VoIP: Vonage, Incumbents & Pure Plays

Voice over Internet Protocol (VoIP), the technology which allows the transmission of voice over the Internet, was pushed into the spotlight last month when Vonage, one of the industry’s big names, lost a patent violation case to Verizon. Penalties in patent suits in the tech arena have not been kind to the losers of late, recall the billion dollar plus suit lost by Microsoft two months ago, and Vonage continues this trend. Vonage was handed a significant penalty, must pay royalties to Verizon, and more recently was blocked from adding any new customers until appeals are settled. This is not a drop in the bucket for Vonage or for the industry; the ripples from the verdict extend well beyond a single company. By justifying court actions, the finding against Vonage opened the door for other companies which may have been considering litigation, many are planning on taking this route. The verdict reveals the somewhat volatile state of the industry. This is still a relatively nascent market and the turf is just now being divided.

On March 8, a jury in the U.S. District Court in Virginia ruled that Vonage had violated three Verizon patents covering VoIP. The jury determined damages of $58 million dollars and a royalty of 5.5 percent of its future revenue for any continuing infringement. More recently a judge handed down an injunction barring Vonage from adding any new customers until the appeal process is over. (This injunction is actually far less harsh than it could have been, at Verizon’s request Vonage has been allowed continue its operations rather than being shut down completely.) Though Vonage has vowed to appeal and says the verdict will not affect the services they currently offer, shares of the company dropped to a 52 week low; almost 4 percent to $4.86. While certainly the most noted, this is not the first sign of stress that the company, which went public last spring and which claims roughly 2 million customers, has shown. According to the New York Times , “Last month, the company announced that it lost $286 million for the year on revenue of $607 million.” Though this was less of a loss than the company posted the previous year, it was accompanied by news that they had gained fewer new customers. Vonage may be in the spotlight, but their troubles reveal more than the instability of a single company.

The Verizon victory has, according to Anthony Cataldo, chief executive of Internet-calling provider VoIP, Inc., “opened up the validity of protecting the patents.” “Before the ruling in the Verizon case (which Vonage is appealing), the benefits of suing for patent infringement in VoIP cases were far from clear,” said Olga Kharif writing for BusinessWeek. Now many companies may unleash similar lawsuits in hopes of big rewards. David McClure, president and CEO of the U.S. Internet Industry Association said, “Part of what’s happened here is the VoIP industry has met with the real world.” And the picture presented there may not be pretty for Vonage or others new to the game. McClure said further, “There’s no question that VoIP is the future. The question is to what extent a new company can go head to head with a telco that’s been around for 100 years.”

While VoIP, which at one time was seen as heralding the death of the incumbent telcos, has stolen some customers and does continue to grow, the old guard now seems less likely than ever to cede its thrown. Incumbents will need to adjust their strategies, but it is the pure play companies, such as Vonage, that appear to be in trouble. In fact the situation Vonage finds itself in may reflect the lot of the pure play vendors as a whole; the extension they have been granted may be little more a stay of execution. Vonage’s attorney, Roger Warin, said of the extension, “It would be the difference of cutting off oxygen as opposed to a bullet to the head.” While analyst firms such as In-Stat and ABI Research report numbers are growing, Forrester Research has reported that the pure play VoIP vendors are showing signs of strangulation.

According to Forrester, “Although 40 percent of U.S. households have the high-speed connection at home that makes residential VoIP possible, consumer adoption of VoIP as a landline replacement remains low.” Rather than opting for VoIP services consumers are choosing other options; the traditional telephone company being the foremost. Forrester points out that the majority of the residential voice market belongs to the telephone companies; they retain 77 percent of the market. While it may be the majority holder of the market, telcos are facing pressure, some from VoIP vendors, but more from mobile devices used in the home. With packages such as flat rates for local and long-distance calls and free nighttime or weekend calling, such mobile phone use in the home is growing. “Today, 60 percent of U.S. households say that they use their mobile phone to make calls at home.” As service improves and coverage area expands this trend will increase.

Even more telling is the statement, “Most consumers, 87 percent, have no intention of abandoning their home voice service or switching to a new provider.” These consumers seem to feel, “that their current service works well enough and is priced fairly,” and that the status quo is, “preferable to the alternative hassle of ordering a new service or changing a phone number.” Furthermore, of the 13 percent of users who plan on leaving their existing situation, only 10 percent intend to adopt a pure-play VoIP provider; 34 percent intend to use another teleco provider, and 28 percent will go mobile. While the pure play vendor may struggle, VoIP is far from dead.

As McClure noted VoIP, if not the future, will at least be a big part of it. Numbers from In-Stat corroborate; almost eight percent of U.S. households, more than nine million, now have at least one voice over IP (VOIP) user. ABI Research sees something in VoIP as well; “Residential VoIP subscriptions will balloon from a base of 38 million users worldwide to more than 267 million in 2012.”

A more complete version of this posting, with journal articles, and research reports can be found at the website of Analyst Views Weekly.

More information on this topic can be found in Norther Light’s Telecommunications & Equipment Market Intelligence Center.

And in the following articles:

10 Million VoIP Homes, But Challenges Ahead Remain
TWICE, April 9, 2007
More than 10 million U.S. homes have at least one active VoIP user, according to research firm In-Stat, but a report from Forrester Research warned that pure-play VoIP providers can’t rest on their laurels if they hope to win over the waiting majority of landline users. The number of U.S. VoIP users has risen from 9 million in the third quarter of 2006, thanks largely to cable operators and Vonage, In-Stat noted.

Vonage Shares Hit New Low after Court Ruling
Reuters, April 9, 2007
Shares in Vonage Holdings Corp. fell as much as 11 percent on Monday after a judge said the Internet phone company could not add new customers as it infringed on Verizon Communications Inc. While Vonage won an emergency stay on the ban, analysts said the patent dispute was turning into a graver setback for the company than they initially expected. The stock hit a new low of $2.88, down 83 percent from their initial public offering price less than a year ago.

Listen Up, Enterprises: Open Source VoIP’s Voice Is Stronger
Tech News World, April 8, 2007
Soon enough, as more companies become comfortable widening their search beyond commercial fare, they will find that open source dial tone is a worthwhile alternative, in it for the long haul. The cost savings are that compelling, as is the promise of greater customization and control.

A Setback Then a Reprieve for Vonage in Courts
New York Times, April 7, 2007
Vonage Holdings, the Internet phone company, had a wild ride in the courtroom yesterday. First, a federal judge in Alexandria, Va., barred Vonage from signing up new customers for its Internet phone service. Then hours later, a federal appeals court gave Vonage a temporary stay of that injunction, allowing the company to continue to enroll customers while it sought to overturn the lower court ruling.

Will Vonage Pay Up Or Shut Down?
Forbes, April 5, 2007
Internet phone upstart Vonage could be told to shut down its business Friday because of a patent dispute with telecommunications giant Verizon Communications. Last month, a jury found that Vonage’s phone system infringes three Verizon patents, and a federal judge said he would issue an injunction forcing Vonage to stop using the patented technologies.

The Mad Scramble over VoIP Patents
BusinessWeek Online, March 19, 2007
There are plenty of VoIP patents to protect. The Patent & Trademark Office says there are 2,273 such patents. Many belong to telecom stalwarts like Verizon, AT&T, Motorola, Broadcom, and Cisco Systems. More than 150 patents, filed as early as 1999, were granted as recently as 2007. Lawsuits could come from inventors both big and small. A Long Island (N.Y.)-based patent holder, Rates Technology, which has received payments from the likes of Cisco and Verizon, has claims pending against Cablevision and a small telecom equipment manufacturer in New York. “Where the monetary temptation looks high, there’s a greater incentive to bring the suits,” explains Jerry Cohen, partner and co-chair of intellectual-property practice at Boston law firm Burns & Levinson.

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