Open Networks: Is VoIP the Key

1
Open Networks Is VoIP the Key?
Reed Hundt
April 2005
2
KEY MESSAGES

• 5M H/Hs could adopt VoIP over the next 12-18
  months ( up from 0.8 M H/Hs today) growing to
  15M H/Hs by 2009
• Up to 40 of cable modem H/Hs are likely to shift
  to VoIP by 2009
• VoIP will substitute for primary lines for HH
  with broadband, and
• VoIP can be a catalyst for conversion to
  broadband. Could increase broadband penetration
  as high as 60 of HH
• ILECs are selling DSL to high-value households,
  but now these subs wants VoIP, if
• VoIP provides a 15 lower monthly bill
• Plus, consumers care about upfront charges, but
  that is okay for
• MSOs, who want to use it to battle DBS, and so
  they will offer
• As low as 35 to 40 per month for VoIP service
  (and win margins of up to 40), which again shows
  advantage of fat pipe over

3
GROWS TO 10 PERCENT HH BY 2009
VoIP preference rate Percent of total U.S.
households
Even higher penetration possible as consumers
grow more comfortable with VoIP
Preference rates at various price points in
2009
2005
Typical price range of current offers
30 MSO 15 OTT
45 MSO 30 OTT
55 MSO 40 OTT
Total monthly bill
Includes taxes and fees
2005 and 2009 modeled for different level of
overall broadband penetration (28 in 2005 to 57
in 2009) Source McKinsey Market Research team
analysis
4
VoIP IN A NUTSHELL

• Voice traffic transported in data packets over
  the public Internet or private data networks,
  rather than voice signal over public switched
  telephone network (PSTN)
• Internet Protocol (IP) enables communication
  between diverse devices by routing data packets
  without dedicated pathway
• Voice over IP (VoIP) is a way to transmit voice
  conversations over a data network using IP
• Internet telephony (or peer-to-peer telephony)
  allows voice calls to be made between PCs over
  the public Internet using IP

• VoIP will bring down industry pricing and change
  the distribution of value among service providers

• VoIP substitutes for standard voice products and
  services
• Service providers and equipment vendors
  incorporate VoIP into offers

Source Team analysis
5
VoIP EVOLUTION OVER THE NEXT 24 MONTHS

• MSOs will be big winners
• MSO VoIP will be widely available at 35/month
  incremental price by EOY 2006
• ILECs will fight back with their own VoIP
  offering and targeted retention efforts
• Despite the hype, non-facilities players will
  substitute for a few percent of access lines at
  most

• ILECs will control SME migration to VoIP
• ILECs retain effective control of sales channel
  to SMEs
• VoIP offering have weak value proposition for
  many SMEs

• VoIP value proposition not compelling enough for
  enterprise customers to break from default
  conservatism and accelerate normal upgrade cycle
• Savings available to enterprise enough to drive
  choice of VoIP for new purchases
• Desire for risk-free conversion to VoIP creates
  long test cycle and slow rollout

6
INCUMBENTS FACE COMPETITORS ON VoIP BATTLEGROUND
7 types of players
Fixed (winback from cable)
Cable
Strategic product portfolio
Wireless (mobile back to fixed)
Converged (seamless experience)
OTT box
Broadband (VoIP as BB Trojan Horse)
Aggressive (Bet the company on NGN)
OTT virtual
Network strategy
Migration (Legacy migration)
FTTx (Abundant bandwidth to the premise)
Robust strategy
P2P
Aggressive entry
Wholesale strategy
Test the waters (e.g., select LATAs, conservative
pricing)
BB Trojan Horse
No entry
Access charge reform
Regulatory strategy
Rights and obligations of VoIP providers
Winback
Unbundled DSL
Service platforms
Convergence play
Other
Device strategy
Billing
7
DOES VoIP BREAK VOICE VALUE CHAIN?
Todays integrated fixed voice value chain
Call origination
Termination
Incumbents
BT
France Telecom
Deutsche Telekom
Possible future OPEN value chain
Call origination
Termination
Open Internet
Source McKinsey
8
WHAT OPEN MEANS
OPEN to all content

• Volume
• Speed
• Intellectual property rights
• Conflict
• Point of view

OPEN to all networks

• Interconnection
• Intercarrier compensation

OPEN to all people

• Ubiquitous
• Mobile
• Affordable
• Usable (disabled, non-English)

OPEN to all designs

• Open protocols

9
JAPAN HAS SEEN MAJOR BROADBAND AND VoIP TAKEUP
Key VoIP moves
Description

• VoIP introduced by Yahoo!BB as on-net and
  outgoing calls only to PSTN. (Line sharing
  allowed incoming calls to be handled by PSTN)
• NTT must interconnect with VoIP players meeting
  quality standard

• Interconnections between different VoIP providers
  expand
• FTTH-based VoIP being introduced with geographic
  phone numbers and ability to disconnect primary
  line

• 2-way interconnection between VoIP and PSTN
  became available from November 2003 enabled by
  050 VoIP prefix

• VoIP bundled free of charge to DSL service
• Free calls on-net
• 7.5 yen per 3 minutes to domestic fixed phone

VoIP Pricing

• NTT enters VoIP market with 280 yen monthly fee
  and somewhat lower discounts than Yahoo!

• FTTH VoIP is slightly priced higher, but with
  PSTN equivalent quality
• FTTH VoIP players including more VAS features,
  sometimes for free

• 7.9

BB penetration

• 19.1

• 45.8(End of 05)

Additionally, about 30 thousand fixed wireless
access subscribers exist. Based on the March
2004 number of total households and forecast by
IDC Japan Source MPHPT IDC Japan
10
10 OF JAPANESE HOUSEHOLDS HAVE VoIP
SUBSCRIPTIONS
VoIP households Thousands
Consumer perception of VoIP quality Percent
Worse than cellular
Better than fixed phone

• 45 of BB households
• 11 of all households

• 29 of BB households
• 8 of all
• households

As good as cellular
Between fixed and cellular phone
As good as fixed phone
01
02
03
04
05
06
07
The Japanese regulator has created a new area
code 050 for VoIP
Source NTT Yahoo Research Institute McKinsey
market survey
11
ELSEWHERE IN ASIA VoIP IS DEVELOPING ALSO
NON-EXHAUSTIVE
Price discount of attacker VoIP versus incumbent
voice Percent
International calls
Monthly fee
Local calls
LD calls
On net
Country
Incumbent
Attacker
Japan
NTT
Yahoo! BB
n.a.
0
-60-80
Free
-81
-22
-85
n.a
Free
0
n.a.
-10-20
Free
0
n.a.
Free
n.a.
Free
Source CLSA Asia-Pacific market
12
FRANCE OVERVIEW
Context
FT response
FT market share
95 of basic subs
Consumer VoIP?

• Initially (Sept 03) no VoIP response as
  cannibalization risk greater than potential
  upside
• Launched VoIP in July 2004
• Euro5/month offer on top of BB for unlimited
  local LD calls
• FT BB share subsequently on the increase again

Broadband penetration
25, 6m HH CAGR 100 03-04
Implications

• VoIP proving to be a killer differentiator for
  winning in the BB market. The market reacts
  quickly to new offers
• Pace of offer innovation has accelerated
  dramatically challenge given typical
  inflexibility of incumbent service platforms
• Market has split in to 2 types of player
• Price players (Tele 2, 9 Telecom,)
• Feature players (Free, France Telecom)
• Reactive and innovative marketing required to win
  in the Features play

Broadband access
Other DSL, some cable
FT DSL
Lower PSTN prices?

• Launched July 2004
• Aggressive introduction of unlimited packages

Free

• TV/DSL launched 12/03
• Videotelephony launched 08/04

VAS

• Attacker VoIP pricing
• On net
• Off net local
• Off national/LD
• Fixed to mobile
• International

• Free
• Free
• Free
• 20 discount
• 50 discount

Regulatory offensive?

• Re-integrated ISP into Telco to avoid  squeeze
  test 
• Campaign to raise/maintain ULL prices

FTTH?

• No, but ADSL2 yes

• Impact of VoIP
• 75 of Free BB users use VoIP (i.e., approx.
  681k)
• Huge marketing value for Free 60 of of new BB
  intentionists say their 1st choice would be Free

Bundling?

• Yes
• VoIP BB
• VoIP BB TV
• Mobile VoIP being considered

13
NETHERLANDS OVERVIEW
Context
KPN response
KPN market share
90 of basic subs
Lessons learned
Broadband penetration
30

• 40-50 of cable households could be on VoIP in 2
  years time
• Once theyre gone, theyre not coming back (5
  annual churn vs. 15-20 for mobile)
• 40 discount to incumbent is sweet spot
• Own the marketing space (explicitly choosing
  customers)
• Operational execution often the bottleneck

• Consumer VoIP Imminent VoIP targeted mainly at
  winback on cable, CPS, and attacker DSL
• VAS Directory services, multiple numbers,
  residential gateways
• Regulatory strategy
• Maximum VoIP freedom (price level freedom, price
  decision freedom, customer specific pricing)
• Barriers to VoIP attackers (no geographic
  numbers, E111 24x7 requirements, no termination
  fees to VoIP numbers)

Broadband access
Other DSL
KPN DSL
Cable

• Attacker VoIP pricing
• Subscription
• National calls
• On-net calls

• 20-40 lower
• 20-30 lower
• 50 lower

• Impact of VoIP
• Cablecos capturing up to 20 of voice lines in
  selected regions

14
VoIP IS ROAD TO DEREGULATION LOWER FEES

• TWC
• Charges Detail
• Monthly charges
• Unlimited LD package 44.95
• Features 0.00
• Total Monthly Charges 44.95
• Other Fees
• Other surcharges 0.00
• Total Other Fees 0.00
• Taxes
• State Sales Tax (6) 2.70
• Federal Excise Tax (3) 1.34

• MCI Neighborhood
• Charges Detail
• Monthly charges
• Unlimited LD package 55.99
• Features 0.00
• Total Monthly Charges 55.99
• Other Fees
• Primary line charge 6.00
• LNP 0.23
• USF 2.20
• Other surcharges 1.83
• Total Other Fees 10.26
• Taxes
• State Sales Tax (6) 3.03
• Federal Excise Tax (3) 2.00

• Charges Detail
• Monthly charges
• Unlimited LD package 24.99
• Features 0.00
• Total Monthly Charges 24.99
• Other Fees
• Reg Recovery Fee 1.50
• Total Other Fees 1.50
• Taxes
• State Sales Tax 0.00
• Federal Excise Tax (3) 1.05

• CableVision
• Account Summary
• Monthly charges
• Unlimited LD package 34.95
• Features 0.00
• Total Monthly Charges 34.95
• Other Fees
• Reg Recovery Fee 0.00
• Total Other Fees 0.00
• Taxes
• State Sales Tax (6) 0.00
• Federal Excise Tax (3) 1.05

• Cablevision and Vonage are not certified as
  telecommunication services and not currently
  required to pay certain regulatory fees (e.g.,
  USF and 911)
• Tine Warner, which is certified as
  telecommunications provider, absorbs these
  regulatory expenses (i.e., consumer not billed
  for these charges)
• MCI passes all the telecom charges including
  surcharges (e.g., primary line and LNP) through
  to the consumer

Additionally, cost savings from access charge
avoidance represent a further 2-3 per sub per
month potential advantage for VoIP players
Source Company Web sites literature search
15
IS VoIP THE WAY TO OPEN NETWORKS?
Major regulatory issues involving VoIP
Potential impacts on VoIP
Status
Access charge reform

• Changes to access charge regime could eliminate
  VoIP arbitrage opportunity by moving to
  bill-and-keep
• Increased SLC or other per access line charges
  could increase VoIP price advantage

• No consensus proposal after collapse of industry
  working group

Will regulatory changes that have effect on VoIP
be decided and implemented in the next 18-24
months?
ILECs obligation to provide naked DSL (DSL
without ILEC voice service)

• Increases vulnerability of DSL subscribers to
  attack by OTT VoIP players
• - Currently, OTT players have weak value
  proposition for DSL subscribers (who often must
  purchase ILEC voice service)

• Some states require ILEC to offer naked DSL

Rights and obligations of VoIP providers

• Potential for VoIP service providers to be
  obliged to comply with fees and obligations
  currently avoided (e.g., E911, USF, LNP, CALEA,
  state taxes) and entitled to resources (e.g.,
  numbers, interconnection agreements)

• Multiple VoIP proceedings underway at FCC and in
  state commissions and Courts that will influence
  outcomes of these issues

16
VoIP CAN BUILD BROADBAND USA
OPEN VALUE CHAIN common carrier,
interconnection, protocols
Transfer revenue from voice to data
Transfer consumers from narrowband to broadband
Transfer computers into telephones
Transfer universal phone into universal broadband
17
WHAT OPEN MEANS
OPEN to all content

• Volume
• Speed
• Intellectual property rights
• Conflict
• Point of view

OPEN to all networks

• Interconnection
• Intercarrier compensation

OPEN to all people

• Ubiquitous
• Mobile
• Affordable
• Usable (disabled, non-English)

OPEN to all designs

• Open protocols