Quiet Crusade

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.