Open Networks: Is VoIP the Key?

Reed Hundt
April 2005
KEY MESSAGES

1. ~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

2. Up to 40% of cable modem H/Hs are likely to shift to VoIP by 2009

1. VoIP will substitute for primary lines for HH with broadband, and …

2. VoIP can be a catalyst for conversion to broadband. Could increase broadband penetration as high as
60% of HH

1. ILECs are selling DSL to high-value households, but now these subs wants VoIP, if

2. VoIP provides a $15 lower monthly bill

1. Plus, consumers care about upfront charges, but that is okay for

2. MSOs, who want to use it to battle DBS, and so they will offer

3. 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

4. ILEC skinny pipe

11. VoIP is really all about being OPEN

2
GROWS TO 10+ PERCENT HH BY 2009

VoIP preference rate

Percent of total U.S. households
14
Even higher penetration possible
12 as consumers grow more
comfortable with VoIP
10
Preference rates**
at various price
8 points in

6 2009

4 2005
Typical price range
2 of current offers

0
$30 MSO $45 MSO $55 MSO
$15 OTT $30 OTT $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 3
VoIP IN A NUTSHELL

What is • Voice traffic transported in data packets over the public Internet or
VoIP? 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

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

• VoIP substitutes for standard voice products and services

Why now? • Service providers and equipment vendors incorporate VoIP into offers

Source: Team analysis 4

VoIP EVOLUTION OVER THE NEXT 24 MONTHS

Consumer
• MSOs will be big winners
– MSO VoIP will be widely available at ~$35/month incremental
market
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

SME • ILECs will control SME migration to VoIP

– ILECs retain effective control of sales channel to SMEs
market*
– VoIP offering have weak value proposition for many SMEs

Enterprise • VoIP value proposition not compelling enough for

market* 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

5
INCUMBENTS FACE COMPETITORS ON VoIP BATTLEGROUND

7 types of players

Fixed (winback from cable)

“Cable”
Strategic Wireless (mobile back to fixed)
product
portfolio Converged (seamless experience)
“OTT” box Broadband (VoIP as BB Trojan Horse)

“OTT” virtual Aggressive (Bet the company on NGN)

Network
strategy Migration (Legacy migration)
FTTx (Abundant bandwidth to the
premise)
“P2P” Robust
strategy Aggressive entry
Wholesale Test the waters (e.g., select LATAs,
strategy conservative pricing)
“BB Trojan
Horse” No entry
Access charge reform
Regulatory
“Winback” Rights and obligations of VoIP providers
strategy
Unbundled DSL

“Convergence Service platforms

play”
Other Device strategy
Billing 6
DOES VoIP BREAK VOICE VALUE CHAIN?

Today’s integrated fixed voice value chain

Value added Call City/local City/local

Transport Termination
services origination access access

Incumbents
BT
France Telecom
Deutsche Telekom

Possible future “OPEN” value chain

Value added Call City/local City/local

Transport Termination
services origination access access

Open
Internet

Source: McKinsey 7
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 protocols
OPEN to all designs

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JAPAN HAS SEEN MAJOR BROADBAND AND VoIP TAKEUP

Key VoIP moves

VoIP offers VoIP offers introduced

Future
introduced by by other competitors
VoIP moves
Yahoo! BB (2002) (2003)

Description • VoIP introduced by • 2-way • Interconnections

Yahoo!BB as on-net and interconnection between different VoIP
outgoing calls only to between VoIP and providers expand
PSTN. (Line sharing PSTN became • FTTH-based VoIP
allowed incoming calls to available from being introduced with
be handled by PSTN) November 2003 geographic phone
• NTT must interconnect enabled by 050 numbers and ability to
with VoIP players meeting VoIP prefix disconnect primary line
quality standard
VoIP Pricing • VoIP bundled free of • NTT enters VoIP • FTTH VoIP is slightly
charge to DSL service market with 280 yen priced higher, but with
• Free calls on-net monthly fee and PSTN equivalent quality
• 7.5 yen per 3 minutes to somewhat lower • FTTH VoIP players
domestic fixed phone discounts than including more VAS
Yahoo! features, sometimes
for free
BB penetration • 7.9% • 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 9
10%+ OF JAPANESE HOUSEHOLDS HAVE VoIP SUBSCRIPTIONS

Consumer perception of VoIP quality VoIP households

Percent Thousands
Worse
than Better than
As • 45%
cellular fixed phone • 29% ofof
BB BB
good households
households
as • 11% of all
cellular 7.9
6.7 3.7 • 8% of all
households
households

Between 28.0
53.6
fixed and
cellular As
phone good
as fixed
01 02 03 04 05 06 07
phone

The Japanese regulator

has created a new area
code 050 for VoIP

Source: NTT; Yahoo Research Institute; McKinsey market survey 10

ELSEWHERE IN ASIA VoIP IS DEVELOPING ALSO NON-EXHAUSTIVE

Price discount of attacker VoIP versus incumbent voice

Percent
Monthly Local International
Country Incumbent Attacker fee calls LD calls calls On net

Japan NTT Yahoo! BB

n.a. 0 -60-80 -90 Free

Korea KT Hanaro Telecom

-81 -22 -85 n.a Free

Hong Kong PCCW Hutchinson

-38 0 n.a. -10-20 Free

Taiwan Chunghwa Seednet

n.a. 0 -16 -40 Free

Singapore SingTel Starhub

-11 -4 n.a. -16 Free

Source: CLSA Asia-Pacific market 11

FRANCE OVERVIEW

Context FT response

FT market share 95% of basic subs Consumer • Initially (Sept 03) no VoIP
VoIP? response as cannibalization risk
Broadband 25%, 6m HH greater than potential upside Implications
penetration CAGR 100% 03-04
• Launched VoIP in July 2004 • VoIP proving to be a killer
Broadband • Euro5/month offer on top of BB differentiator for winning in
access for unlimited local & LD calls
Other • FT BB share subsequently on the the BB market. The market
30 reacts quickly to new offers
DSL, increase again
FT
some 50 DSL
Lower • Launched July 2004
cable
18 • Aggressive introduction of • Pace of offer innovation has
PSTN accelerated dramatically –
Free unlimited packages
prices? challenge given typical
• TV/DSL launched 12/03 inflexibility of incumbent
Attacker VoIP VAS service platforms
• Videotelephony launched 08/04
pricing
• On net • Free Regulatory • Re-integrated ISP into Telco to • Market has split in to 2
• Off net local • Free offensive? avoid « squeeze test » types of player:
• Off national/LD • Free • Campaign to raise/maintain ULL
• Price players (Tele 2, 9
• Fixed to mobile • ~20% discount prices
Telecom,…)
• International • ~50% discount • Feature players (Free,
FTTH? • No, but ADSL2+ yes France Telecom)
Impact of VoIP • Reactive and innovative
• 75% of Free BB users use VoIP (i.e., Bundling? Yes marketing required to win in
approx. 681k) • VoIP + BB the Features play
• Huge marketing value for Free: 60% of • VoIP+ BB+ TV
• Mobile + VoIP being
of new BB intentionists say their 1st considered
choice would be Free

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NETHERLANDS OVERVIEW

Context KPN response

KPN market share 90% of basic subs

Broadband 30% Lessons learned
penetration
• Consumer VoIP: Imminent VoIP • 40-50% of cable
Broadband households could be
access Other DSL targeted mainly at winback on
cable, CPS, and attacker DSL on VoIP in 2 years time
10
• VAS: Directory services, multiple • Once they’re gone,
50 numbers, residential gateways they’re not coming
KPN 40 back (5% annual churn
Cable
DSL vs. 15-20% for mobile)
• Regulatory strategy
– Maximum VoIP freedom (price
level freedom, price decision • 40% discount to
Attacker VoIP incumbent is sweet
pricing freedom, customer specific
pricing) spot
• Subscription • 20-40% lower
• National calls • 20-30% lower – Barriers to VoIP attackers (no
• On-net calls • 50% lower geographic numbers, E111 • Own the marketing
24x7 requirements, no space (explicitly
termination fees to VoIP choosing customers)
numbers)
• Operational execution
Impact of VoIP often the bottleneck
• Cablecos capturing up to 20% of voice
lines in selected regions

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VoIP IS ROAD TO DEREGULATION = LOWER FEES

CableVision TWC MCI Neighborhood

Account Summary Charges Detail Charges Detail Charges Detail

Monthly charges Monthly charges Monthly charges Monthly charges

• Unlimited LD package $ 34.95 • Unlimited LD package $ 24.99 • Unlimited LD package $ 44.95 • Unlimited LD package $ 55.99
• Features $ 0.00 • Features $ 0.00 • Features $ 0.00 • Features $ 0.00
Total Monthly Charges $ 34.95 Total Monthly Charges $ 24.99 Total Monthly Charges $ 44.95 Total Monthly Charges $ 55.99

Other Fees Other Fees Other Fees Other Fees

• Reg Recovery Fee $ 0.00 • Reg Recovery Fee $ 1.50 • Other surcharges $ 0.00 • Primary line charge $ 6.00
Total Other Fees $ 0.00 Total Other Fees $ 1.50 Total Other Fees $ 0.00 • LNP $ 0.23
• USF $ 2.20
• Other surcharges $ 1.83
Total Other Fees $10.26

Taxes Taxes Taxes Taxes

• State Sales Tax (6%) $ 0.00 • State Sales Tax $ 0.00 • State Sales Tax (6%) $ 2.70 • State Sales Tax (6%) $ 3.03
• Federal Excise Tax (3%) $ 1.05 • Federal Excise Tax (3%) $ 1.05 • Federal Excise Tax (3%) $ 1.34 • Federal Excise Tax (3%) $ 2.00
Total Taxes $ 1.05 Total Taxes $ 1.02 Total Taxes $ 4.04 Total Taxes $ 5.03

Total CableVision Charges $ 36.04 Total Vonage charges $ 27.51 Total TWC charges $ 48.99 Total MCI charges $ 71.28

• 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 14

IS VoIP THE WAY TO OPEN NETWORKS?

Major regulatory issues

involving VoIP Potential impacts on VoIP Status
Access charge reform • Changes to access charge • No consensus proposal after
regime could eliminate VoIP collapse of industry working group
arbitrage opportunity by moving
to bill-and-keep
• Increased SLC or other per
access line charges could
increase VoIP price advantage
Will regulatory
ILECs obligation to • Increases vulnerability of DSL • Some states require ILEC to
changes that have
provide “naked DSL” subscribers to attack by OTT offer naked DSL effect on VoIP be
(DSL without ILEC voice VoIP players decided and
service) - Currently, OTT players have implemented in
weak value proposition for
DSL subscribers (who often
the next 18-24
must purchase ILEC voice months?
service)

Rights and obligations of • Potential for VoIP service • Multiple VoIP proceedings
VoIP providers providers to be obliged to underway at FCC and in state
comply with fees and commissions and Courts that will
obligations currently avoided influence outcomes of these
(e.g., E911, USF, LNP, CALEA, issues
state taxes) and entitled to
resources (e.g., numbers,
interconnection agreements)

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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

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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 protocols
OPEN to all designs

17