Home >  Articles > VoIP: great equaliser or great threat?

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Say you opened a takeaway shop, and the only place you could buy hamburger patties was from McDonald's. Not only would you be competing with them, but you'd have to charge a higher price to keep your margins. Even worse, they would effectively get a share of the revenue from every hamburger you sell.

It may sound unfair, but that's exactly how Australia's telecommunications industry has functioned for years. Although many companies buy call minutes from trunk carriers and resell them at lower prices, Telstra still owns virtually all 'local loop' last mile connections - the link between the local communications exchange and customer premises within a radius of that exchange.

For Campbell Sallabank, general manager of product development and strategy with Primus Telecommunications, the current situation is far from palatable. "We have spent hundreds of millions of dollars building our network, but we still pay hundreds of millions of dollars per year to Telstra, and we're not particularly happy about it," he says. "Telstra's gross margins are around 80%, and ours are just around 40%. That gap is the opportunity for us."

Seizing that opportunity has proved troublesome in the past, but times are changing as the ACCC's stoush with Telstra over ADSL wholesale pricing has opened up access to broadband. Following hot on its heels, competing carriers are in the process of flooding the market with commercial-scale VoIP services that threaten to rewrite the rules of the telecoms game forever.

Building a new local loop

Carriers such as PowerTel and Uecomm (now purchased by Optus) have long had direct access to their customers. This was only possible, however, deep in capital city CBDs, where the carriers have spent millions of dollars laying fibre optic cable that literally runs into office buildings' basements and to their tenants' doorsteps.

Outside of the CBD, however, that model just doesn't work. Fibre is expensive and impractical to run across widely dispersed areas; apart from emerging long-range wireless solutions, the only real alternative is to run fibre past Telstra's suburban telecommunications exchanges.

Ever since the Australian Communications Authority (ACA) gave competitors access to Telstra exchanges several years ago, competitors have been able to get space from Telstra to install their own DSLAMs (digital subscriber line access multiplexers) - special switches that serve as aggregators for DSL connections running along a few kilometres of local loop to locations within the exchange's coverage range.

Once an ISP has set up a DSLAM in a Telstra exchange, it's easy enough to run voice alongside the broadband internet connection using similar technologies.

Voice over DSL (VoDSL) was the first of these, using compression techniques to squeeze up to 150 voice channels onto a single 1.5 Mbps DSL connection. Calls are carried from the DSLAM to an integrated access device (IAD) installed at the customer premises, which peels off individual phone lines and delivers them to extensions throughout the building.

Businesses can use VoDSL to save tens of thousands of dollars they've typically paid Telstra every year to lease ISDN primary rate interface (PRI) connections for exclusive use by their PABX. Request DSL (recently purchased by PowerTel) and Primus Telecommunications were early leaders in Australian VoDSL services, to some success - PowerTel marketing manager Glenn Christensen says over 300 businesses are using the company's VoDSL service to get 13 cent local calls, 12 cent-per-minute STD and a lower-than-Telstra line rental charge.

"PowerTel has positioned itself to compete on call costs," says Christensen, "but this is a full service offering with all the features business customers want. [In the past] you couldn't buy four plain telephone lines from anybody but Telstra. But this service never touches Telstra's network; it's PowerTel all the way."

Entering the VoIP fray

Providing VoDSL services requires that carriers have a physical presence in the nearest Telstra exchange; that's limited their applicability to business customers having enough lines to justify the rollout of VoDSL. Whereas VoDSL is tied to physical copper wiring, however, VoIP services operate at a higher logical level: data packets that might flow over the carrier's IP network, a company's intranet, or the internet at large.

VoIP calls run from computer to computer, computer to conventional phone, or conventional phone to conventional phone. Because calls are carried all or most of the way as data, they cost telecommunications carriers virtually nothing. VoIP is so effective that many carriers use it to carry calls over their internal data networks even though they're delivered onto the switched PSTN at either end; an estimated 10% of all phone calls are already carried this way.

Extending VoIP carriage into the retail space threatens to take the bottom out of telecommunications pricing. In the US, more than 100,000 customers of broadband carrier Vonage pay around US$35 a month to make as many untimed calls within the US and Canada as they like; international calls cost just a few cents per minute. Similar services from AT&T, cable broadband competitor Covad and a lengthening string of competitors including ITXC, Level 3 Communications, MCI, 8x8 and VoicePulse promise to make the timed phone call a thing of the past.

In Australia, commercial VoIP services quietly debuted last year with Telstra's IP telephony service, which surprised many observers who figured the monopolist would try to delay its introduction as long as possible.

This year, however, VoIP has quickly come to lead the telecoms agenda as virtually every carrier launches, or announces plans to launch, retail VoIP services. For carriers, widespread adoption of VoIP promises more efficient infrastructure usage and higher margins; for customers, the biggest carrot is the promise of call rates that are a fraction of current PSTN charges. Neighborhood Cable, for example, charges its rural customer base just 30 cents for untimed calls to Melbourne, a 40-cent flat rate to Sydney and Brisbane, and national calls at 20 cents per minute.

In February, excitement over VoIP took on a whole new level when wholesale bandwidth giant Comindico launched a wholesale VoIP service, eCall, which weighs in at just 8 cents for untimed local calls, 6 cents per minute for national calls, and an 8-cent flat rate for untimed calls between eCall customers anywhere in Australia.

As important as Comindico's low prices is the fact that eCall is a wholesale service; this means that virtually any ISP will be able to bundle Comindico voice calling with their broadband services at very little incremental cost - and throw in IP-based sweeteners such as online service configuration, call forwarding to hunt groups, and unified messaging. With over 700 ISPs currently operating in Australia, competition over VoIP customers will be intense indeed - and the market will be forced to grow up very quickly as leaders experiment with the profitability of various product bundles.

"VoIP is not the end game," says Jennifer Tejada, chief marketing officer with AAPT, which recently kicked off its own VoIP services. "It lets us be more flexible in terms of delivering what customers are looking for. We're taking a very solutions focused point of view with this, and will bundle it with other offerings based on what customers' business objectives are."

Indeed, virtually any company could theoretically resell wholesale VoIP services to its customers - opening up tremendous possibilities for large retailers with equally large numbers of customers.

Many of those customers are currently using Telstra, but faced with the prospect of such significant savings it can only be a matter of time before even Telstra diehards succumb to the upswell of competitors for whom VoIP is a way to circumvent Telstra's local loop completely. Few customers, after all, will be able to ignore the flat-rate, unlimited nationwide calling plans that industry observers feel will become commonplace with the spread of VoIP.

Expect more companies to jump into the fray as VoIP's revenue possibilities become apparent - particularly once the Vonage-style flat-rate plan rears its head in the Australian market.

"If you can get an internet connection without having to have a phone line, the economics are far more compelling," says Sallabank. "There's more margin in it, and we're passing a lot of that added value through to the customer. Carriers can do [flat rate calling plans] even with a variable cost base; they've just got to manage their averages and excessive usage very well."

Addressing the regulatory quandary

Commercial VoIP services are still in a nascent stage in Australia, but a hint of the future may be easy to spot in the experience of VoIP providers in the US. There, UBS Warburg recently reported that local voice and voice related services generated more than 60% of carrier revenues and more than 75% of their profits. If VoIP providers like Vonage can steal customers, those voice revenues will be very difficult to replace - spelling disaster for conventional telephony.

Telstra is particularly exposed when it comes to VoIP. The number of voice calls Telstra carries has dropped steadily in recent years, with the company's latest half-year results showing local call volumes dropped from 5 billion in 2H2002 to 4.8 billion in 2H2003; the number of national long distance minutes dropped from 4.6 billion to 4.3 billion; and international direct dialled minutes dropped from 387 million to 338 million.

This trend can only be hastened by the introduction of cut-price VoIP services. And while concerns over lost taxes and quality of service have led the US Federal Communications Commission into an enquiry exploring potential regulatory regimes for VoIP services, in Australia there will be no such shelter for Telstra; here, VoIP providers won't even need telecommunications licences - for now.

"Our rules on what's regulated are not technology specific, so it then becomes a question of how new services fit the current rules," Greg Naylan, manager network selection with the ACA, told Voice&Data earlier this year. "Our initial look at VoIP is that there's no obvious problem with the current rules. If [VoIP carriers] are service providers, the assumption is that they're using an underlying carrier that is licensed and that we can regulate."

The rapid evolution of VoIP in Australia is reflected in the ACA's recent turnaround on VoIP regulation. In May, ACA acting chairman Dr Bob Horton told an industry publication that by July the ACA will circulate draft regulatory guidelines that will give emerging and established telecommunications players the chance to sound off on questions such as necessary minimum standards for VoIP service delivery. Expect publication of draft guidelines by February 2005 and issuance of a formal set of regulatory guidelines by July.

Just how prescriptive those guidelines will be remains to be seen. Horton's discussion focused on the handling of services such as emergency calls and management of customers' quality expectations.

Other potential areas of heated discussion include the transferring of the universal service obligations (USO) requirements imposed on conventional carriers. Number portability has been an early victim, with Neighborhood Cable last year granted an exemption from the requirement to provide portability for customers of its Chatphone VoIP service, who must get new numbers when signing up. Also likely to be tricky is the question of law enforcement access to VoIP calls - something that becomes particularly hard when customers encrypt their VoIP streams.

In the long term, regulators will have to find the right balance between encouraging telecommunications competition - by exempting some VoIP carriers from certain regulations - and the need to ensure universal services. Natural market dynamics will play a role, as customers vote with their feet to determine just what they're willing to sacrifice for cheaper calls.

Perceived quality will certainly count: one recent US survey, by AT&T Customer Insights Group, found that while nearly 74% of US consumers know about VoIP services, over 71% of them would only buy from a big-name carrier; only 16% said they would buy VoIP from a smaller startup company.

How these numbers change over time remains to be seen. Ultimately, the benefits of VoIP services will be enough to convince many people to finally make the plunge into broadband, since the fate of the two will be so closely linked. And because VoIP allows voice calls to be managed completely independently of Telstra, alternative carriers of all types will finally have the chance to build their own customer value without the monopoly player getting a slice.

This will free all sorts of companies to offer commodity voice services at rock-bottom prices. Not only will that takeaway food shop get the chance to order from the most competitive beef provider, but it will be able to give customers a few dozen minutes of voice calls to go with that side of chips.

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