through 2004, according to IDC.
Among the early entrants into the international wholesale space are entrepreneurial firms such as iBasis; NTC; ITXC Corp., Princeton, N.J.; and Stonehenge Telecom, Hofddorp, the Netherlands. Heavyweight Teleglobe Communications Corp., Reston, Va., threw its hat into the ring in mid-September with an announcement that it is offering wholesale VoIP services over its global fiber backbone.
For the most part, these IP telephony wholesalers are targeting international routes to emerging economies, such as Bangladesh, Ghana and Lebanon, where international long distance calling remains expensive at 40, 50 or 60 cents per minute. They are rarely in competition for routes to the United Kingdom or Hong Kong, which are overbuilt with circuits and sell for less than a nickel a minute wholesale. The reasons are twofold. One, the arbitrage opportunity on emerging routes is greater. And two, the IP network often remains unregulated in those countries, allowing for the transport of voice calls in the gray, or outside of the accounting rate settlements system that relies on bilateral agreements between common carriers (e.g., the PTT and the foreign carrier).
Domestic Play
While less dramatic, arbitrage currently is the primary seller for domestic U.S. VoIP wholesalers, too. However, for these companies, such as NetVoice Technologies Inc., Dallas, the impetus is funding network buildout for their own retail offerings, which will center not on low-cost calling, but on value-added services promised by IP's multimedia capability.
While wholesale accounts for at least 75 percent of its business today, NetVoice Vice President of Sales Fred Rackers expects that to decline to 50 percent within six months. By the end of 2000, the company plans only 30 percent of its business to be wholesale traffic.
"Wholesale has helped us to build our network and will continue to be a portion of our business," he says, noting he expects other domestic carriers will build out their own IP networks, thereby eliminating the arbitrage opportunity.
Rackers' expectations likely are to be accurate. Much ado has been made of the IP networks that are being deployed by next-generation carriers such as Level 3 Communications Inc., Broomfield, Colo. Heretofore, it has been mostly noise, but such carriers are sure to make good on their promises to shareholders. Level 3, for example, reported in its September quarterly report that it is on track for deployment of its VoIP services yet this year. The company had signed a four-year, $250 million agreement with Lucent Technologies Inc., Murray Hill, N.J., for the deployment of the switch maker's "softswitches" to support voice services in its network.
Other carriers, such as Qwest Communications International Inc., Denver, and Frontier Corp., Rochester, N.Y., are turning their fiber optic networks into IP backbones by trading in their circuit switches for packet switches. IXC Communications Inc., Austin, Texas, is deploying a coast-to-coast OC-48 IP backbone called Gemini-2000. Three of the aggregation points already are online, with the remainder expected to go live this fall. When this transformation is completed, these wholesale heavyweights surely will step into the wholesale VoIP ring.
Between the startups on one hand and the large wholesalers on the other are a few integrated communications carriers such as ICG Communications Inc., Englewood, Colo., and ITC^Deltacom, West Point, Ga., each of which has announced offering VoIP services to resellers domestically.
Make no mistake, however; these are by no means the only ones dabbling in VoIP. Says NetVoice's Rackers, there are many other carriers that are using and investing in IP that aren't talking about it. He may be right. Recent research from Allied Business Intelligence (ABI), Oyster Bay, N.Y., shows that the total world market for VoIP equipment--gateways and gatekeepers--will rise from $163 million in 1998 to $3.1 billion in 2004. Most of this growth is driven by service providers, ABI researchers report. "After several years of tire-kicking, service providers let loose a burst of contracts in 1999 for the deployment of commercial networks. This service expansion became earnest in the latter half of 1999 and will continue into early 2000," they state in a Sept. 15 press release announcing the new data.
Quality vs. Price Debate
Why would there be so much interest when arbitrage opportunities by definition are artificial and short-lived? Sources say that the arbitrage opportunity internationally will last at least two or three more years--longer, too, on some routes, and longer still depending on the methodology the wholesaler uses to transport calls.
VoIP can utilize a dedicated IP network, the public Internet or a combination of both. The cost differential can be significant when compared to circuit-switched transport and even when compared to one another. In a presentation, ITXC compares the costs of transport media to illustrate graphically the savings possible using IP. In the example, ITXC assumes that an uncompressed T1 circuit from the United States to Sao Paolo, Brazil, costs $70,000 per month. Assuming 27 percent loading, a circuit-switched call would be 20 cents per minute. Compressed at 6:1 (180 calls per minute), a circuit-switched call would be 3.3 cents per minute. A call over a dedicated IP route compressed at 8:1 (240 calls per minute) costs 2.5 cents per minute.
In contrast, the same route over the public Internet costs $7,000 ($2,000 to connect to the Internet service provider [ISP] in Sao Paolo and $5,000 for the ISP to connect into the public switched telephone network [PSTN]). So, a voice call over the public Internet at the 8:1 compression cost 0.2 cents per minute.
By using the public Internet, a VoIP wholesaler or retailer can improve its margins significantly, withstanding competitive price pressures almost indefinitely. This certainly is true when looking at pure math. However, there is considerable debate over the quality of call that can be achieved over the public Internet. Many carriers are insistent that the quality and reliability does not equal that of the traditional telephony network and, therefore, is inadequate as a PSTN replacement.
In launching its wholesale VoIP services, Teleglobe announced its calls would traverse its global fiber backbone instead of the public Internet. Andrew Burroughs, vice president of global marketing and product management, says the company explored use of the public Internet and found that the call quality was inconsistent. "Our customers want quality that is equal to or better [than the PSTN], not worse," he says.
Over dedicated facilities, he says, "VoIP calls are not subject to degradation resulting from regional and peak bandwidth fluctuations."
While most people would agree dedicated facilities are superior to the public Internet, the quality of the Internet worldwide is improving as more and more bandwidth is deployed. Additionally, there are instances where the ideal--PSTN replacement--is secondary to another criterion, such as price or function-ality. While those of us in the United States cannot appreciate fully the value of accessible and affordable phone services, many consumers and business people in Russia, Africa and other low-teledensity areas are eager to get phone service, especially reasonably priced phone service, no matter what the quality.
Companies such as ITXC and PC-to-phone market leader Net2Phone Inc., Hackensack, N.J., have had considerable success signing customers for services that use the public Internet. Net2phone, for example, has resale agreements with many major telephone concerns in the United States and abroad. In September, for example, it agreed to provide its IP telephony services--PC-to-phone, phone-to-phone and PC-to-fax--to SMART Communications, the Philippines' leading mobile phone company. In the United States, Net2phone signed with Sprint Corp. in August to trial its VoIP services for calls to Asia. Called Sprint Callternatives, the service will originate, carry and terminate consumer long distance calls to China, Hong Kong, India, Japan, Taiwan, Thailand and Vietnam.
Additionally, there are some services, such as click-to-talk customer service via the web, that require transporting calls at least partially over the public Internet. Interestingly, this web-care feature was cited by nearly all VoIP wholesalers as one of the many value-added features they would offer to their customers to maintain their revenue stream as the arbitrage opportunity fades away. Among the others were phone cards (which many, such as NTC and iBasis, already offer) and unified messaging services.
According to IDC researchers, these carriers are right on the money. Few applications beyond long distance calling are expected before 2000. By 2001, voice-enabled e-commerce features, such as click-to-chat and click-to-conference, will become a significant revenue stream. In 2002-2003, IDC analysts say other enhanced services--unified messaging, groupware/collaboration and real-time video--will take off, and after 2004, applications will dominate the market.
Khali Henderson is editor-in-chief of PHONE+ magazine.
