Quantifying the VoIP bubble: even true believers like Jeff Pulver recognize challenging economics

America's Network, July 15, 2004 by Grahame Lynch

There's been much talk about a VoIP bubble lately, not only in this magazine, but also from some quite unexpected quarters. Jeff Pulver isn't the type of guy one would expect to be fanning the flames of such talk, given his track record as a regulatory and industry advocate.

But just last month on his personal weblog, Pulver wrote, "The number of voice over broadband service providers that already exist, combined with those which have announced intentions of entering the marketplace coupled with those known to be operating in stealth mode, will in effect flood the marketplace with their mostly undifferentiated service offerings.

"For a short while, the consumers will benefit since a price war is inevitable. But in the end, many of the investors will be the losers for being responsible for backing so many new service providers. Many without any real vision," Pulver concluded.

Interesting stuff. But many of the arguments in favor of a bubble scenario to date have been based more on observation than analysis--for example, perceptions of activity at trade shows or anecdotal evidence of technical hitches with VoIP scalability.

WILLINGNESS TO PAY

There's one exception: Dr Paul Rappoport, a little-known associate professor of economics at Temple University. In recent months, he and colleagues have highlighted research into the willingness to pay for VoIP.

These results are somewhat disturbing. Rappoport points out that the average U.S. household expenditure on fixed voice communications is around $42 per month. In other words, half the population spends less than this amount and a considerable proportion significantly less.

VoIP services tend to be priced at between $20 and $50 per month and require a broadband connection, which typically costs the same amount. What's more, traditional telcos are now forcing prices down on all-you-can-eat packages to as low as $35. This all suggests that there are a few too many service providers chasing a narrow and deflating market.

Rappoport also points out that the size of the market opportunity is quite small. There are just 24 million households in the U.S. connected to broadband, and that will only grow to 35 million in five years, he believes.

But it's on willingness-to-pay scenarios that the size of the bubble becomes most apparent. According to an econometric analysis he helped present at Columbia University in May, at a monthly price of $20, demand for VoIP service tops out at a maximum universe of approximately 6 million households. At $30, that drops to 2.7 million, at $40 to 2.1 million and at $50 to a mere 810,000.

With upwards of 75 service providers chasing the space, the argument for a bubble become clear, suggests Rappoport.

EVENTUAL PAIN

Of course, there's a countervailing argument for such a contention. The telecommunications industry has been surprisingly adept at coming up with new products and services that wrest money from consumers. About 60 million households in the U.S. pay some kind of monthly subscription for an Internet service. About twice that number are forking out even bigger sums for monthly cellular service.

The big question mark is whether VoIP can carve out enough differentiation (on more than price) to justify the massive entry of players into the market and the claim on household spending. As Pulver says, there is too little differentiation amongst current offerings. And the traditional providers can boast of largely sunk investments on their circuit-switched gear, which gives them more recourse to price against upstart VoIP providers.

In VoIP's potential also lies its most probable undoing. If it effectively provides a meaningful substitute for voice telephony, it will no longer be able to boast of being a mere information service. New providers will inevitably be forced to share in the miasma of regulations and taxes that provide its current arbitrage advantage.

Grahame Lynch is a former editorial director of this magazine and heads Decisive Publishing in Thailand.