4

The Diffusion of VoIP & Strategies for Incumbent Telecommunications

Providers

LAURENCE CUA

KETKI GADGIL MAHESH JADHAV

MARCELO MASSARENTE RICCARDO VOLPATI

November 21, 2005Professor Greenstein

MGMT 463 – Management of Technology

Table of Contents

Executive Summary......................................................................................1

Introduction to VoIP Technology..............................................................1

VoIP Market Overview.................................................................................2

Key Players in the VoIP Industry and Their Business Models..............7

Threats for Incumbent Telecom Companies..........................................10

Opportunities for Incumbent Telecom Companies...............................12

Lessons Learned in Other Countries.......................................................13

Recommendations – Status Quo is not an Option.................................13

The Diffusion of VoIP & Strategies for Incumbent Telecommunications Providers

MANAGEMENT 463 – MANAGEMENT OF TECHNOLOGY

KELLOGG SCHOOL OF MANAGEMENT

Executive Summary

The following report will analyze the diffusion of VoIP technology and to

examine how the emergence of VoIP is redefining the telecommunications

industry in the United States. The report introduces VoIP technology, de-

scribes key characteristics of the VoIP market, forecasts trends with each

different business models (software providers, indirect providers, cable op-

erators, and incumbent fixed line operators), analyzes the threats and op-

portunities facing incumbent telephone operators, and finally provides

strategic recommendations for incumbents to maintain their market leader-

ship in the near future.

As incumbent fixed line operators face the rapid adoption of lower-cost

VoIP and the influx of new competitors, they must simultaneously embrace

this technology while keeping new competitors at bay. Most importantly,

incumbents must quickly develop and introduce value-added services to

compete with the bundled offerings of cable companies (video, voice and

broadband) while leveraging on their large PSTN customer base.

The report focuses on businesses competing with fixed-line operations.

The scope of this report excludes mobile carriers and wireless-related tech-

nologies (e.g. WiMax).

Introduction to VoIP Technology

1




VoIP stands for Voice over Internet Protocol, and refers to the routing of

voice communication over an IP network, including the Internet. Voice data

is transferred across a “general-purpose packet-switched network, instead

of traditional dedicated, circuit-switched voice transmission lines.”1

Although there exists several categories of VoIP services, VoIP technol-

ogy generally holds three key advantages over traditional Public Switched

Telephone Networks (PSTN):

Cost. Because VoIP uses general-purpose networks meant for both

voice and data, cost is spread across more services, i.e. a single pipe

provides cable TV, Internet, and voice. Similarly, some VoIP providers

utilize existing network capacity and do not charge any fee for use of

their basic services.

Mobility. All incoming calls are routed directly to a VoIP phone, re-

gardless where that VoIP phone is connected to the network. A VoIP

phone with a US number can therefore be plugged in overseas and

still receive calls. This is particularly helpful for frequent travelers

and mobile workers.

Added services. Several VoIP providers offer additional services over

the Internet, including file transfers, instant messaging, and video and

audio conferencing.

However, VoIP has limitations that are still being addressed by VoIP

providers:

2




Reliability. Unlike traditional phones, most VoIP services rely on

some sort of broadband modem powered by household electricity,

making them vulnerable to power outages. Currently, the only way

around this is by using an uninterruptible power supply or generator.

Quality. If a network is highly congested, quality over a VoIP system

suffers, usually resulting in delayed or lost sound. Quality also suffers

in long-distance connections.

Emergency calls. Not all VoIP providers offer e911 service, primar-

ily because of the technical challenge in locating a VoIP phone’s geo-

graphic location.

Compatibility. Since there is no global standard that VoIP ser-

vices share, not all VoIP phones can communicate with each

other.

VoIP Market Overview

Market Size

According to the research firm, TeleGeography, by the end 2005, 4 mil-

lion households in the US market will be subscribed to VoIP providers. This

figure does not include people who use PC or software-based VoIP services

like Skype. Analysts estimate that this figure will grow to 17 million Ameri-

can subscribers by 20102. TeleGeography predicts that revenues generated

from VoIP services will rapidly climb from today’s level of $220 million to $3

billion in just two years. 2

3




Has VoIP Crossed the Chasm?

In the US market, VoIP technology has held a long history. Early

adopters have typically used PC and software-based VoIP technology. Re-

cently, several factors have accelerated the adoption of VoIP as a main-

stream technology which we believe will eventually lead to mass market

adoption:

Rise in broadband Internet connection penetration.

New products replicate traditional calling experience. Services

such as Vonage, allows consumers to make calls with a user friendly

handset, and offer typical features such as voicemail, and call waiting.

Aggressive price competition. Independent VoIP providers, such as

Vonage, are using aggressive pricing packages to attract mainstream

customers

Quality of service improvements. Perception of improved quality of

service, comparable to PSTN based calls, has improved adoption of

technology

Increased awareness by mainstream public of VoIP technology.

Mass market advertising campaigns by Vonage, significant media cov-

erage of eBay’s acquisition of Skype, and mainstream press on the

technology has improved awareness around VoIP technology

Skype, Yahoo, MSN encouraging trial with the early majority.

Growing popularity of instant messaging (IM) services such as Skype,

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Yahoo Instant Messenger, Google Talk which bundle voice services

with their IM platforms, are increasing trial of VoIP and establishing

the value of VoIP and quality of the voice services

Established brands, such as AT&T and Verizon entering the

market. Recent introductions of VoIP services by established players,

such as AT&T CallVantage and Verizon VoiceWing lend credibility of

VoIP technology to the mainstream. In 2005, a number of established

telecommunications providers plan to enter the VoIP market includ-

ing: SBC, BellSouth, Qwest, MCI and Comcast.

A clear example of the rapid adoption of VoIP is the phenomenal growth of

Vonage’s US subscriber base, tripling to 750,000 subscribers from last

year3. The real question is not if VoIP will cross the chasm, but how quickly

it will diffuse into the mainstream market and which VoIP service providers

consumers will choose. The speed of this diffusion will be highly depen-

dent on overcoming key barriers to adoption beyond the technical limita-

tions that are already being addressed.

The Security Problem: a key barrier to adoption

“The development of enterprise VoIP or IP Telephony is accelerating

rapidly, but security isn’t necessarily keeping up”4.

1 “Voice over IP”, www.wikipedia.org (http://en.wikipedia.org/wiki/Voip), re-trieved on November 20, 2005 3

? “Number of Internet-phone consumers soars”, USA Today, August 17, 2005

5




The PSTN is largely perceived as being a secure network; the Internet is

not. Well known websites and service providers are frequently affected by

security breaches. In this context, current implementations of VoIP are also

vulnerable and service and network operators will need to undertake more

work to assure the wider consumer market that replacement VoIP offerings

are at least as safe as traditional voice services. The presence of malicious

agents and software code on the Internet give rise to concern over the

wider resilience of VoIP services. For this reason, in its transition from the

early adopters to the early majority stage of the adoption cycle, VoIP must

prove itself to be immune to such threats. As of today, the isolation and ro-

bustness of the PSTN is still a major strength and one not to be overlooked

when projecting a broad technology switch. These VoIP security threats in-

clude:

Service availability attacks. DoS (Denial of Service) attacks, spam

and viruses. DoS attacks are intended to flood a target call manager,

phone or VoIP infrastructure with an overwhelming amount of ficti-

tious requests or information. Voice spam is expected to emerge in

the same way as it did with email services, filling up users’ voicemail

boxes. Viruses exploit weaknesses in operating systems and applica-

tions leading to network instability.

Eavesdropping. It is very easy to find on the Internet free applica-

tions that allow users to listen to phone calls on VoIP networks. This

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way, attackers can have access to confidential conversations. For ex-

ample in July 2005 a flaw was identified in Cisco’s Call Manager that

could have allowed intruders to listen to calls routed through it5.

Impersonation. A hijacker can impersonate a user profile to commit

fraud, access confidential information or disrupt business in organiza-

tions.

Theft of service. Call tracking tools can be used in order to capture

users’ authentication information with the objective of placing calls on

the user’s expense.

Regulatory and other organizations are trying to provide solutions to

help address the need for security. In January 2005, the U.S. National Insti-

tute of Standards and Technology published a strategic report on VoIP secu-

rity, urging organizations to proceed with caution and outlined recommen-

dations for deployment. Furthermore, VoIP technology and security prod-

uct providers have founded VoIP Security Alliance (VoIPSA), in February

2005. VoIPSA’s main activity is to “help define the many potential security

threats to VoIP deployments, services, and end users”6. Recently, VoIPSA

developed and released a formal framework for VoIP security and privacy

risk assessment.

“Unlike data communication, VoIP is a real-time service and requires se-

curity infrastructure to provide automated, real time security responses to

preserve the very high availability expected by telephone users”Error: Ref-

7




erence source not found. Organizations need to recognize the uniqueness of

VoIP networks, with new types of attacks and challenges that require a dif-

ferent approach to proactive security. With well adapted policies and spe-

cific technology in place, VoIP services can be made as secure, or even

more so, than traditional telephone networks.

Regulatory Issues

The fast growth of broadband Internet and new service offerings, includ-

ing VoIP, represent a big challenge for regulators. “The problem is that the

current philosophies of most regulators are predicated on three assump-

tions that no longer hold true. First, that telecommunications mainly con-

cerns voice calls. Second, that Telecoms networks are in effect natural mo-

nopolies. And third, that in most cases the firm that owns the network also

provides the service”7. In actual facts, the advent and mass adoption of

broadband technology is proving all three assumptions to be no longer

valid. Everywhere in the world networks are being built or upgraded in or-

der to carry voice, video and data and to provide customers with a choice of

ways to get on to the network. Telecom monopoly is no longer the norm and

there is an increasing decoupling of firms providing the service and those

owning the networks.

In this era of change, regulations can make a big difference in shaping

competition and growth in the VoIP industry. Regulators must be cautious

not to suffocate such a fledgling business, ensuring at the same time that no

8




unfair discrimination is made between telephone service providers based

merely on the technology used. Furthermore, regulators have to guarantee

that VoIP offers the same social safeguards that the public expects from any

critical infrastructure.

An example of this regulatory effort was the recent vote of the FCC to re-

quire Internet phone companies to offer a 911 emergency call service. With

this move, the FCC made a significant change from its previous hands-off

approach, making a big step towards imposing traditional telecoms rules on

the Internet. According to the FCC, VoIP providers will have to either im-

plement the 911 capability, or disconnect users who do not explicitly con-

firm being aware that the service does not allow emergency calls. Providing

access to 911 systems can be complex, costly and perhaps not feasible for

many small VoIP providers. However, “This alone won’t kill the VoIP indus-

try but will tighten it up a little bit. The danger is that companies that have

done a lot of innovating to bring these products and services to the market

are now looking at a higher cost of entry”8.

Based on the above, the players that are likely to be the most impacted

by the 911 regulation are indirect access providers, particularly the small

ones. The new rule introduces barriers in a sector whose previous cost of

entry was low, and makes operation more costly for existing competitors.

Key Players in the VoIP Industry and Their Business Models

9




Sandvine, a telecom-equipment firm, estimates that there are 1,100 VoIP

providers in America.9 The multitude of VoIP providers can be classified

into four main categories.

Software

This most basic form of VoIP, also commonly referred to as PC-based

VoIP, has been in existence for over ten years. This form of VoIP only

requires users to install software on their computers, and have a

microphone and speaker/headset connected to their PC. Prominent players

in this category include AOL, Yahoo, MSN and the eBay-owned Skype.

These providers offer integrated VoIP services with their instant messaging

platforms, allowing users to make calls to other users of the service over the

Internet for free. Both Yahoo and Skype have added capabilities to offer

landling calling and voicemail for additional fees. The main objective of

2 “The war of the wires – Telecoms, TV, and the Internet”, The Economist, July 30, 20054

? Paul Slaby, “The Dangers of VoIP”, Globeandmail.com, November 4, 20055

? Riva Richmond, “Flaws Are Found in Cisco’s Web-Calling Software”, The Wall Street Journal, July 14, 20056

? VoIP Security Alliance, www.voipsa.org, retrieved on November 20, 20057

? “Why a Light Touch is Best – Internet regulation”, The Economist, May 28, 2005 8

? Schwartz, A. and Young, S. “FCC Wants Web Phones to Have Access to 911 Within Four Months”, The Wall Street Journal, May 20, 20059

? “The meaning of free speech – Telecoms and the Internet”, The Economist, September 17, 2005

10




these providers is to integrate voice communications with other Internet

activities. For example, eBay shoppers can ”Skype” a vendor to get more

information about a product to aid the completion of a transaction.

With the big three Internet portals sharing a quarter billion instant

messaging users between them, this form of VoIP is the most popular

amongst consumers. However there are several drawbacks to PC-based

VoIP that prevent it from being a real threat to the mainstream

communications business. First, the form factor and usability of PC-based

communications prevent it from being a real threat. Second, the

fragmented nature of messaging networks limit consumers from being able

to communicate with all their contacts for free. Third, since calls are

carried over the public Internet, these providers have limited control over

quality of service or security. With significant limitations, we expect that

PC-based VoIP services will co-exist with traditional telephone service.

However, these services will primarily be used for free net calling as it will

be difficult for software VoIP providers to generate revenues from off-net

calling.

Indirect Providers

Indirect providers offer consumers voice services most closely resem-

bling standard phone service. Customers with high speed Internet connec-

tions plug an adapter into a regular telephone or an IP based handset and

get service that is quite identical to standard phone service, except that it

11




runs over an Internet connection. Vonage, with the largest US subscriber

base, is the dominant player in this category. Indirect operators are posi-

tioning themselves as a low cost replacement to traditional phone services

as they are able to offer deep discounts over traditional fixed line operators

because of significant cost advantages. These VoIP providers do not have to

pay call origination charges in same way as PSTN-based alternative opera-

tors, because their calls are carried over a broadband line. Furthermore,

these firms do not have the expense of maintaining their own communica-

tions networks. Indirect providers do not own the access infrastructure and

most of the calls are routed through the mostly public Internet. Steep com-

petition in this market and the entry of traditional players such as AT&T

and Verizon is causing a downward spiraling pressure on pricing of voice

services. Since Vonage began offering its services it has reduced prices

twice and has gone from offering services at $35 down to $25 by September

2005. While Vonage and others have alleviated some of this pressure by of-

fering different tiers of packages, the downward pricing will ultimately be

harmful to all players. Indirect players may not be able to sustain lower

prices in the long term. Established players will see considerable erosion of

the traditional PSTN revenue base and low margins in VoIP services. Indi-

rect players have also tried to differentiate on the basis of features. How-

ever, as more players enter the VoIP market, these features are becoming

standard and no longer constitute as competitive differentiators. While

12




most indirect players have had the first mover advantage to fuel the initial

growth of the VoIP market, we believe that many can be squeezed out as

competition increases. Additionally, because indirect providers do not

maintain their own network, they are constrained in ensuring consistent

quality and security.

Cable Operators

Cable Operators are rapidly entering the VoIP market by offering voice

services over their own local access networks. These companies hope to en-

tice customers with a “triple-play” package of voice, video and high speed

Internet services. US cable companies believe that VoIP services will drive

growth. According to one estimate, Comcast, the largest US cable operator,

plans to add 250,000 subscribers of Internet telephony by the fourth quar-

ter of 2005 and 1 million by 200610.

Incumbent Fixed Line Telephone Operators

Pressured by indirect providers and cable operators that offer VoIP,

Incumbent telephone service providers, such as SBC, Verizon, and AT&T,

have recently entered the consumer US VoIP market. Like cable operators,

incumbent telephone operators will bundle VoIP with other services. By

offering lower price and lower margin VoIP services, these operators risk

cannibalizing revenues from their traditional phone service.

10

? “Why VoIP telephony is quickly coming of age”, Financial Times, September 8, 2005

13




Who will capture Share of revenues?

We believe that largest share can be captured by traditional fixed line

operators and cable operators, as they have direct control over their

networks and they have the ability to bundle VoIP with other services.

Second share would go to a few indirect providers such as Vonage, with

smaller indirect providers getting squeezed out. Finally, we foresee

software client providers to co-exist as an alternate means of

communication that is tied more closely to complementary internet

activities.

The success of traditional fixed line operators, however, can only be

realized if they are able to address key threats from VoIP and cable

operators while leveraging opportunities offered by VoIP.

Threats for Incumbent Telecom Companies

Market share erosion and revenue shrinkage in the voice business

The first impact that VoIP will cause on the incumbent telecom compa-

nies is to erode their market share on the voice market and put pressure on

prices and revenues. Because VoIP is not capital intensive, it greatly in-

creases the number of alternative voice service providers. Furthermore,

VoIP providers can be much more competitive in pricing and drive drastic

revenue losses for the incumbents. “Factors such as the distance between

the callers or the duration of a call, the key determinants of cost today, are

14




simply irrelevant with VoIP” 9. Over IP, the concept of distance means noth-

ing. As described earlier, one can simply plug a VoIP phone to any broad-

band connection in the world and still use the same phone number and

rates.

Interconnection issues deserve a paper per se, but let’s try to summarize

the main points. Even when calling from a VoIP phone to a regular phone,

VoIP can avoid interconnecting fees in the origin, cutting its costs and the

revenues of the network owner at the same time. When one VoIP phone

calls another, the impact can be even higher; if both VoIP phone belong to

the same provider, there are no connecting fees at all. However, when the

originating and receiving VoIP phones are in different providers, they still

need to be connected through the PSTN. But this is likely to change, as

VoIP connecting standards (ex: ENUM) are created and global VoIP carry-

ing services emerge, i.e. the one UK’s Cable & Wireless launched on Octo-

ber 200511.

Finally, the regulatory environment adds to VoIP’s competitiveness. By

considering VoIP as a data service rather than a voice service, VoIP is ex-

empted from the lots of taxes that correspond to over 40%-50% of a regular

phone bill12.

11

? “Cable & Wireless launches global VoIP interconnect”, Internet Business News, October 12, 200512

? “Tax Questions Confront VoIP Services”, Mondaq Business Briefing, Febru-ary 23, 2005

15




As a result, Verizon for example was not only forced to reduce its prices

in most of the East Coast, but also lost 518,000 traditional lines in the sec-

ond quarter of 200513. SBC also reported a 5.1% decline in its lines in the

third quarter14. Incumbents are also launching flat fee plans for the tradi-

tional phone lines and offering their own VoIP services to prevent market

shares losses. However, net revenues from a VoIP client are at least $10/

month less than the traditional offering15.

Impact on incumbents’ broadband business

Many telecom companies are counting on the increased revenues in pro-

viding DSL broadband services to offset part of the losses in voice. How-

ever, even this is threatened by VoIP.

First, “parasite” VoIP providers, like Vonage, can drive higher utilization

and traffic on the incumbent’s network, forcing the incumbents to invest

even more, without bringing them any revenues (actually, using their assets

to steal revenues from their voice services). In fact, some DSL providers

are studying legal ways to prioritize any data traffic on their networks over

VoIP packages not routed through their providers16.

13

? “Why VoIP is telephony is coming of age”, Financial Times (www.ft.com), September 8, 200514

? “SBC's CFO Takes on Its Rivals; The telecom giant's Richard Lindner out-lines plans for combating price pressure -- and a growing threat from cable and VoIP providers”, BusinessWeek Online, November 14, 200515

? “The phone call is dead; long live the phone call”, The Economist, Decem-ber 4, 2004

16




Second, VoIP can open the way to “naked broadband” services. So far,

because consumers need to have a phone line anyway, the incumbents can

easily sell a bundle of voice and broadband services with limited competi-

tion17. When consumers have the option to contract VoIP services from an-

other provider, the attractiveness of a “naked broadband” offering increases

and incumbents might see themselves without both voice and data markets.

Indeed, many phone companies today refuse to sell DSL without a phone

subscription, but regulations may eventually force them to do so.

Third, VoIP is a great opportunity for cable operators to gain a head start

in the upcoming "battle for convergence”. It has been long discussed that

the future is to provide “triple-play”18 services (TV, Internet, voice) and to

control the flow of digital content into consumers’ homes. Cable operators

actually see VoIP from the opposite direction of incumbents. Because cable

companies don’t depend on voice for their revenues today, and VoIP uses

very little bandwidth compared to video, cable providers can offer cheap

VoIP as a competitive weapon against incumbents9. Cable companies are

taking this seriously. All the major operators in the US are already offering

16

? “The war of the wires – Telecoms, television and the internet”, The Econo-mist, July 30, 200517

? “Naked Come the Callers? Skype and its internet calling service are get-ting lots of attention, but “naked broadband” may be the real threat to tradi-tional phone outfits”, BusinessWeek Online, September 12, 200518

? “VoIP providers beat a path to consumer’s doorways.”, Financial Times, January 10, 2005

17




VoIP services. Time Warner had already 220,000 VoIP subscribers by the

end of 2004, adding 10,000 per week, and Cablevision had over 350,000

VoIP clients by mid-March19. Phone companies are responding. An SBC ex-

ecutive recently said that “we’re not a telephone company anymore; I sort

of resent that”16, in a reference to their “lightspeed” project of offering IPTV

in the future.

Opportunities for Incumbent Telecom Companies

Geographical expansion

Because offering VoIP services doesn’t require the deployment of one’s

own network, incumbents can take the chance to expand themselves into

other markets, both domestic and abroad. SBC has already announced that

after it completes the acquisition of AT&T, it will aggressively market its

VoIP services in states beyond the 13 where they currently offer traditional

telephone services20. This is a risky move, as it will pit incumbents against

one another more fiercely than ever before.

Rebuild their own networks

Phone companies have the chance to rebuild their entire networks

around VoIP, which is inherently more efficient than traditional PSTN. In

doing so, they can capture the cost savings that come with VoIP and build

19

? “Cable groups see VoIP services take off”, Financial Times, April 12, 200520

? “Cheap talk: Market for Internet calling, Once tiny, gets crowd fast- Better technology, few rules spur flood of competition; pace of change is Dizzying- Vonage takes on ‘Von-a-bess”, The Wall Street Journal, August 26, 2005

18




the capability to offer other VoIP-related services in the future. This may

also be necessary in anticipation of the “battle for convergence” with cable

operators, which already have most of their networks in IP format. Some

people estimate that in the near future, even if some consumers continue to

use traditional phone lines, the entire network behind their handsets will in-

deed be VoIP-based. Verizon has estimated that to run one single IP net-

work for voice, TV and data would cost 40% less than 3 traditional ones20,

while BT has already started to work on its 21CN network, which should re-

place the PSTN network by the end of the decade10.

Lessons Learned in Other Countries

In Japan, incumbent NTT has lost significant voice revenues as a result of

customers switching to VoIP. NTT lost 35% of its revenue over 2 years and

even after launching its own VoIP service, has not been able to recoup its

lost revenue. Yahoo! Broadband Japan, on the other hand, has already re-

cruited 4 million customers. Similarly, Fastweb in Italy has gained 400,000

customers. With these as archetypal examples, key lessons learned from

other countries are:

It’s not a question of “if” VoIP will have an impact, it’s a question of

“when”.

Strong network externalities suggest that being first to market with a

new service is much more advantageous to get market share

Recommendations – Status Quo is not an Option

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Our analysis shows that while fixed line operators are foreseen to retain

a large revenue share of voice communications, their present business

model is under serious threat from the disruptiveness of VoIP technology

and the velocity of its adoption. Given that first movers have an advantage

and that cable operators are getting into VoIP aggressively, incumbents

should embrace VoIP. Knowing that they do not yet have a distinct competi-

tive advantage against cable operators’ “triple play” offering—mainly be-

cause they lack the content that cable operators have—incumbents must

balance the tradeoffs between the inevitability of VoIP and their strength in

PSTN. As such, incumbents must simultaneously migrate their main prod-

uct offerings to VoIP while slowing down competition. We recommend a

four pronged strategy to succeed in this rapidly evolving phenomenon: Sur-

vive, Adapt, Defend, Attack

1. Surviving in Chaos: worst case scenario and the need for organizational

paranoia

Fixed line operators need to act with urgency and create a sense of para-

noia within their organizations – without creating panic of course. A good

strategy would be for the CEO to prepare a memo like Bill Gates did in 1995

to address the Internet threat. We believe that this technology change is

disruptive in nature and incumbent fixed line operators should consider

changing their business model over a period of time.

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2. Adapting to Change: go-to-market strategies

VoIP is disruptive technology that needs a different business model. In-

cumbents need to lead change instead of being led by change. We recom-

mend that incumbents invest heavily over next 2 to 3 years to build a value

proposition based on VoIP and entertainment to counter the threat of cable

operators. Incumbents should also consider their positioning – merely giv-

ing a low cost VoIP will not win customers. IP based services should be po-

sitioned as a value-add. Although Clayton Christensen’s framework may not

apply directly, we believe that incumbents need a different culture and dif-

ferent organization to succeed in this endeavor to create a new business

model. We recommend that incumbents form a separate subsidiary with

different organization, compensation than current structures to launch VoIP

and value added services. To overcome the total company inertia, this sub-

sidiary should not be completely separated from regular operations. In fact,

development in VoIP and related value-added services should be highlighted

in all cycle meetings.

The biggest advantage the incumbents have is the sheer size of its cus-

tomer base and the information available about their spending habits. As

VoIP moves into early adopter stage of the technology-adoption life-cycle,

incumbents should leverage this strength and build go-to-market strategies

that address customer needs based on demographics, geographies, income

levels, etc. Special emphasis should be paid to people making long-distance

21




and international calls. The biggest cost savings for customers will arise in

these two categories and if the right VoIP service is provided. Lower rev-

enue due to lower prices may be partially made up for by an increase in

minutes-volume.

3. Defensive Strategies – lobbying regulators for a level play field

Indirect VoIP providers today enjoy an unfair advantage over incumbents

in the sense that they pay no taxes (as they technically provide information

services) which result a price advantage of 30-50%. Incumbents, with their

clout and large contributions to campaigns, should lobby with regulators to

reduce their tax incidence and bring it in line with the indirect providers or,

conversely, lobby for a VoIP origination fee to reduce price-competitiveness

of other VoIP provider offerings.

Incumbents should also deploy their R&D resources to generate intellec-

tual property and a series of patents that will require indirect firms to pay

royalty for their usage.

As they develop their VoIP capabilities and IP-related value-added ser-

vices, incumbents should attempt to raise FUD about the security and qual-

ity of service of indirect providers and cable operators to further slow down

their momentum.

4. Offensive Strategies

a. Thriving together - partnering with content providers: We believe

that the battle for the customer of 21st century will be won by firms

22




that provide a one-stop solution: connectivity, collaboration and con-

tent. Incumbents provide connectivity but they need to partner with

Yahoo, Google and other community builders to provide customers the

ability to collaborate with each other and also partner with content

providers like Disney, MGM and TV networks to provide a pay-per-

view and on demand video

b. Differentiating yourself – competing with cable, indirect, software

vendors: Incumbents in the voice market need to review how they de-

light their customer. They should view themselves as serving the in-

formation, communication and entertainment needs of the customer.

This requires a completely different business and customer model and

a drastic change to the current organization structures. Incumbents

will be able to better target their customers as they have superior IT

infrastructure compared to cable firms. In short, incumbents can

have better insight of their customers and do not have any cannibal-

ization in their video services. If they can deliver high quality and re-

liable voice and video services then customers would retain incum-

bents for voice and also switch their prime time TV service away from

cable operators. Indirect firms do not have access to large amounts of

funds for R&D and they are mere consolidators. So, incumbents can

use their R&D and IT capability to provide better value add services

and block indirect firms by using blocking patents. Furthermore, in-

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cumbents will want to partner with software firms and content

providers.

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