Taking Inventory of the Systems-ServiceProposition

Posted: 05/1999

Taking Inventory of the Systems-Service

By Khali Henderson

InstantOffice from Vertical Networks Inc. provides a
single-platform solution for the voice and data communications needs of small businesses.

The bundle is the sales slogan for competitive telecommunications service. One 1999
study by Arthur Andersen LLP, Chicago, predicts that 94 percent of service providers will
be offering service bundles to their business customers within the next two years. But,
for the traditionally underserved small-business market is a bundle of network
services–local, long distance and data–complete? Some vendors and their service provider
disciples argue that it ignores an integral piece of the communications puzzle for this
target: customer pre-mise equipment (CPE).

While many integrated communications providers (ICPs) are loathe to muddy their
pristine world of invisible minutes of use (MOUs) and megabytes with that of cabinets,
consoles and cards, experts say they may be jeopardizing a stronghold gained over years of
servicing the small business segment with low-cost, flat-rate long distance services,
network-based enhanced services and personalized customer service.

Small-Business Dilemma

Technologies, such as the PC, the Internet and the web, have leveled the playing field
between small and large businesses somewhat. However, U.S. small businesses–estimated by
International Data Corp. (IDC), Framingham, Mass., to number 5.7 million in 1998 and as
many as 6 million in 2002–still find themselves smack dab in the middle of a
communications gap between home office and enterprise solutions.

Home office solutions, such as two-line phones, dial-up Internet access and answering
machines, are not scaleable for the small businesses’ larger staffs (between two and 30
people). According to IDC, the average small business has twice as many full-time
employees as do home offices, and with more staff comes a greater need for telephone
products and services, PCs and a variety of other products.

On the other side of the chasm, enterprise solutions are costly and complex. A typical
full-featured phone system, for example, can cost between $5,000 and $20,000–a price tag
that’s out of reach for most small businesses. Additionally, without an information
technology (IT) specialist on staff, small business are woefully unprepared to specify,
purchase, install and maintain a comprehensive communications system, which requires,
among other things, a private branch exchange (PBX), voice mail system, fax services,
local area network (LAN) and data router.

Simplified Solutions

This Goldilocks syndrome need not persist, according to some recent startups that have
come to market with solutions that integrate all of these functions into a simple,
low-cost box. These companies–Vertical Networks Inc., Sunnyvale, Calif., and Bizfon Inc.,
Salem, N.H.–have developed systems to address the unique and growing voice and data
communications needs of small businesses in a single economical platform.

Vertical Networks InstantOffice (pictured above), for example, incorporates functions
such as PBX, voice mail and automated attendant, computer telephony applications,
multiprotocol routing, channel service unit (CSU)/data service unit (DSU), LAN hub, remote
access server and multiservice wide area network (WAN) modules. Later additions include
interactive voice response (IVR) and automatic call distribution (ACD) functions.
InstantOffice is retail priced at $250 to $475 per user depending on the capabilities

Similarly, Bizfon combines the phone switch, auto attendant, voice mail, web server,
modem, fax server, unified messaging system, Internet service and LAN interface. Its
retail price for a six-line, eight-telephone system is $699.

Carrier Convergence Opportunity

Capitalizing on the symbiosis between communications systems and services, both
Vertical Networks and Bizfon are looking to ICPs as one distribution channel into the
small business market. "An integrated communications solution not only includes
pipes, but rendering usage of the pipes for customers," says Reed Henry, co-founder
and vice president of marketing for Vertical Networks.

Among the possible business relationships between these platform providers and carriers

* Referral model. In a reference sale or co-marketing agreement, the carrier
brings in the hardware vendor, who must close the sale. There is no commission paid to
either party.

* System integration model. In this situation, the carrier acts as the systems
integrator for the CPE purchased by the end user from the carrier, which purchased the CPE
at wholesale.

* Customer-located equipment model. In this scenario, the carrier retains
ownership of the CPE and leases it to the end user or includes it into the price for
network services.

Customer retention and acquisition gains, more so than direct revenue from the
sale/lease of CPE, are the reasons that ICPs should be looking at bundling CPE, both
vendors and service providers say.

One ICP, Signal Core Communications, New York, is offering InstantOffice as a lead-in
to T1 sales, says President Michael Schwartz. "It’s the only thing that has worked
for us," says Schwartz of the startup carrier’s sales efforts. Schwartz says that
although Signal Core makes a standard 35 percent on the sale of the phone system, the
company is more interested in the recurring revenue model it has built around the sale of
circuits and enterprise directory services. All the company’s T1 customers also are
InstantOffice users.

Henry says that other carrier customers lead with the InstantOffice offer. While they
don’t sell the system to all of them (conversion rate is about 25 percent to 40 percent),
they successfully have exploited the product as a way in the door to sell their network

Of the takers, system makers say that the value-add helps to retain those customers
longer. In fact, says a Bizfon spokesperson, CPE should be viewed as part of a
customer-retention program. For example, a long distance carrier could combine CPE rental
with long distance in a term contract, which is uncommon for long distance service alone.
The long distance carrier now has something more compelling to offer its customers than a
half-cent reduction on their rates as well as the opportunity to lock in their business,
thus reducing churn and win-back costs (see table, "A Systems-Service Impact
Model," below).

A Systems-Service Impact Model

This simplified model attempts to show the incremental
improvement in customer acquisition and retention by combining the Bizfon Inc.
small-business communications solution with a long distance service. Based on the
assumptions noted, a long distance company could earn more than $500, or 40 percent, more
per year on this small-business account.

Long Distance Only Long Distance with Integrated CPE
Assumptions # of customers 1 1
Revenue per minute 9 cents 9 cents
# of users per customer 5 5
MOUs per day 40 40
Work days per month 21 21
CPE contract in months 0 24
Profit and Loss: Long distance revenue during CPE contract $9,072 $9,072
Annual sales $4,536 $4,536
Annual cost of sales (50 percent) $2,268 $2,268
Gross margin $2,268 $2,268
Estimated marketing costs (10 percent) ($454) ($454)
Estimated G&A (12 percent) ($544) ($544)
CPE capital cost 0 ($800)
CPE rental income ($33.50 per month) 0 $804
Estimated retention improvement (1 percent per month) 0 $272
Estimated acquisition improvement (-10 percent) 0 $227
Net profit $1,270 $1,773
Net profit percentage 28% 39.1%

Critics of these systems say they are doing little to help carriers achieve the cost
efficiencies of integration on the network side. To solve this, Vertical Networks
partnered in late January with Castle Networks Inc., Westford, Mass., to pair
InstantOffice with Castle’s C2100 Services Mediation Platform, which supports the
integration of voice and data on a single line.

"The combination of the Castle Networks’ and Vertical Networks’ products offers a
compelling value proposition for new service providers trying to capture and retain
business from incumbent carriers," says Chris Nicoll, network services analyst,
Current Analysis Inc., Sterling, Va. "There is a clear opportunity [for carriers] to
differentiate [themselves] by providing a more comprehensive and cost-effective
voice/data-integration solution tailored to specific customer segments."

In the Trench

One of the reasons carriers have been happy to stay out of the CPE business is its
considerable baggage in the form of inventory, installation and support. Certainly, for
long distance carriers, which can operate nationwide easily from a centralized location,
the prospect of providing support on a local level is daunting. Even for competitive local
exchange carriers (CLECs), which are concerned with building out their networks, adding a
layer of costly support personnel is low on the priority list.

For this reason, Vertical Networks and Bizfon both have built their systems to be
managed by the end user with backup remote support from the carrier or from the
manufacturer under contract to the carrier. (Remember, both also sell these systems
directly and are supporting their own customers.) Additionally, they have installation and
maintenance agreements, which carriers can ride, with national support companies. Vertical
Networks, for example, has an agreement for support with NCR Corp., Dayton, Ohio, a
company that provides technology-enabled business solutions.

As a Vertical Networks partner Signal Core takes advantage of the NCR relationship for
customers outside of the New York area. Within its headquarters city, however, it has
contracted with an interconnect for installation and on-site support. However, Schwartz
says, that part of the appeal of the InstantOffice system is the remote management option,
which it offers to customers on a contract basis. The system is so well-designed, he says,
that most of his customers are comfortable managing most of the adds/moves/changes
themselves through the graphical, web-based management system.

Khali Henderson is editor-in-chief of PHONE+ magazine.

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