Net telephony: MS to the rescue?

Five years after Net telephony promised to revolutionise the way the world communicates, Net phone companies are pinning their hopes on an unlikely player: Microsoft.

Gavin Cowie isn't in the Net phone business, but it didn't take him long to figure out why the technology has never taken off

"It's worth it because it's so cheap, but sometimes it sounds like I'm underwater," said Cowie, a 28-year-old Web consultant who uses Net2Phone's service to call his family in the United Kingdom. "You need a headset or microphone, and I don't think people will be happy talking into a computer screen."

Five years after Net telephony promised to revolutionise the way the world communicates, the same roadblocks to mass adoption remain. Voice quality is still sketchy, and using a PC to reach out and touch someone is unnatural for people who grew up with traditional phones.

Today, however, Internet phone companies like Net2Phone, Deltathree and Dialpad Communications are pinning their hopes on an unlikely player in the telecommunications market: Microsoft. Telecommunications executives and analysts say recent moves by the software giant into Internet telephony may be the last chance for the technology to reach the mainstream.

The new Windows XP operating system includes communications software that promises to make the quality of Net-based calls comparable to that of traditional phones. More important, struggling Net phone companies believe that the software giant's mere presence will provide a much-needed boost to the long-dormant market.

"People spend so much time in front of PCs. And these days, it's more and more," Deltathree chief executive Noam Bardin said. "Microsoft is not the Holy Grail, but they have the power to make or break a technology."

But even the mighty Microsoft can't make Internet phones a consumer necessity single-handedly, and its prowess in providing communications services in general has been called into question since its MSN Messenger service went on the blink two weeks ago. The key to Internet telephony's future -- if it has one -- will be the alliances that are struck with or against the software company.

Although the importance of Microsoft's telephony software is questionable, companies are rushing to respond to the potential influence of its entry into the market, especially because of the mass-distribution power of the Windows operating system. Some Net-based phone companies are looking for a partnership simply to avoid the odious prospect of having Microsoft as an enemy.

"You're talking about owning the desktop space," Net2Phone Vice President Sarah Hofstetter said.

With the recent demise of, FireTalk Communications and Lipstream Networks, a partnership with Microsoft could help the remaining Net telephony companies survive the trend toward consolidation. Microsoft plans to do multiple deals with traditional phone companies, such as AT&T, SBC Communications and Verizon Communications, in time for the October launch of Windows XP. Qwest and other service providers capable of handling voice communications could enter the fray as well.

PC-to-phone calls "haven't scorched the earth," said Joe Aibindir, who manages AT&T's Internet telephony services aimed at businesses. "But Microsoft is an innovative company. So Microsoft would have great strength in the technology with the appropriate relationships."

Gemini Voice plans to shut down its PC-to-phone business, but the company would continue offering the service if it could strike a deal with Microsoft, said Gemini chief executive Charan Khurana.

"I'd like to participate in the Microsoft deal," Khurana said. "If someone can give me a good, profitable business model, I'd keep it alive." In recent years, Net-based phone companies have increasingly turned to large partnerships to attract new customers, such as Net2Phone's deals to offer voice services for Web portals such as Yahoo and instant messaging services such as MSN Messenger and AOL Instant Messenger. But nothing would beat having their phone service available on Microsoft Windows, analysts say.

"These companies could get into an arena they never got into before. When you have Microsoft in the space, it gets people to notice," Yankee Group analyst Aurica Yen said. "XP isn't even here yet, and it's getting such a splashy entrance. It's five months away but getting hyped every day."

Still, it will take far more than hype to fulfil the grand promises of Internet telephony, originally seen as competition that could kill off long-distance giants like AT&T, Sprint and WorldCom. As these carriers lowered their rates, Net phone companies scrambled for new strategies, such as their recent move to sell devices that let people make calls over a high-speed Net connection using a regular phone.

For example, 60 percent of Net2Phone's yearly revenue comes from phone calls that do not involve PCs at all. The company has entered the corporate market and sells calling cards that allow consumers to use regular phones for cheaper Net-based calls.

Market research firm iLocus estimates that about 31.8 million people have tried PC-to-phone service worldwide, but only 9.7 million of them are actively using the technology. Of that number, only 1.9 million are paying customers. With PC-based phone calls, Net2Phone leads the pack with US$4.2 million in monthly revenue, followed by Deltathree with US$800,000 a month and PhoneFree with about US$150,000.

In addition, Net companies have not been able to improve revenues with new Web-based voice services such as "click to talk" services that allow shoppers to speak with customer service representatives through Web sites.

If PC phone service were to become popular, networking and other infrastructure companies would need to expand quickly to avoid communications logjams. So far, however, that urgency has not arisen. "It's an architecture issue. We'd have to tweak the existing infrastructure, kind of like Akamai and Digital Island were created to handle streaming media," IDC analyst Mark Winther said. "But there's ample bandwidth. There's plenty of specialists out there like ITXC, iBasis, Genuity, Level 3 and Qwest who have solid networks."

One of the worst setbacks to the Internet telephony business came from its own ranks in late 1999, when such companies as Dialpad began offering free advertising-based Internet phone calls through PCs. The new competition forced Internet telephony pioneers like Net2Phone and Deltathree to follow suit with free domestic calls.

"The free model hurt everyone," Deltathree's Bardin said. "We had to battle against an irrational business model."

As the dot-com bubble burst, slow ad sales forced many of the Net phone companies out of business. Deltathree and Net2Phone switched back to charging customers, and Dialpad and PhoneFree began charging for calls.

By then, however, the damage had already been done.

"In telecommunications markets, consumers are used to declining calling rates, not the other way around," iLocus analyst Roderick Beck said in a recent report. Free services lured millions of customers to try PC phone calls but did not retain loyal customers, he added.

Microsoft, too, had limited success in previous forays into Internet telephony. Its NetMeeting software, which allows people to speak from PC to PC, had poor voice quality and was difficult to use, said Tom Laemmel, Microsoft's product manager for Windows XP.

But that, as is always the case in the software business, can change quickly if Microsoft makes it a priority.

"Voice-over-IP is still very immature. The quality is poor, but once that changes I think PCs will become your phone, so Microsoft will have a very good opportunity there," said Mike McCue, chief executive of Tellme Networks, a voice-activated Internet service. "I think it's two to four years off. But (Microsoft's support) is a big deal, because it's like a supercharger for the overall market."

In the meantime, Gavin Cowie won't be holding his breath. The Web consultant has noticed better quality in his PC calls since switching to a high-speed DSL connection, but it's still a far cry from using a regular phone -- and he's not convinced that the general public will ever feel comfortable talking through a computer.

"I was never fooled that I wasn't on a regular phone," Cowie said. "It's not natural, so I can't see people going out of their way for it."