The Evolution of Internet Telephony

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The Evolution of Internet Telephony

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As a founding member of the new Internet Operators Group, AT&T holds a vast amount of experience and expertise in building and operating IP-based networks. We participate in North American Network Operators Group (NANOG), the Internet Engineering Task Force (IETF) and Internet2 in addition to sponsoring the AT&T Center for Internet Research and the AT&T Interoperability Lab. We intend to be the number one global provider of communications services delivered over the Internet by pursuing a worldwide, facilities-based strategy. Recently, AT&T has taken aggressive steps toward realizing this vision. Teleport Communications Group (TCG) brings to AT&T......

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  1. White Paper: The Future of Online Communication Section I: The Evolution of Internet Telephony H. Mine, Executive Vice President, Probe Research, Inc. Section II: AT&T’s IP Telephony Initiatives October 1998
  2. Section I: The Evolution of Internet Telephony Hilary Mine Probe Research, Inc. Three Wing Drive, Suite 240 Cedar Knolls, NJ 07927 www.proberesearch.com Tel: 973-285-1500 September 1998
  3. TABLE OF CONTENTS VOICE AND DATA – CONVERGENCE HAS BEEN A LONG TIME COMING ...........................................4 EMERGENCE OF THE INTERNET........................................................................................................................6 INTERNET TELEPHONY - MARKET EVOLUTION AND DRIVERS............................................................8 HOBBYIST PHASE - IP TELEPHONY AS HAM RADIO SUBSTITUTE .....................................................................................9 TARIFF ARBITRAGE - CALLING CARD REPLACEMENT....................................................................................................9 TARIFF ARBITRAGE - ENTERPRISE TRUNK REPLACEMENT.............................................................................................11 FEATURE PARITY.................................................................................................................................................11 NEW APPLICATIONS..............................................................................................................................................12 Conferencing Applications.................................................................................................................................12 Call Center Applications....................................................................................................................................13 IP Messaging......................................................................................................................................................14 IP Call Waiting...................................................................................................................................................14 COST PARITY......................................................................................................................................................14 MARKET AND TECHNOLOGY BARRIERS TO INTERNET TELEPHONY AND THE NEW PUBLIC NETWORK.................................................................................................................................................................15 INTEROPERABILITY CHALLENGES.............................................................................................................................15 QUALITY OF SERVICE............................................................................................................................................16 COST TO DEPLOY IPT..........................................................................................................................................17 OPERATIONAL SUPPORT SYSTEMS............................................................................................................................17 REGULATION - THE VERY REAL THREAT.....................................................................................................17 SERVICE MARKET OPPORTUNITIES IN INTERNET TELEPHONY.........................................................19 THE VALUE OF EARLY MARKET LEADERSHIP/ TODAY’S INTERNET TELEPHONY SERVICE PROVIDERS...............................................................................................................................................................20 AT&T IP TELEPHONY INITIATIVES.................................................................................................................23 CONSUMERS........................................................................................................................................................23 CARRIERS...........................................................................................................................................................23 BUSINESS CUSTOMERS..........................................................................................................................................24 RESEARCH INITIATIVES..........................................................................................................................................24 AT&T ADVANTAGE............................................................................................................................................24 SUMMARY..........................................................................................................................................................25
  4. Voice and Data – Convergence Has Been A Long Time Coming The promise of a single network carrying both voice and data is as old the first data networks themselves. The fundamental notion that a single network offers economic advantages, both in terms of upfront equipment costs, and with respect to management and administration costs, goes back literally decades. Perhaps the most famous failure of convergence was ISDN (Integrated Services Digital Network, or “It Still Does Nothing” as it is colloquially referred to), which is finally beginning to be deployed today, but which has been available to service providers since the mid 1980s. Just as its name implies, the idea behind ISDN was integration of voice and data over the public network. The expectation was that a customer would use one 64 Kbps B channel for voice, and the other for data. But carriers did not deploy the technology in any significant way in the U.S., largely because their business structures prevented them from being able to prove in business cases. In addition, as is generally true of new technologies, the developments of true interoperability and standards, as well as the cost of early customer premise equipment (e.g., modems) were also significant barriers to the success of ISDN. Finally, however, there was a lack of mass market demand for data networking. This particular market barrier remains, of course, subject to much debate. Despite the fact that 45% of US homes have at least one PC in use, and the majority of those are Internet subscribers, there are still those in traditional carriers (e.g. BellSouth) who remain convinced that end users are not willing to pay the true costs to provide data network services, with the exception of a few large business customers. With the advent of the Internet, there is little doubt that end users in both the consumer and business markets are very interested in data services. Willingness to pay has still to be proven in, since the mass market Internet is arguably being subsidized at this time. Nonetheless, data traffic even prior to the rise of the Internet, has been growing dramatically faster than voice traffic, and this pattern is at the crux of the integrated network dream.
  5. Figure 1: GLOBAL NETWORK TRAFFIC Terabytes/Yr 1997 1998 1999 2000 2001 2002 2003 2004 2005 PSTN VOICE PACKET & PRIVATE WAN VOICE PSTN DATA PACKET & PRIVATE WAN DATA Source: Probe Research, Inc. estimates Figure 1 shows Probe's estimates of total global communications traffic. PSTN refers to the public switched telephone network, or the traditional telephone network. Private Wide Area Networks (WANs) refer to leased line and virtual private networks (VPNs) that large companies and institutions use for internal communications. Packet refers to packet network based traffic. Today, over 70-75% of this traffic is still voice, but as we have observed, data is growing much faster. By the year 2005, data will account for nearly half of global traffic. It is critically important to note, however, that voice traffic will be growing as well over this period, and will still be the bulk of traffic on many routes. A few service providers have begun to observe portions of their networks reaching the magic 50% data traffic threshold, and anticipate that on some segments (particularly international routes), data traffic will account for as much as 80% of traffic within the next 5-7 years. This is generally true of routes (e.g., Tokyo to London) that are dominated by business traffic. As a rule, the more local the traffic, the more it is dominated by residential and small business traffic, and consequently, the more it is dominated by voice versus data traffic. In the long run, multimedia applications that are targeted to consumers, such as interactive video, Internet TV, videoconferencing, and more, will radically alter the mix of voice and data. Once the standards, customer premise equipment, applications, and above all the economics come together, then voice traffic will indeed be eclipsed. Based on Probe's ongoing analysis of bandwidth to the home and small office, and all of the associated terminal equipment, standards, and other issues surrounding the take off of residential multimedia, we remain convinced that mass market adoption is at least five years off even in the best of circumstances (e.g., in the
  6. heart of Silicon Valley). This is not to say that there are not already many households that generate more data than voice traffic (e.g., in Silicon Valley), but rather that it will be some time before early adopters give way to mass market consumers. For most communities, mass market adoption is even further away (7 years or more). Emergence of the Internet The overwhelming driver of data traffic today is the Internet, as well as wide area private/virtual private IP networks (e.g., Intranets and Extranets). While global voice traffic continues to grow at less then 8% annually, data traffic is growing at roughly 35%. Although the Internet Protocol has been defined for decades, its use became widespread only recently. The market for Internet services was born in great part due to the privatization and commercialization of NSFnet. Indeed several key players, including BBN Planet, MCI, Sprint, etc., originally became involved in the Internet as government contractors. Others, including UUNet and PSINet, launched commercial services in 1991, as soon as the NSF allowed it, and were founded and staffed by NSFNet veterans. While proprietary online services and Bulletin Board Systems (BBS') attracted aficionados and hobbyists for over a decade, the audience for these services remained limited due to constraints on content, incompatibility between networks, and exceedingly slow access, as well as the basic issue of limited PC deployment. In the early 1990s, however, several factors coincided to cause the Internet to become a viable commercial platform: 1991 - NSF allowed commercial use of the Internet, and the first Commercial Internet Exchange was launched; 1992 - The number of Internet hosts reached 1 million (largely academic and military); 1993 - WWW and the Mosaic browser were introduced; and 1994 - The penetration rate of PCs in US homes reached 33%; 28.8 Kbps modem standard was approved. By year end 1998, PC penetration amongst US households is approaching 45%. Importantly, this figure takes into account households with multiple PCs, and excludes those with inactive PCs.
  7. FIGURE 2: INTERNET TRAFFIC: 1991-1997 Global (Terabytes/Month) Internet Users pass 3,000 50M OSP business 2,500 PC Penetration model in US Homes fails; OSPs reaches 33%; Internet 2,000 become 28.8Kbps Users ISPs Modem Pass 1,500 Standard 10M Approved 1,000 WWW and NSF Allows Mosaic Commercial 500 Introduced Internet Use - 1991 1992 1993 1994 1995 1996 1997 Sourc e: NSFNet ac tuals to 12/94; Pr obe es timates after 12/94 By year end 1998, there will be an estimated 100 million Internet users worldwide (including business, consumer, students, etc.). See Figure 3. For perspective, there are well over 600 million telephone users worldwide. Nonetheless, the Internet has proven to be the clear technology winner as a user interface to a global public data network.
  8. Figure 3: Worldwide Internet Users: 1997-2002 300,000,000 250,000,000 Internet Users 200,000,000 150,000,000 100,000,000 50,000,000 - 1997 1998 1999 2000 2001 2002 Europe/Middle East/Africa Asia/Pacific North America Latin America/Caribbean Source: Probe Research, Inc. estimates Internet Telephony - Market Evolution and Drivers In its brief life, IPT has already seen two distinct phases of market evolution, and is on the verge of a third. In this section we describe the expected development of IPT as a market, and explore the factors that will drive each phase of adoption of the technology. Figure 4 provides a general overview of the evolution, including Probe's projections of global voice and fax over IP in minutes of use.
  9. Figure 4: GLOBAL VOICE/FAX OVER IP TRAFFIC AND MARKET DRIVERS 90000.0000 80000.0000 Cost Parity 70000.0000 Millions of Minutes 60000.0000 New Applications 50000.0000 40000.0000 Feature 30000.0000 Parity Tariff 20000.0000 Arbitrage 10000.0000 Hobbyist 0.0000 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source: Probe Research, Inc. Hobbyist Phase - IP Telephony as Ham Radio Substitute In late 1995, a few technologists and hobbyists recognized the potential of the Internet to carry voice traffic. Companies such as VocalTec, NetSpeak, Quarterdeck, and others developed a new class of software that enabled any two Internet users to talk to each other from their PCs. This approach, which relied entirely on the PCs at each end, required not only soundcards and high speed modems at each end, but also that end users use the same software. Each solution was proprietary – a VocalTec user could not talk to a NetSpeak user. Nonetheless, the draw of free phone calls was compelling. By year end 1996, over a million copies of this class of software had shipped, and players like Microsoft and Intel had jumped in to develop standards-based client software as part of their larger vision of using the Internet as an alternative voice and conferencing platform. Not surprisingly, early adopters of this technology largely treated it as a chat room alternative. VocalTec and other companies set up Internet relay chat rooms (IRCs), where users could go to find other users with the same software, or where users might set up private meetings. Despite all the awkwardness of this form of communication, literally millions of conversations were completed between PC users over the Internet in 1996. Tariff Arbitrage - Calling Card Replacement The long distance communications market is extremely price elastic. This is important because it is currently the underlying market driver for Internet telephony, and will remain so for the next three to five years. To support this statement, consider the impact of competition on the US
  10. long distance market in the 1980s. Figure 5 shows indices of price per minute versus minutes of use of interstate long distance in the US during the period 1981 to 1993. As prices fell, traffic grew considerably. Indeed the highest rates of traffic growth occurred during the period 1984 through 1988, when prices were falling their fastest (an average of 7.3% annually). Figure 5: Price Sensitivity in Long Distance 18.0% 2.0% Annual Percentage Change in Price per Minute 16.0% 0.0% Annual Percetnage Increase in Minutes of Traffic 14.0% -2.0% 12.0% Conversation 10.0% -4.0% 8.0% -6.0% 6.0% Price -8.0% 4.0% -10.0% 2.0% 0.0% -12.0% 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Source: FCC and Probe Research, Inc. estimates Early adopters of IP telephony quickly realized that the initial acceptance of the technology hinged on its ability to bypass regulatory regimes and tariff structures. International call back service providers, such as IDT, were among those most threatened. Their customers are amongst the most price sensitive, and are willing to dial additional digits or suffer other inconveniences to save money. Consequently, these types of service providers were the first to develop IP telephony services. Other service providers, such as AT&T, Sprint, etc. also paid early attention to IPT as a threat and therefore also an opportunity. Simultaneously, vendors such as VocalTec, Vienna Systems, and Clarent Corp. recognized that while the PC hobbyist market was a nice start, the installed base of multimedia computers was rather limited compared to the installed base of traditional telephones. Moreover, the biggest problem with IPT, the quality of the voice, was seriously affected by the end user’s own ability to configure their system (the PC, the software settings, etc), and the reality is that non-hobbyist users are more interested in communicating than in understanding the finer points of codecs. The market potential of phone-to-phone and PC-to-phone IPT drove the development of first
  11. generation of IPT gateways. And service provider fear of lost revenues provided the demand that has fueled the next generation of IP telephony platform, the gateway. IPT gateways, which enable end users to make IP calls from traditional wireline or wireless telephones, can be deployed in an end user or service provider network. The function of these gateways is to packetize the voice signal on the originating end of a call so that it can be transported over an IP network. At the terminating end of the call, another gateway converts the packets back, and re-assembles the voice signals for the traditional telephone network. In the past year, voice over IP has eclipsed the Internet itself as a source of hype. There is little question, however, that this market is no longer a vague fantasy shared by a few hobbyists and technologists. Several service providers now report traffic in the millions of minutes per month, and many more are ramping up trial networks as well as commercial networks globally. There are a variety of factors driving growth in the internet telephony and fax market. Amongst traditional service providers/PTTs, voice and fax over IP has caught on the fastest driven largely by fear. Those with the most to lose are understandably the most aggressive in testing and deploying new technology. ISPs are grappling with growing competition and declining margins in the plain vanilla internet access market. Consequently, most are exploring a variety of value-added services to increase revenue per subscriber. Now that the technology is maturing, and large carriers have moved beyond the announcement stage into the full-scale trial stage, ISPs are testing the water and beginning to understand the true nature of the opportunity. Tariff Arbitrage - Enterprise Trunk Replacement Amongst enterprises, IPT networks have been slower to take off. This reflects several factors, including lack of properly packaged solutions for the enterprise market, skepticism about the quality of service afforded by IPT, and the immaturity of the equipment and software. Enterprises have voice networks that work today, and need compelling business cases to replace those. Moreover, the MIS and telecom purchasing decision makers still tend to be separate and often at war. Nonetheless, enterprises have deployed thousands of IPT gateway systems, and are also trialing IPT services in growing numbers. For many, IPT services are the point of entry -- rather than replace or overhaul the PBX, an enterprise might introduce cost efficiencies by using IPT calling cards for traveling execs to call the home office for example. All in all, however, the market is largely a service provider market today, and is expected to continue to be for the next couple of years. The tariff arbitrage opportunity is, however, expected to wane. As it does, we anticipate that feature parity and new applications will sustain the next wave of market growth. Feature Parity The next wave of potential users of IPT that are attracted to lower prices will adopt the technology only after it is equally convenient to traditional voice services. This phase requires the next generation of IPT equipment. Although the gateway market has evolved at a tremendous pace, the IPT gateways that are available as of late 1998 are still lacking in several
  12. regards. Today's gateways are not interoperable with each other, they do not interoperate effectively with the existing circuit switched network, they do not scale well, and they are extremely expensive when compared to the traditional public switched network. However, network equipment vendors are working feverishly on these problems. Probe estimates that the number of engineers and developers devoted full-time to IPT has grown fivefold in the past 18 months. We expect to see substantial progress on all of these issues over the next 18 months. Importantly, we are already seeing the beginning of feature parity, and this is what will drive the next wave of IPT adoption by end users. In early 1999, several service providers will introduce IPT and fax services that no longer require the end user to dial any differently than they would for a regular phone call -- this is referred to as single stage dialing. This and other key features that users expect of the traditional voice network will be available in IPT networks as vendors introduce SS7 integration into their IPT solutions. As was true in the US with the introduction of long distance services, it was not until users had the option to do single stage dialing for their choice of carriers that competition took off. New Applications While price is the key driver of the IPT market today, most observers agree that extending end user feature control and functionality are the real benefit that will drive the IPT market in the longer run. Indeed the very future of IPT depends in part on the development of compelling applications. There are a variety of potential applications, many of which we have probably not even conceived of, that leverage the integration of voice and data on a single network and user interface. Internet telephony may well prove to be first killer application that finally drives widespread adoption of computer based telephony. Some of the applications that are already possible today include:  Multimedia Conferencing;  Multicast;  Collaborative Workgroup applications;  Call Center applications;  Message unification; and  IP Call Waiting. Conferencing Applications The first three are closely related. VocalTec, Nortel, and others sell software applications today, generally H.323 compliant, that enable end users to simultaneously talk and share data over a single IP connection, conduct videoconferences over IP, and share documents over that same connection. Visual interaction and the ability to work with a document despite physical distance is of tremendous value to certain applications. For example, a commercial building project in Mexico City may require intermittent real-time interaction between an architectural team based in New York and a builder team on location. Today, the two teams might pass faxes or electronic copies of documents back and forth in non-real time between telephone and email discussions of alterations that are required. With videoconferencing, both teams can make a
  13. series of decisions in real-time as they simultaneously look at the plans and redraw them. This might save literally days of elapsed time, and significant sums of money for a given project. Other examples abound. Needless to say, there is also a significant residential/consumer demand for videoconferencing as the cost becomes reasonable, the quality improves, and the implementation becomes standardized. Audio-conferencing, not to mention videoconferencing, remains one of the most expensive carrier services. The highest cost of provisioning conference services is in the administration/ management and call set-up. Enabling users to do this work themselves via software has allowed even traditional carriers to sharply lower their pricing. Conferencing is a prime target for IPT, both due to dramatic pricing differences, and to the increased user control inherent to IPT versus traditional teleconferencing. One of the increasingly most common applications of audio conferencing is to make announcements to various segments of the public -- quarterly reports to financial analysts, new product announcements to user groups, etc. For this application, Internet solutions are especially valuable as they enable users to visually follow along (the usual method now is to fax or email ahead copies of presentation materials). Call Center Applications IPT offers compelling benefits in call center applications. The most common IPT call center solutions enable a user to talk to an agent over the same line with which the user is browsing the Web. This gives the call center agent the advantage of being able to view the users’ activities. This is especially powerful in help desk and sales applications. Consider the numerous occasions during which the help desk agent’s ability to observe a user typing commands would save untold frustration and time, e.g., installing a new modem and struggling with archaic communication set-up strings; trying to import and export documents from Windows to Macintosh; installing any software; handling the inevitable bugs that result from marginal compatibility, etc. From an enterprise perspective, imagine a user browsing your web site. You sell insurance and offer a comlpex assortment of options to be competitive. A variety of questions come to mind as your prospect compares your prices to his current provider over his lunch break. The user clicks on a button that dials through to an agent who is immediately armed with information about the user, including the most recently browsed items, and perhaps additional information from a personal profile form. The agent can make suggestions based on which items the user looks at, and can guide the customer through decisions. Above all, you did not lose the prospect's interest -- he did not have to go offline and place a call, nor was there any other delay. Eventually, as Internet bandwidth and technology permit, videoconferencing with a customer will be viable over the net. While this is of course possible, and practiced by a few bleeding edge users today, it remains fairly impractical. Nonetheless, the time will come when video over the Internet is feasible, and this will open a whole new set of possibilities.
  14. IP Messaging Voice messaging over the net offers several advantages, not just cost reduction. First, it is easy to forward or broadcast a voice message over a network (whether its the Internet, or an Intranet, or just a traditional private network). If a sales manager needs to get a quick message to the sales force, and she doesn’t have her computer with her, a product called AMAIL enables her to use a regular phone to send an audio message over the net via her corporate web page (be it inter or Intranet) to the entire sales force with a single phone call. Perhaps even more exciting is the hope of unified messaging. For the business traveler, this is an especially important offering. Consider the activities of the average business traveler trying to keep in touch from the road, repeating the following process 2 to 3 times each day. Check the corporate e-mail, pager, voicemail, and a fax service or, more commonly, a helping hand who will forward faxes to the user’s hotel room or other temporary space. A key application for Intranets will be unified messaging, where a user can pull down all of these from the corporate web page. IP Call Waiting Replication of traditional PSTN-based services in the IP network is a increasingly perceived as key to the widespread adoption of IPT. Clearly, to achieve feature parity, a user must be able to get all of the features they are accustomed to from the new network that were provided by the old network. The benefit and promise of IPT is that new user interfaces will greatly enrich many of the old standby services. IP Call Waiting is a fabulous example of an IP version of a standard public network service that is richer and more powerful for the end user. In the traditional PSTN environment, call waiting means that as an end user if I am on the phone and another call comes in, I hear a beep, and I have the option to put my current call on hold and answer the incoming call, or I can ignore the incoming call. Best case scenario, my service provider may offer me the option of sending the call automatically to voicemail. With IPT Call Waiting in a computer telephony world, I might be conversing with my manager on my web phone (which has a browser up), and I can visually see that a call is coming in from an important client -- their name appears on my screen due to the magic of caller ID. I put my manager on hold -- he's calling from the airport -- and I answer my client's call to see what he needs. While I am on that call, I can see my husband calling (because I can get more than two calls now), so I send him to voicemail. In today's PSTN scenario, my husband would get a busy signal, and wouldn't be able to leave me the message that he can’t pick up our daughter after school. Note that this could all be occurring over a mobile web phone with a touch pad or voice input in my car just as easily as over a PC at my desk. Cost Parity If IPT is ever really going to take off, however, there must be true cost parity between packet voice and circuit-switched voice technologies. Today, the cheapest large scale IPT networks are still roughly four times as expensive as their circuit-switched cousins. Network service providers are pushing vendors extremely hard to bring the costs down. At the same time,
  15. traditional equipment vendors continue to apply Moore's Law to circuit switching, and know they must sustain their cost advantage as long as possible. In theory operating an integrated voice/data network should be cheaper than managing two separate overlay networks. In practice, however, this is highly debatable, and no one that has really delved into the issue has been able to prove the business case, particularly for all of the many service providers that have embedded networks. In the case of a new or greenfield network, the business case has to assume either that the network deployment costs can reach parity as networks scale over the next few years, or that the operational savings of IP are significant enough to justify added network investment. Probe expects that network equipment and operational cost parity will be achieved by the year 2002, and will be the primary driver of the IPT market over the long term when combined with application, network management, and operational support flexibility. In the very long run, this will drive replacement of circuit switching in the long distance network globally, as well as in elements of the local network. Market and Technology Barriers to Internet Telephony and the New Public Network As of late 1998, there remain several critical barriers to deployment of IP telephony, including: • Lack of interoperability not only between IP telephony networks, but also between IP telephony and the traditional circuit-switched network and other data networks; • Quality of Service (QoS) and perceptions about QoS; • Cost to deploy IPT; • Lack of carrier grade network management, operational support, and billing/rating solutions. Driven by significant pressure from service providers, a variety of vendors are accelerating solutions and standards to address these barriers, and we expect to see most if not all of these issues resolved within 18-24 months (i.e., by mid to late 2000). Interoperability Challenges Interoperability at a variety of levels presents the most serious set of challenges, and will require a market environment that continues to push vendors extremely hard with the promise of real rewards. There are several interoperability issues that need to be resolved. Most obviously, network vendors must supply gateways and gatekeepers that are interoperable. No service provider will be comfortable in the long run deploying a proprietary solution in large scale. Gateway interoperability, which is not fully addressed by the H.323 protocol, is also expected to be furthered by additional standards efforts such as IPDC. While H.323 specifies some of the elements of interoperability, there remain several features of gateways that cause them to have trouble interoperating.
  16. New approaches, such as the proposed IPDC protocol, provide significantly increased gateway interoperability as well as defining preliminary gatekeeper to public switched network interworking. In addition, virtually every major gateway vendor is deeply engaged in developing SS7 integration into their IP telephony solutions to ensure PSTN interworking, a critical first step in the move to a public IP telephony network. Finally, vendors must address the larger issue of seamless voice transport across IP, Frame Relay, and ATM networks. Nonetheless, the standards process can be excruciatingly slow, dampened by in-fighting over technology and intellectual property rights. The standards process in the IP space in particular has become increasingly like that in the public telecom industry as each vendor’s commercial interests and agenda take on growing prominence. Thus, it would be naïve to assume that interoperability solutions are all on the verge of arriving. Rather, we expect to see gateway interoperability almost immediately, followed by huge battles over gatekeeper interoperability, since that is where the real network value and intelligence resides. Quality of Service In the early days of IPT, sound quality was a huge and overriding problem. In part this can be attributed to the fact that most calls were PC-to-PC, and therefore required the end user on each side to have proper equipment, and to optimize their software for each individual call. The quality of a voice conversation over the Internet today is still highly variable, and often unsatisfactory in comparison to a circuit-switched voice conversation. The quality of sound is most impacted by latency (or delay) and lost/dropped packets. The Internet is not a controllable environment. Consequently, as soon as an IPT call goes onto the Internet, rather than a single controlled IP network, it is subject to unpredictable quality issues. When an AOL end user sends a message to a PSINet customer, the message may travel over only two networks (UUNET and PSINet), but it may also traverse others depending on the routing tables, peering agreements, and other factors. Moreover, the first packet may travel very efficiently while the next packet travels through ten times as many routers. The nature of the IP protocol is that it offers connectionless networking. It was intentionally designed this way for reliability and other reasons. The circuit switched network is connection oriented -- when User A calls User B, the network sets up an end to end connection between those two points, which ensures that all of the voice traffic is transported over the same route at the same rate. The reality today is that IPT in a controlled network is toll quality. Indeed, calls over the Internet using IP gateways are also often nearly toll quality. In the near term, most service providers are really offering voice over an Intranet (meaning their own IP network) as a means of controlling network quality. Enterprises are deploying IPT similarly over their own Intranets initially for internal communications purposes rather than trying to interface with customers over the Internet. Over the next several years, service providers plan to deploy differentiated service qualities on their IP networks for a variety of reasons, including to offer toll quality voice. Vendors and service providers are developing a variety of standards and approaches that enable connection- oriented services to retain higher priority over the connectionless IP network. RSVP
  17. (ReSerVation bandwidth Protocol), Diff Serv (Differentiated Services), and approaches that enable ATM/IP interoperability such as MPLS are all moving forward. The real story about IPT in 1998 was the fact that quality is no longer the huge barrier that it was in 1997. By the year 2000, it will not be a major topic of discussion. However, the price of establishing quality of service on IP networks that meets the requirements of toll quality voice may well be that the economics of IP lose to the economics of circuit switching for years to come. If deploying IPT means establishing permanent connections over an IP network, the economic advantages of connectionless transport are lost, and a host of network management and bandwidth issues raise their heads. Fundamentally, the economic case for IP networking becomes less clear. Cost to Deploy IPT From a service provider perspective, deploying IPT gateways is much more expensive today than deploying comparable voice switching equipment on a per port basis (where a port is a measurement of potential simultaneous calls). IPT gateways sold for an average price of over $1,800 per port in 1997 and will be down to about $600/port in 1999 for a networked, managed port. The same port in a traditional carrier network would cost less than $100. Thus traditional carriers continue to have objections to large scale deployments of IPT in lieu of circuit switching. The cost of IPT gateways is declining very rapidly, and no one has yet developed a meaningful analysis of the loaded cost of operating and maintaining a circuit switched voice network versus an IPT network. As we discussed in the previous section, the true cost of an IPT network with quality of service, billing mechanisms, and all the other paraphernalia of the traditional PSTN added in may well be greater than the cost of today's PSTN for the same capacity. Unless the IP model is proven to be lower cost in the long run, we will not see the fourth and most promising stage of IPT -- cost parity -- take off. Operational Support Systems Finally, today's IPT solutions do not have the associated network management and operational support systems developed to the same sophistication as the PSTN. We expect this market barrier to be alleviated in 1999 and 2000. A variety of software vendors, from Bellcore to Portal and beyond, are applying tremendous energy and resources to the development of IP-oriented network management and OSS as well as billing systems. However, these are clearly a key requirements of any service provider that hopes to scale up IPT as a major offer. Regulation - The Very Real Threat There is a critical race in progress today that has serious implications for the entire IPT industry. This is the race between a shifting regulatory environment and the elimination of technology barriers to IPT. Today, the entire IP telephony industry is being funded and driven by a tariff arbitrage business case as we described above. Either of two opposing forces could throw a
  18. wrench in the development of the IPT market. If either scenario plays out, then feature parity and compelling enhanced applications become much more urgent. In the first instance, if pricing of the PSTN reflected true costs rather than government subsidies, the tariff arbitrage demand would disappear, and IPT would have to offer lower true cost or sufficiently compelling enhanced applications to drive demand. For the past decade, much of the world has been moving toward deregulation of the telecom sector. Many government owned PTTs have been privatized. The World Trade Organization (WTO) agreed on a plan to reduce international settlement rates globally, and the cost of telecom has been declining for much of the world for several years now. The reduction of international telecom costs in particular eats into the demand for IPT as long as IPT is driven by the argument that it is cheaper. The general consensus has been that this movement of tariffs and settlement rates downward will continue to occur at a reasonably slow pace, leaving sufficient room for IPT providers and vendors to fund the fledgling market in the near term. However, one should never forget that most IPT service provider business plans today rely on their ability to offer IPT at essentially a subsidized rate, since IP is not subject to all of the same tariffs as PSTN. Even in the US, as soon as companies like Qwest and Netcom lose their enhanced services provider exemption, which currently enables them to avoid paying access charges that AT&T and other long distance carriers pay to local carriers, their ability to offer IPT any more cheaply than AT&T offers PSTN will disappear. There looms a different scenario, however, that has not garnered the notice it probably should, and that is the specter of a reversal in global trends towards deregulation. As with all progressive movements, telecom deregulation is not universally popular. Indeed, deregulation itself is a highly politicized process. There are in every country many interests, from labor unions to local copper cable suppliers, that would prefer a status quo or more regulated telecom industry structure. Understandably, shareholders in British Telecom would prefer to have maintained monopoly status rather than face competition. Many governments benefit from international settlement rates, and are strongly opposed to the FCC's proposal for globalization of international carrier charges. If these forces were to gain strength for any myriad of reasons over the next few years, a serious disruption of the IPT market is possible. Indeed, IPT is outlawed in many countries, and is illegal but currently tolerated in others. One can certainly construct any number of political scenarios that might turn the tide towards more closed rather than open telecom sectors around the world. In particular, there is the very real threat of a global recession as the economies of Japan, Russia, and most of Asia suffer from their respective financial crises. In times of economic uncertainty, we often see a shift in the political environment, and we almost always see a return to nationalism. Consider the recent election in Germany, which replaced an international leader with a leader much more focused on the domestic agenda, one who is moreover closely backed by labor unions. In reality, telecom policy is continually subject to shifting governments and business interests. We should not assume that the environment of the very recent past is a foregone conclusion for the future.
  19. Service Market Opportunities in Internet Telephony There are a variety of market opportunities generated by IPT. In general, we segment these into three major service markets: Wholesale (or carrier's carrier); consumer/small business; and enterprise/institution. Figure 6 below provides an overview of Probe's projections of global fax and voice over IP service revenues in each segment over the next six years. These figures do not take into account PC-to-PC IPT, as that activity generates no direct service revenues. As with all carrier service markets, any element that is sold as a retail offer may also be provided by a wholesale carrier to service providers with limited or even no facilities. Today's IPT market is characterized by a great deal of calling card activity, which reflects the fact both that multi-stage dialing is required, and the target customers are very price focused. The way many calling card sales work is that a retailer buys minutes from a carrier that sells them those minutes in packs of cards. An increasingly common approach is to sell pre-paid calling cards at retail outlets such as office supply stores, convenience store, etc. The wholesale market shown below is therefore money that comes from the retail sector -- thus there is an inherent double count of revenues in the figure below that one can adjust simply by pulling out the wholesale. Note that wholesale services is only counted as the revenues that a carrier receives for wholesaling a voice or fax over IP solution -- we are not including for example, the revenue that a backbone ISP generates by providing pure backbone services to another carrier that then sells a total IPT solution using that backbone. The wholesale market is a significant component of the total IPT market, and will remain important as service providers seek to provide global solutions. The residential and small business market currently dominates the retail sector for IPT, again because the calling card model has taken off so successfully for the moment. Over the next five years, this segment is expected to remain dominant, with an increasingly strong business element. Large enterprises and institutions typically use private leased line networks or virtual private networks for much of their voice communication. As IP-based VPN's become more widely deployed, we expect to see increasing us of IPT over VPNs by larger organizations. However, migration will be very slow, due to the resistance that always exists to replacing working systems, and we expect most of the large enterprise and institutional market to be driven by expansion, new branch offices, etc. The retail markets will also be driven more over the long run by enhanced applications. Again, we expect to see these take off amongst consumer, small office/home office (SOHO) and small business first. Some service providers, notably AT&T, are developing Internet-centric applications that integrate traditional internet communications (such as chat and email) with voice targeted at consumer applications. Naturally the hope amongst service providers is to create value added services that raise IPT from a cheap PSTN substitute to a premium service offering feature rich communication.
  20. Figure 6: IP Voice/Fax Service Markets by Segment 14,000 12,000 10,000 $US Millions 8,000 6,000 4,000 2,000 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 Consumer & Small Business Enterprise & Institutions Wholesale The Value of Early Market Leadership/ Today’s Internet Telephony Service Providers In 1998, the IP telephony services market is dominated by a small handful of pioneers, including Delta Three, IDT, AT&T, ITXC, and VIP Calling. Others, such as Qwest, PSINet, KDD, Deutsche Telekom, and ICG/Netcom are only beginning to sell services in any meaningful way in the 4th quarter of the year. Interestingly, large ISPs such as UUNET and PSINet have generally shied away from full IPT, in part we believe due to fear of bringing regulatory attention to the Enhanced Service Provider exemption in the US that protects them from paying access charges. UUNET has focused on IP-based fax services, while PSINet is rolling out VPN based services that are much less vulnerable to the argument that they are just selling voice minutes. The three current market leaders globally are IDT, AT&T, and Delta Three, with VIP Calling a not too distant fourth. Market leadership is difficult to establish -- in such a fast growing market we often find that it changes month by month. All four of these are, however, carrying millions of minutes each of IPT on their networks. Despite the entry of other players, Delta Three and IDT have managed to retain leadership by leveraging their early market experience. Perhaps

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