Why VoIP Providers Fail

Considering how long internet voice services (VoIP) have been around I found it surprising how often folks, including those in the business, misunderstand the business of VoIP. When I read this recent article in GigaOM by Ian Andrew Bell I was motivated make a few points.

First the obvious - VoIP is not a business model, it is a technology. The technology has been used by many startups to offer a telephone service that undercuts the prices of conventional service, especially where distance is involved. This is better known as price arbitrage, where the new kids on the block are unencumbered with the regulation-mandated fees between carriers and the cost structure of the incumbents. There is nothing inherent in VoIP that makes it low cost; it's just arbitrage.

These VoIP providers became viable when always-on broadband reached significant penetration levels early in this decade. That was needed since utility VoIP service that mimics conventional telephony requires that it be in place - it's a prerequisite. The early players knew full well that if their consumer pitch was something like, "$9.99 per month for all you can eat telephony, and, um, you also need to sign up for $40/month broadband," it would not fly. However once the consumer has eaten that cost the pitch became very attractive.

So now they're failing. Vonage is perhaps the poster boy for struggling VoIP providers since it was the biggest pure-play out there. Nevertheless they are all in trouble, as the GigaOM article states. But why? VoIP is more popular than ever.

Let me describe what I feel are the true reasons for the failures before I come back to what Bell suggests are the reasons.

• Low barriers to entry - Anyone with a few bucks can get into the business. All of them use the same equipment and applications from the same vendors, interconnect via the same set of conventional telephony carriers and are poorly differentiated from each other on both price and features. It is not surprising that Vonage has spent hundreds of millions of dollars on advertising to sustain and grow their business. And it was all for nought.
• Utterly dependent on their fiercest competitors - Every one of these VoIP providers depends on reaching their customers via the services offered by the telephone and cable companies, who are larger, meaner and wilier than they are, and are not at all pleased to see customers drop their high-margin services to switch to these pesky new guys. But rather than compete solely on price, which guts their profits, they have successfully impeded their competitors by various means. These include application filters, lobbying for regulations that force VoIP providers to incur higher costs, refusing interconnection, patent suits, and, perhaps more ethically pure, lowering prices by marketing bundles that the pure play VoIP providers cannot offer. Like them or not, these tactics work.

There are no other reasons of similar significance that are shredding the pure-play VoIP providers. This is not to say they haven't tried.

Years ago Vonage and others tried to offer white label VoIP services to cable companies, all of whom were well behind in the VoIP game. Instead the cable companies chose to forego the service for a few years while the technology improved and they were better placed financially and technologically to deploy, in volume, competitive telephony services. They did not want to share revenue with the upstarts, or dependent on them.

Others have built VoIP apps for mobile handsets only to find the devices and networks turned against them. Sometimes it works, sometimes it doesn't, making it very risky for consumers. One of the biggest surprises to me was how undifferentiated all these companies have been. There are a few innovative players out there, like Grandcentral (Google) and Skype (EBay), but they are noteworthy by their rarity.

Enough of that. Now I'll address a few points I disagree with in Bell's article.

Evolution vs. Revolution: Companies like Nortel, Siemens and Ericsson rank among the top VoIP equipment vendors today, not startups. Technologists completely underestimated the sway and leverage that the traditional vendors held over their customers.

This is wrong. The real reason is that big companies prefer to do business with other big companies. Smart startups, if they can swing it, distribute via the large vendors or, better for the investors, get acquired by them. The others die, as they should - this is the startup game.

SIP in a Box: SIP might be an open protocol, but networks were built proprietarily and have not been bridged together. Most telecom services still communicate with each other via public switching, meaning that the wonderful possibilities that SIP might enable are limited by the capabilities of the plain old telephone system.

This is partly right, partly wrong. Interconnection of VoIP (SIP) islands is moving at a glacial pace because there is no compelling business reason to do so. We should not confuse fancy slideware from the vendors and service providers with customer willingness to buy. All these fancy SIP services have been used, to date, within these islands, with little customer desire to have them work outside their enterprises or, on the consumer side, outside small groups of family and friends.

Landline Decline: Even as networks were evolving, the number of landlines around the globe was shrinking. People found more convenient ways to communicate via wireless, SMS, instant messaging or pervasive email.

This is an odd statement. Wireless is still telephony, and people are talking to each other more than ever before. Sure communications is evolving, but this has not done in the VoIP providers any more than it has the conventional telephony providers.

In closing, I would fervently agree with Bell that there is a race to the bottom in telephony, but that it is happening regardless of the technology. Basic voice telephony, both wireline and wireless, VoIP or PSTN is getting cheaper and there is no end in sight. This is why all service providers, regardless of technology, are struggling, clumsily at times, to find the elements of value that can replace the lost revenue. We are still in the middle innings of this game.