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Telcos' evolving response to Net phone services

While Verizon fights Vonage in court, Deutsche Telekom makes a strategic investment in another Internet calling company.
Written by Marguerite Reardon, Contributor
Deutsche Telekom's recent announcement that it will take a stake in Internet phone service upstart Jajah is the first sign that big telephone companies could see the next generation of Net-phone companies as friends instead of foes.

T-Online Venture Fund, the investment arm of Deutsche Telekom, announced Tuesday it has joined a $20 million round of investment for the company, which is being led by Intel Capital.

The deal is significant because it signals a shift in how traditional telephone companies view a crop of new start-ups that use voice over Internet Protocol, or VoIP, to deliver low-cost telephony services. Previously, major phone companies, especially in the United States, have regarded companies such as eBay's Skype, which offers free PC-to-PC calling, and others such as Vonage, which turns broadband connections into phone lines, as threats to their traditional telephone business.

Verizon Communications has even gone so far as to sue Vonage, which in March was ordered by a Virginia court to pay $58 million in damages.

But that could soon change. Jajah, which allows people to use their existing phone or mobile handset to make free or low-cost VoIP calls, is the first of the new start-ups to officially get backing from a major telephone service provider. Experts say it's not surprising that the first move toward befriending VoIP companies comes from a European carrier, where the telecommunications market is highly competitive. But they question whether operators here in the U.S. will follow suit.

"This investment marks a significant change in attitude for the carriers," said Will Stofega, research manager for VoIP services for IDC. "Phone companies have a lot to learn from these start-ups. But I'm not sure the U.S. phone companies will be as willing to open themselves up. They still look at these guys as a threat that could bleed off voice minutes."

Friends and foes
The overall VoIP market is still relatively small, but phone companies still see it as a threat. This is especially true as all-you-can-eat long distance calling plans from cell phone operators have pushed phone rates lower and lower.

As a result phone companies have been forced to expand their businesses, spending billions of dollars to build new networks to support more services like high-speed Internet access and television. But even with these new services, a significant portion of the phone company's revenue still comes from renting the old telephone lines. Even the most basic phone service, without any additional features like call waiting, three-way calling or voice mail, still costs about $20 a month. That's $20 in revenue that is generated for every customer without the carrier doing anything more than providing dial tone.

Customers using Skype can bypass all parts of the old phone network by installing software on their PCs and buying a headset and microphone, essentially turning their computer into a phone. Vonage customers can completely cut their home phone lines by using a router that hooks to their broadband connection to carry calls over the Internet.

But Jajah differs from these other VoIP services because it allows people to use their existing phone, whether it's a wired phone in the home or a mobile phone, to make low-cost calls over the Internet. Users simply go to the company's Web site and enter their phone number plus the number they want to call. Jajah calls both numbers. Then it connects the calls by finding the cheapest and most reliable IP link. The service works in 55 countries and international rates can be around 3 cents a minute. Executives claim the service can cut international long distance rates by about 80 percent from rates charged by the traditional telephone companies.

"We're very telco-friendly," said Trevor Healy, CEO of Jajah. "We recognize that the phone companies make money from renting their traditional lines, and our service does nothing to take that away from them."

That argument was enough to convince Deutsche Telekom's investment arm, T-Venture Holding.

"Jajah is not a threat, because the user still requires a landline or mobile subscription to use Jajah," said Georg Schwegler, CEO of T-Venture Holding. "There remains a certain cannibalization effect for a few use cases, but overall the global approach and the geographical distribution of Jajah business plus the attractive synergy potentials outweigh the threat potential by far."

Not just about cheap calls
Other companies have come up with similar services that marry IP with the phone company's existing phone network. A company called Jangl allows people to make low-cost VoIP phone calls from cell phones or regular phones. The service, which allows for anonymous calling, has been developed for people using social-networking sites. It assigns local phone numbers that can then be associated with a particular e-mail address or user name, and calls can be initiated simply by clicking a name. The technology is already being used by the dating Web site Match.com.

Jajah and Jangl allow consumers to make cheap international calls without buying extra equipment or downloading software. But cheap international calling won't be the killer application forever, Stofega notes. Instead, VoIP companies will have to leverage their software more broadly so that it's used to connect other parts of the communication network.

"The mistake that Vonage made is that it got too caught up in becoming a phone replacement service," Stofega said. "Then they got bogged down in requirements like E-911 (for calls made to local emergency services), and they haven't really innovated in two or three years."

Stofega added that the real value in the new generation of VoIP companies is their software, which can be embedded into desktop applications or into mobile devices themselves. He explained that what is needed today is a universal communications client that sits in a device or on a desktop and ties together all the phone, instant messaging and e-mail functionality into a single client across all platforms. The technology, which would be embedded in the actual devices, would be intelligent enough to know where to find you, regardless of which device you're using.

Jajah's strategic partnership with Intel Capital appears to be a step in this direction. Intel is also an investor in Jajah's latest round of funding. Putting VoIP software on chips could link all kinds of consumer electronic devices to an intelligent communications network.

"Making cheap phone calls is just one application," Healy said. "Embedding our software across platforms to interconnect the communications network is the bigger picture."

But start-ups aren't the only companies dreaming up new applications for VoIP. Google and Yahoo are also doing a lot of work with voice, especially in voice-based search. Stofega believes this work could open up a whole new array of applications, such as allowing avatars to act as surrogates for people doing things like scheduling dentist appointments.

While it's clear that Deutsche Telekom sees the value in the next generation of VoIP companies, Stofega said that U.S. operators may not be as receptive. Even though Verizon and AT&T each offer their own flavor of a VoIP service, they have not spent much money or effort marketing the services.

"Historically, phone companies don't like to open up their networks," Stofega said. "Right now they're battling cable companies and their own landline loss. And when it comes to new applications they want to develop them and own them."

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