Posted: 03/2002

WHOLESALE CHANNEL

Wholesale Voice Traffic
Flocks to IP

By Nick Regas and Judy Reed
Smith

Use of Internet protocol for wholesale voice telephony is an emerging high-growth market within the telecom industry. Wholesale voice over IP (VoIP) continues to play an increasing important role for telecom service providers as the pressure to decrease costs and increase margins intensifies.

A January report, “IP Telephony: 2002-2007 Sizing, Case Studies & Trends,” by Boston-based ATLANTIC-ACM, says international wholesale VoIP minutes during 2001 exceeded 10 billion minutes and will reach at least 300 billion minutes by 2006. Wholesale providers such as ITXC and iBasis are migrating these minutes from the PSTN to VoIP.

In 2001, ITXC was already the seventh-largest international long–distance carrier carrying in excess of 2 billion minutes. iBasis was close behind, trafficking approximately 1.37 billion minutes.

Tier 1 players, such as AT&T and Sprint, are sending more traffic to key wholesale VoIP providers. During the second quarter of 2000, 3.6 percent of ITXC’s traffic was from Tier 1 providers. In contrast, traffic from Tier 1 providers dramatically increased to 29.1 percent of ITXC’s total traffic during the second quarter of 2001. Even more impressive is that 50 percent of iBasis’ traffic is from Tier 1 providers. With increasing confidence from these Tier 1 providers, analysts are bullish about the continued move from PSTN to VoIP and the increased cost savings that come with the migration.

‘Class 5’ Credibility

The stage was set for VoIP when the National Science Foundation first permitted commercial use of the Internet in 1991. Thereafter, advances in technology and infrastructure gradually moved toward a point of achievement that has enabled VoIP to become a widely offered consumer service.

Highlights of this history include the explosive growth in consumer PC ownership and Internet usage, development of software products enabling PC-to-PC and PC-to-phone calls, and the early introduction of gateway switches linking the public Internet with the PSTN. In 1997, the International Telecommunications Union (ITU) issued speech-encoding standards as part of its H.323 (VoIP) protocol further facilitating interoperability. During the last several years, most major carriers and equipment manufacturers have jumped on the VoIP bandwagon through major market initiatives and efforts to ensure seamless interfacing between networks and equipment brands. During 2001, a number of providers introduced softswitches affording such features as call forwarding, call waiting and voicemail — options normally handled by Class 5 (5ESS) switches on the PSTN. All these developments will help the VoIP perceptions among the old guard.

Public Pressure

VoIP can be deployed over the public Internet or a private IP network. Each approach has advantages and drawbacks with respect to operations.

Providers ITXC and iBasis have chosen to use the public Internet. This business model has proven beneficial in that the companies can expand into new markets quickly with less infrastructure costs than a provider deploying its own private network. However, congestion, security and QoS issues can represent significant headaches related to use of the public Internet. Moreover, carriers offering IP telephony usually must provide customers with guaranteed PSTN or private IP backup, adding substantially to business overhead costs.

Wholesale VoIP providers using the public Internet have overcome these potential hurdles by developing proprietary software that monitors and routes voice traffic according to network availability. This ensures voice quality equivalent to that provided by a Tier 1 long-distance provider. While sometimes this means the software routes traffic to the least congested network, at other times it means sending the voice traffic over the PSTN. In fact, approximately 20 percent of “VoIP” traffic finds its way over the PSTN. Despite the fact that this PSTN traffic increases costs, this helps ensure appropriate quality of calls and high call-completion rates.

Private IP telephony networks afford control and more predictable QoS. Conversely, they require a significant initial investment. Global Crossing and Genuity chose this route for their business models and have been burdened with large debts. This debt along with lack of robust revenue caused Global Crossing to file Jan. 28 for Chapter 11 bankruptcy protection. Rumors had been flying that Global Crossing had so much trouble in reaching revenue targets that up to 25 percent of its revenues came from sales to other wholesale providers. This makes the public Internet look like the better option.

North American IP Revenue and Minutes 200-2006
Chart
Source: ATLANTIC*ACM (www.atlantic-acm.com)

High Hurdles

The struggles wholesale VoIP providers had in 2001 were not hard to find. First, numerous telecom companies that were customers of wholesale VoIP providers filed for Chapter 11 protection. Many customers went months without paying bills and burdened VoIP providers with long lists of accounts receivables and mounting legal bills. Past defaults on payments wounded many providers. Some of this has been remedied by the tightening of contracts and qualification for customers.

Wholesale VoIP providers still are struggling to reach the elusive “profitability” stage. Even though minutes continue to shoot through the roof and revenue doubles from year to year, cost continues to exceed revenue. Take ITXC’s costs in 2001 as an example. As a percentage of revenue, telecom costs were approximately 84.3 percent. In addition, sales and marketing costs amounted to 14.7 percent and general and administrative totaled 13.2 percent of revenue. Despite these numbers, providers remain optimistic about reaching profitability — hopefully, sometime in 2002. The rationale for reaching profitability is predicated on achieving a critical mass in minutes, such that revenue will exceed cost.

Growing minutes of use while decreasing cost as a percentage of revenue is easier said than done. Managing growth is one the biggest challenges for wholesale VoIP providers. Developing systems that can handle high volumes of traffic effectively is difficult. As more traffic is sent over the network, companies must ensure that the appropriate measures are taken to maintain the QoS that has been given in the past. Also, as the amount of traffic increases, the complexity of managing the network increases exponentially.

Other obstacles still loom over VoIP’s total acceptance: Even though IP telephony has improved dramatically during the past few years, concerns over quality and security will continue until a majority of providers improves voice transmission and protection of signal content.

Some foreign countries do not permit VoIP because it circumvents local access charges levied by incumbent state-owned network service providers. However, many countries are beginning to realize the value of IP telephony and are opening up their countries to IP.

Until all IP networks and service providers adopt common interface and conversion schemes, such as those contained in the ITU’s H.323 standard or the more recent Session Initiation Protocol (SIP), complete international interoperability will not occur.

Migratory Pattern

The primary factor in supporting the growth of wholesale VoIP is the pressure for providers, such as AT&T and WorldCom, to maintain margins in a shrinking long-distance market. Several providers are attempting to maintain margins by price increases, while most all are seeking decreasing costs through VoIP and other means, including online customer support and other automated functions.

In addition to cost savings, it is expected that feature and service options such as unified messaging, multimedia conferencing, web callback, voice portals, click-to-talk capability will become strong incentives for adoption of VoIP.

While IP telephony will not take over the PSTN world during the next couple years, wholesale PSTN traffic will continue to migrate to IP. Don’t be surprised to see Tier 1 providers send traffic over IP, and for almost all providers to use wholesale IP telephony as they become increasingly confident with VoIP. In addition, with the current economic conditions, further refinements in infrastructure technology and broadly adopted common network interface standards, the value of VoIP will become recognized widely and its business promise fully realized.

Judy Reed Smith is CEO and Nick Regas is a senior consultant for ATLANTIC-ACM, a Boston-based strategy consulting firm. They can be reached at
[email protected].