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David G. McIntrye - Black Star for Asiaweek

When Phone Calls Are Free
International telephone calls are migrating to the Internet - where they are becoming too cheap to meter. Can a telecommunications industry bloodbath be far behind?

Tanya Porquez is no consumer activist. She's just trying to save a buck. The U.S.-born Filipino, now working in Manila, economizes by placing phone calls to her family in the States over the Internet. She has to connect using her computer at work, a process almost as clumsy as the one E.T. devised when he wanted to phone home. And some conversations sound like it's E.T., not mom, on the end of the line. Porquez, 26, is willing to put up with the hassle because the calls cost nothing. "I used to call long distance on the telephone and feel guilty because it's so expensive. Then I'd get the bill and feel even more guilty."

She may have something else to feel guilty about. In her own small way, she is hastening the demise of the global telecommunications system as we know it. Placing phone calls over the Internet may not seem like a revolutionary act - most people still consider holding a conversation through a desktop computer something for gearheads and hobbyists - but millions of people, and a growing number of businesses, are dramatically cutting their international direct dial (IDD) phone bills through "Internet telephony." Also known as Inter-net Protocol (IP) telephony, the technology lets users bypass conventional long-distance telephone systems. Calls are instead shunted over the public Internet or private data networks - thereby escaping charges related to the distance a call travels and tariffs related to the IDD world's regulated rate-settlement system.

Transmission quality can be poor and most services require callers to connect via a website - a problem in Asia where Internet use is still relatively low. But the technology is improving, service is re-markably cheap and, like the Internet itself, it's growing explosively. While traffic over conventional phone networks is increasing 12% to 16% annually, so-called "voice-over-IP" is as much as tripling each year. Some 40% of this new traffic originates in Asia and terminates in North America and Europe. And the number of minutes of voice calls placed over the Net is projected to grow from 2.7 billion minutes last year to more than 135 billion minutes in 2004, according to technology consultancy International Data Corp. (IDC).

That has traditional telephone companies, called telcos for short, sitting up. The digital convergence of voice, fax and data on the Internet is "totally changing the entire landscape as far as the provision of telephone services is concerned," says Sandra Ng, associate director for communications research at IDC in Singapore. IP voice traffic represents less than 5% of long-distance calls in Asia, she says. But particularly in countries where IDD rates are artificially high, it is starting to have an impact. U.S.-based iBasis, which is building a global system for voice-over-IP communications, claims that since June it has carried as much as 10% of all phone traffic between China and the U.S. through a partnership with China Unicom, the mainland's second-largest carrier. Al-though Internet telephony is seen as a threat to government-licensed carriers and is allowed only on a trial basis, more than 40 firms have applied for permission to provide the service in China. In South Ko-rea and Japan, up to 15% of international phone traffic was routed over the Net last year, says IDC. "IP telephony is the driving force" in the telecommunications business, says Norman Chan, managing director for iBasis in Hong Kong (and Asia-week's cover subject). "And when the market opens, the price is going down."

Chan's company is part of a wave of start-ups that are forming to exploit the shift. Armed with cost-effective technologies, these "next generation" telcos are challenging conventional networks run by long-dominant carriers. According to IDC, some 300 Internet telephony service pro-viders were already operating in mid-1999. Some are cutting-edge subsidiaries of giants such as MCI Worldcom and AT&T. Others, like U.S.-based Level 3 Communications and Hong Kong's, are building or operating state-of-the art fiber-optic networks to carry voice and data. Still others are dotcom hybrids such as Dialpad, Net2Phone and Singapore's MediaRing, who hope to profit by offering free or low-cost calls while selling website advertising.

High-speed, globe-spanning IP networks are proliferating like a new strain of jungle vine, threatening to crowd out the old-growth flora. "It will take some time," says Alex Liu, managing director/Asia for next-generation telco oCen Communi-cations, a Hong Kong Internet telephony company backed by New World Cyber-base among other investors. "But a lot of people believe we are at the beginning of a tidal wave here - and the laws of economics are on our side."

Applied in the Internet ecosystem, supply/demand equations will produce results that a few years ago would have seemed ludicrous. Many computer and telecoms industry observers believe that in a few years, there will be no distinction between a voice call and other forms of communication. It will all be digital bits, transmitted over converged IP networks. Compared with the vast amount of data that will be exchanged for e-commerce and multimedia Net activities, conversations will be "too cheap to meter." A typical five-minute phone call, for example, amounts to less than 1/70th of the data contained in five minutes of video transmission. Companies will simply give voice service away as a free add-on to data services. "IDD in the U.S. cost $12 a mi-nute seven years ago, 5 cents a minute today, and in 2005 it will be zero cents a minute," says Don Tapscott, chairman of the Alliance for Converging Technologies, a Toronto-based industry think tank. "When people are taking Lexus's for virtual 3-D test drives on the Internet, voice traffic is nothing."

Of course, the price of long-distance service is already declining rapidly the world over due to deregulation and competition from alternative carriers and call-back services. Long-distance service is fast becoming, instead of a pricey premium, a marketing giveaway to attract customers. When South Korea's Hanaro Telecom began offering free Web-to-phone international service in January, more than 300,000 people signed up in the first two days of operation. "There are companies out there giving away free Internet access," says Matthew Kapp, president of 3Com Asia Pacific. "Consumers are going to get free telephony as well."

What will make this possible is a fundamental change in the way global telephone networks operate - a change that "has profound implications on the way we communicate and on the traditional telephony business," according to Steve Liddell, Level 3's chief executive for Asia. Today, almost all voice traffic is carried over traditional "circuit-switch-ed" systems. The basic technology for circuit-switched networks has been around for more than a century and is as simple in concept as two tin cans connected by a string. When a phone number is dialed, a series of switches is activated, clearing a dedicated electronic pathway between caller and receiver. The connection is "nailed up," in telecom-speak, for the duration of the call. No one can butt in and use the line for anything else, even if the parties set down their handsets and go off to make dinner.

Circuit-switched networks have been wonderfully reliable, but they are being hastened towards retirement by the micro-chip, the computer and most especially the Internet. The Net is based on what is known as a "packet-switched" technology, which offers a far more efficient way of managing communications traffic.

In a packet-switched network, digital data - be it an e-mail message, a video clip, or the sound of a voice - is broken into chunks, discrete packets of ones and zeros, which are sent towards their intended recipient over the network. Each packet seeks its own best path to the receiver, passing at lightspeed through routers and switches along the way. The packets are reassembled in the proper order when they reach their destination.

In other words, a circuit-switched call is like a train of data-laden box cars running back and forth on its own dedicated track. An Internet phone call is more like a fleet of trucks operating independently over a vast public highway system. The railroad may sound more efficient. It isn't. Remember that nobody else can use that track for as long as the train is running, even when the boxcars are empty - the capacity of the system is wasted when nobody is speaking during a phone call. In a packet-switched network, everybody shares the highways, and trucks carrying voice, data, video, whatever, can squeeze into every opening in traffic, making efficient use of the available roads.

Same old calls, brand new routes
Today, 95% of all voice traffic is carried over traditional "circuit-switched" telephone networks. Circuit-switching operates like an express train shuttling words back and forth on a private rail line for the duration of the call.

The Internet is based on "packet-switching," which breaks digital data, including voice, into chunks. A webphone call becomes a fleet of trucks, each carrying a piece of conversation and seeking the fastest route on a vast highway system.

The railroad seems more efficient, but isn't. Only one train can run on each track. On the Net, trucks carrying different conversations can squeeze onto every bit of road on the highway.

Merrill Lynch estimates phone companies that convert to IP networks can cut operating costs by 30%, but that's just part of the economic edge. Circuit-switched networks were developed in an environment of regulated monopolies. Band-width was by definition scarce (read: expensive). Equipment was proprietary and made by a handful of giants such as AT&T (read: expensive). The Internet, on the other hand, operates on non-proprietary standards and technology adapted from the computer industry. Equipment is constantly falling in price and is manufactured by a multitude of highly competitive companies including Cisco Systems, 3Com, Lucent and Nortel Networks. The mammoth switches used in conventional phone networks cost up to $10 million. A "gateway" switch that shunts calls be-tween the regular phone network and the Internet costs less than $50,000.

Moreover, IP technology is improving in price and performance more than twice as fast as circuit-switched technology. The cost of moving a megabit of data has declined by 90% in the last two years alone, according to Michael Nelson, program director for IBM's Internet technology program. "If you look at the lower costs and the flexibility, it's clear why service providers are desperate to get into the packet-switched game," says Todd Abbott, vice president/Asia for Cisco.

The vast differential between Internet economics and conventional telco economics offers seductive competitive advantages to companies such as, a next-gen phone company that recently opened its global headquarters in Hong Kong. The company, an offshoot of Taiwan's Pacific Group, Asia's largest maker of electrical and communications cables, is busily piecing together a global IP telephony and data services network using a highly unorthodox strategy. It is, in effect, building out a system by giving away hardware to its customers. - which was the first Asian company to receive an investment from a communications-industry venture capital fund set up by chipmaker Intel - helps businesses create "virtual private networks" for global transmission of voice and data. Instead of selling the necessary IP gateways and switches to its clients, it installs them for free (an affiliated company manufactures the equipment). retains ownership of the equipment, which it incorporates into its system and uses to relay IP traffic from other customers.

It's a win-win arrangement, says chairman Chris Pon-Yean Lee, who counts among his first customers computer maker Acer Corp. of Taiwan. The client saves money by lowering phone bills with a minimal investment in circuitry. (Lee estimates that customers, by bypassing traditional carriers, save up to 70% on telecommunications costs.) has used the strategy to place 80 gateways - 13 of them in Acer premises around the world - and it can now complete voice calls in 280 countries. "We took the Acer contract from AT&T," Lee says. "We told [Acer Chairman] Stan [Shih] the gateways cost you nothing, and he told AT&T that they have to beat that cost."

Mavericks like, which had just $7 million in revenue last year, face major obstacles to winning corporate business. Although voice-over-IP service promises big cost savings, most companies aren't considering it because of the perception that Internet call quality is poor. Network congestion is a big part of the problem. While Internet bandwidth is expanding rapidly - globally, new communications links will increase capacity tenfold over the next three years, according to Merrill Lynch - a recent study by Faulkner Information Services indicates that only 7% of corporations in the U.S. are testing IP voice service. Carriers offer quality guarantees to corporate customers by carefully managing traffic over private networks. But public Internet telephony is so unpredictable that Web-based services often carry disclaimers warning users not to use them for emergency calls.

Clogged plumbing isn't the only obstacle. Internet calls must travel at least part way over public phone lines, yet there is no common global settlement system in place whereby network operators can share revenues for handling traffic. In addition, Internet phone companies usually are not able to offer service to every country - they can only complete calls to countries in which they have partnerships with conventional telcos connecting to homes and businesses. Too, making calls with computers is clunky, although solutions that allow "phone-to-phone" Internet telephony are quickly reaching maturity.

In Asia, the biggest barrier to rapid IP telephony uptake may be legal. It is against the law to sell Internet phone service in many countries - in-cluding China, India, Thailand and the Philippines - because it upsets regulated markets and jeopardizes the revenue stream of government-protected mono-poly carriers. It is also nearly impossible to prevent in the long run. Corporations are free to set up private IP networks to handle internal voice traffic. Websites operating beyond a country's borders can easily be accessed by citizens wishing to bypass licensed phone companies. The technology makes it feasible for many types of Internet players, including Net access providers and cable-TV outlets, to become de facto phone companies even if they are legally out-of-bounds. "If you don't [allow] it," says Nelson of IBM, "the Internet will just route around you."

The fear of lagging in the communications race - and being left out of the information economy - led China last year to approve testing of Internet telephony in most major cities. The same forces recently drove the Communications Au-thority of Thailand, that country's international carrier, to sign an agreement with iBasis allowing the authority to route telephone and fax traffic over the iBasis network. Singapore this month opened up its telecommunications market - two years ahead of schedule - awarding 29 companies licenses that allow them to offer IP telephony. "We're going to see the same changes rippling through Asian markets as policymakers see that the benefits of delivering this kind of infrastructure outweigh all other concerns, including national security and protecting one's own monopoly or duopoly," says Liddell. "Regulators will realize that keeping markets closed works against the economic interests of many of these countries."

Incumbent telcos are finding themselves under seige. They still dominate their markets, but they are saddled with high-cost circuit-switched networks that were built under regimes in which they were guaranteed profits. Now, costly equipment that was supposed to be depreciated over decades faces near-term obsolescence. Traditional carriers are also being forced to compete against more efficient operators that can slash transmission prices seemingly at will, while their own prices are often dependent on international negotiations among regulators. "The telecom companies are right in the epicenter of change," says 3Com's Matthew Kapp. "They are open to attack from a new business model that can completely disintermediate costs." Whether they can survive and prosper will depend on how quickly regulators open markets, and on how willing the operators are to cannibalize their old businesses and offer new, Internet-centric services.

One company that has recognized the urgent need is Wharf Holdings, owner of New T&T, Hong Kong's second-largest telephone company, and majority owner of broadband Internet access provider i-Cable Communications. Stephen Ng, who is deputy chairman of i-Cable and chairman of New T&T, says both groups are developing IP products, the latter targeting businesses, the former aiming at consu-mers. "With i-Cable we'll be starting with a clean sheet, using voice-over-IP to attack the market," Ng says. Testing will begin later this year, he says. IP telephony is seen as merely a part of a host of advanced telecommunications services made possible when data and voice are carried on the same network. "A telecom operator that relies solely on voice to make a living is a dying company," says Ng. "All of us must go after much higher-value traffic or run the risk of becoming the next dinosaur."

Indeed, IP telephony's proponents say their biggest advantage is the ability to offer heretofore unavailable services such as unified messaging, where fax, voice and e-mail messages are merged, as well as voice-enabled e-commerce portals. "The strength of IP telephony is the integration of the Internet and traditional networks," says Robson Liang, general manager of Hong Kong First Telecom. His two-year-old start-up is rolling out software that, when installed on e-commerce websites, provides free "800" phone service to customers anywhere in the world. The technology allows site visitors to click a button and be immediately connected to a customer service representative for a chat. Hong Kong First Telecom plans to offer the software to more than 200,000 enterprises in southern China. "This will allow small and medium companies to be big on the Net, getting the same type of service that used to be only affordable for large companies," Liang says.

Meanwhile, Singapore-based MediaRing, a free Web telephony provider, is exploring other bells and whistles made possible by voice-data integration. MediaRing lets users send voice greetings through e-mail. Web surfers can also modify their speech to sound like a chipmunk or a robot. Another offering allows people to leave voice messages on a home page - for example, a local football team website. In its first five weeks of operation, the service generated 100,000 messages, says Ng Ede-Phang, MediaRing chief executive. "We are not just a telephone replacement," he says. "We are an integrated communication-services company."

Ng of IDC says that it will be several years before Internet telephony really begins to take off. Voice quality and ease-of-use remain impediments to widespread acceptance by consumers and corporations. "People expect 99.9% reliability when they pick up the phone, and we aren't at that point yet," says Mark Leigh, president for Lucent's enterprise networks group in Asia. But technical improvements in network management tools and the boom in bandwidth means "toll-quality" IP telephone calls are 12 to 18 months away, he says.

And as old telecom industry business models unravel, there won't be much to prevent phone calls from being free - or nearly so. After all, what's in a word, or even a few hundred? When we are all sending video e-mails to each other over broadband networks, an old-fashioned voice telephone call will seem quaint -and not worth charging money for.
With reporting by Alan C. Robles/Manila

Write to Asiaweek at

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