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Lessons from a VoIP Entrepreneur
This needs a lot more work, but since time is short, I may never get around to it, so here I provide the less than fully formed version.
Om Malik today posted about the woes of a silicon valley VoIP startup that launched with much fanfare last year. In this post, Om says:
the company focused on developing strange concept promotions for a device whose value proposition in a nut shell is: cheap calls. Cheap calling is a tough, low margin and volume business
I stand by everything I said about that company’s business plan as far back as 2004. Specifically:
- “The product solves a problem (call costs) that is going away (costs are going to zero without them)”
This was not obvious back in 2004, when a lot of people were still paying 10 cents per minute for domestic calls, and “discount” rates were still around 5 cents per minute, but we certainly see it coming true today. What’s more important than call costs going to “zero”, is that the costs for long-distance calls stops being a pressing issue for people - it stops being on their radar. I think we can safely argue that this point has already arrived - especially for domestic calls which is the key selling proposition of the product. We can even argue that it’s no longer a high priority issue even for landline calls between many popular regions (there are exceptions, like India, where cost is still a major issue). - “People won’t open their wallet for a large upfront purchase, as shown by Tivo etc. and especially not for “phone stuff” which is perceived as “should be cheap”
First, very few consumer products cost over $400, and certainly nothing in the telephone aisle costs that much; it’s rare to find phone products costing more than $100. One can buy an entire multi-handset cordless phone setup for under $50 these days. A home phone is not an iPod and $39, to say nothing of $399, is considered “expensive” in the phone aisle.
These are fundamental problems and dropping the price to $250 is not going to change anything in any meaningful way.
Sitting on the outside, with nothing at stake, it’s easy to criticize other peoples’ business and marketing plans. We constantly hear how we need to move beyond the “cheap” message for VoIP. However, the problem is that the “save money” message is the only thing that consistently drives customers to action. We could argue that it’s a self-inflicted wound, and is driven by the fact that “cheap” is the only selling proposition companies push, so therefore it’s the only message customers seek. There is truth to that, but I now believe there’s more to it than that.
I’ve been at this for more than four years now and have gathered a lot of real world experience and informing data, including lots and lots of marketing A/B testing, feedback from real customers, plus actual behavior data (what people actually do is not the same as what they say they do). And all this points to an interesting conundrum for VoIP. It’s a catch-22 problem very similar to that of TiVo. TiVo has the problem that people don’t know their TV is broken until they have TiVo. They have to buy the product to figure out that they want to buy the product.
We find a similar thing with VoIP. Customers adopt the product on the premise of saving money, but they often fall in love with it due to something else and “saving money” becomes merely icing on the cake. The problem is, they only figured this out AFTER they already bought the product - catch 22.
This is the major marketing challenge for VoIP. You can’t blame companies for selling on the “cheap” message. The reality is, nothing else drives customers to their product as effectively, so what are they supposed to do? Again, much like TiVo, these other value propositions are too complicated, making them too expensive. You’ve got all kinds of different VoIP models out there, but nobody has cracked this conundrum… yet. When they do, it will change everything.
Andy and others on “free” business models
Andy Abramson refers us to Dean Bubley’s post on Pudding Media and Ike Elliott’s post on Free is Not a model and says:
[it] pretty much sums up what I’ve been saying for years on Ken Radio..about the “If It’s Free It’s Me, If I Gotta Pay It’s No Way” crowd.
While on the one hand I agree, I don’t think investors are there yet. If we look where they make their bets (where they distribute their money) we see jaxtr, Rebtel, Jajah, and the latest, MSFT $240 million investment in Facebook just last week.
These companies are clearly not valued based on revenue (to say nothing of profit). They are valued on potential. Andy rightly says “what media planner in their right mind wants a 4-6 percent conversion user base after years of free use?” I’d argue that many of these companies will be lucky to get 4-6 percent conversion. Jaxtr’s CEO has been quoted as saying they hope to get just 1% of users to pay.
Elliott says:
You have to have a plan for monetizing the eyeballs. Google did a great job of this, which is why they are over $700 a share.
Someone needs a history reminder. Google DID NOT have a “plan” for doing so. They eventually stumbled upon adwords and they have been riding that one trick pony ever since. These investors invest in My Space, LinkedIn, Facebook, et al because they hope those companies will be so lucky too. Obviously, these companies probably do have some kind of “plan” for revenue on paper. Just as obviously, Andy isn’t buying it.
The really funny part is this is nothing new. Yahoo! was perhaps the first example of a colossal failure in this area when they tried to offer a paid version of their service and found no takers among their millions of “eyeballs”. But for the moment at least, despite these historical data points and despite what Dean and Andy say, investors are still ga ga for the “freemium” model.
Jaxtr math doesn’t add up
Jaxtr also seems to be another of these companies where the math just doesn’t work and one has to wonder on what basis they raised money and (supposedly) have received acquisition offers.
According to Tech Untangled, they are signing up 16,000 accounts per day. That is pretty impressive, for sure (if true - and nobody is saying how much they’re spending in marketing to get those subs).
But looking closer, they say that 80% of their customers are in “220 countries outside the US.” According to Michael Cerda, a majority of usage comes from “India, China, and Sri Lanka (the CEO himself said about 75% of their users are in these areas)” — we know these geographies do not tend to hold high revenue potential:
customers there are loyal only to your offer of “free” or “cheap” - when something cheaper comes along, those customers are gone.
Jaxtr plans to make money by charging people who use more than their allotted 100 minutes per month. An interesting choice, given that there aren’t many businesses with lower margins than calling minutes.
Their stated goal is to reach 20 million subscribers in 12 months and to get 1% of these to pay for additional minutes.
That math doesn’t add up. Jaxtr gives out local numbers to the caller (not one number for the callee). These have real costs, whether they are used or not. Jaxtr gives away the first 100 minutes (and extra minutes for signing up new customers). Given that about 75% of users are making calls from mobile phones, these 100 minutes also have significant costs (mobile calls outside the US cost typically 10x - 20x the cost of landline calls).
I don’t even see how the supposed 1% of paying customers will result in gross margin, or, in other words, how such a customer offsets the costs of that one customer. To say nothing of how they will offset the costs of the other 99%! And all this is BEFORE any marketing costs, G&A, salaries, etc.
My math says that those 16,000 new accounts represent, conservatively, at least $10K in new monthly costs added per day (I would not be surprised if it were really $100K); and that means their monthly costs increase by roughly $300K each month, which means they burn through the $10 million they just raised in less than 12 months, before they hit their goal. Even if they reach their goal, if they get 1% to pay $2 per month (average), they will have revenues of $400K per month — but their costs will be something like $20 million per month! Of course, this doesn’t factor in advertising revenue, but I don’t think that changes things enough to make Jaxtr work (especially given that these are just direct operating costs, not including salaries, marketing etc.)
Although, I suppose in this game of “sell it while it’s hot”, the whole idea of profits is not part of the equation. Skype didn’t need any for their multi-billion dollar sale to Ebay (and may still not have any profits, given how Ebay doesn’t say). Grandcentral didn’t even have revenues. The list goes on.
What am I missing?
Survey says more households with cell-only than landline-only
In a survey of 13,000 homes, Mediamark Research found that 14 percent of homes had only a cell phone and no landline, whereas only 12.3 percent had a landline and no cell-phone.
Based on the comments around the net on this survey, it’s clear the trend is age biased, something confirmed by analyst Andy Arthur “But there’s an older group that will never give up landlines, and will never accept the new technology.” The arguments of landline vs. cell-phone tend to be around safety and reliability (availability) with some people saying cell-phones won’t work in emergencies and others saying landlines are just as likely to not work.
I think it ultimately comes down to whether you see it as a good thing for your “house” to have a phone number. One poster said it simply:
One word: babysitter. If we’re out of the house, and something happens to one of the kids, I don’t want to rely on the babysitter to (a) have a cellphone and (b) have it adequately charged.
To the reliability in an emergency situation, I don’t think it’s smart to rely on any single thing. If it really matters to you, then have as many ways to contact people as you can, mobile phone, landline, and even Internet phone and IM, which are probably as likely to work in an emergency as either landline or cell phones. As to whether a landline or a cell-phone is more likely to continue to work or not, there is no clear answer - don’t believe the hype or myths from either camp. It depends on the specific emergency and there is no cut and dry answer. That’s why, if you really care about that issue, you should have both. Otherwise simply accept the risk that you might be out of touch in an emergency.
I still find value in having a separate number for the house (or household) and other conveniences of a fixed phone. But that’s my situation today (with a child still living at home). Many people are in a different situation. The following comment provides a good understanding of why the telephone companies are losing their landline customers though:
The land line is reasonably enough priced that I *would* have one except for the OVER ONE HUNDRED PERCENT taxes and fees which make it unreasonable!!! Yes, the base landline here is $12/mo. There is another $14/mo in taxes and fees.
…
Greedy archaic landline companies need to get with the times. They’ve lose me for good, but they might be able to stem the tide of people dropping landlines if they act quickly. HAHAHAHA who am I kidding - they won’t do anything and then they’ll ask for government money to bolster their failing profits and bail them out of trouble.
It’s a good point. The telephone companies are going to have to do something, something beyond the stupid triple-play and N-play marketing gimmicks. How much longer will I continue to find value in that overpriced landline service and how long will I stomach those unruly bogus “taxes and fees” (they are not really taxes, but simply profit for the telephone companies).
Vonage would be in the same mess even without the Verizon patent case
While the Verizon patent situation may be an accellerator (perhaps a very rapid one, if an injunction denying Vonage the ability to add customers comes down in the decision due April 24), it is my belief that Vonage’s problems go deeper than this litigation, and I’ve been saying as much for several years, at least since 2004.
I’ll repeat now, what I said back then, with this short list of the fundamental issues with the Vonage strategy:
- Low barriers to entry mean constantly increasing competition and fragmentation
There are now hundreds (if not thousands) of services that are essentially exact replicas of Vonage. The primary barrier to entry is marketing dollars. Other than slight pricing model variations, there are almost no differentiators between these clones of each other. - Decreasing Revenue per subscriber combined with Increasing customer acquisition costs over time
Due to the competition above, and general trends in telephone services, the retail prices of undifferentiated services was trending down when Vonage et al were being formed five years ago, and continues to do so. Vonage started at $39.99 per month and people at the time thought it was a bargain. They have dropped their price several times with increasing competition and market pressure. At the same time as their revenue per subscriber has come down, the cost to acquire new customers has gone up. And it will contunue to do so as they move past early adopters and saturate the market of those customers that fit their one and only value proposition: “cheaper phone service”. For many mainstream customers, the cost of their home phone service is not high on their list of problems that need attention. This means Vonage has to spend more and more money to “sell” these customers and get them to take action and switch. - Insufficient operational advantages over existing models
I have said for a long time that building a Vonage-like phone service cost about the same as building a “traditional” phone service, if one were starting from scratch. Vonage doesn’t have to build the copper plant to the home and that’s the primary economic advantage. However, they lack buying power on the back-end (IP to PSTN termination, DIDs, etc.) making the overall costs of providing service roughly a wash, compared to the existing telcos. Certainly, the op ex advantages, if any, are not 100x or 1000x better. - Regulatory Nightmares
For a long time, Vonage called themselves “The Broadband Phone Company”. They should not have been surprised, then, when the FCC came calling. Many of the operational advantages that Vonage originally enjoyed, such as not incurring costs for 911 and CALEA have now been taken away. Even without that, they live in a regulatory quagmire, an environment where traditional telcos thrive and where Vonage is a mere child among men.
In short, the Vonage strategy lacks the ingredients to achieve disruption. And this applies to all the competitors in this Pure-play VoIP space, by the way (see Phone over IP or PoIP). It’s possible to have a modestly successful business in this space by focusing on niches and keeping customer acquisition costs low, but as a general disruptive force, it’s not going to happen with this model. And I said as much over five years ago.
It’s a slightly different story for the Cable companies and their version of PoIP service because they are leveraging network/access assets they already must build-out to support their TV service, so the econmonics are more favorable, in terms of both customer acquisition costs and operational costs. It doesn’t change anything in terms of expanding out-of-maket etc. but adding a PoIP offering in the areas they already serve can work (and Cable companies are already familiar with fighting regulatory issues on a more equal footing with telcos), but this could hardly be described as disruptive.
So maybe it wouldn’t come as fast, but soon enough, Vonage would be faced with these same issues, even without this Verizon suit and other pending litigation. In fact, it would be far better IMHO if they win this case against Verizon, because the more I look at it, the more it appears to be totally bogus and we should all be standing up to defend Vonage.
When is Vonage a good acquisition target?
Andy says Vonage’s best move is a sale.
That may be true, from Vonage’s perspective, but let’s look at the numbers. At a stock price of around $3/share, the market cap of the company is roughly $500MM, or about the same as the cash they have in the bank. At that point, $750MM looks like a “steal” for the company. However, none of the problems with the Vonage business metrics go away with a new buyer. The fundamental issue comes down to churn and customer acquisition costs.
If one simply buys the business for the 2.2 million customers, how much are they really worth? Hypothetically, if we spend no marketing money to replace customers, and assuming churn remains about the same, all the customers are gone in about 2 years and the total revenue collected is under $100MM (and all the key value assets are out the window). This says that VG is worth no more than $100MM over their cash, less debt and other liabilities. I.e. the actual customer base is only worth about $100 million.
As a growth business, there is no ‘there’ there because every customer Vonage adds reduces the value of the company based on their historical metrics. No one in this replacement VoIP or PoIP business has shown a viable NPV model. So why would anyone want to pay more than 1.0 times revenue for such a business?
And none of this factors in the ongoing patent and other legal liabilities. Toss this in, and maybe even 1.0 times revenue is too much to pay for these 2.2 million customers.
Open Telephony, beyond the abstract
Alec Saunders revisits the state of Voice 2.0 in a response to a post by Jim Van Meggelen regarding the lack of integration between PBX�s and carriers.
At a recent telephony conference, we saw many telcos reporting about the progress on their open platform initiatives and how there was this glorious future for us all to look forward to. They showed slides and used all the right language about it. That’s all well and good, when it is nothing more than slides, with no definitive dates and nothing concrete about it all really. I’m sure the carrier is quite comfortable talking about open-platforms, as long as it’s slideware discussing some some ill-defined “out there” future.
But how comfortable are they when the idea of an open platform, that really lets third-parties offer tightly-coupled services to their customers, stops being just an “idea” and becomes a reality, here and now?
The picture below shows what the PhoneGnome technology, as a platform, does to the value chain (or application stack) when an end user plugs in that little CPE device:
On the left, we have the closed vertical platform provided by carriers today. The same applies whether we’re talking about a traditional 130 year-old carrier, or an upstart 3-year old VoIP player. The supposedly revolutionary 3 year-olds simply copied their grandparents when it comes to opening their platform to third-party innovation.
On the right, we have the result after a customer connects the PhoneGnome device. With PhoneGnome installed, the services stack above “access” (the local number and local services) is open to any third party provider, without the support or cooperation of the underlying telco access provider required. It is “unbundling” at the customer premise (or “unbundling at the edge”) without the nightmare that is traditional telco-based “unbundling”.
“Open” is beyond the abstract and slideware now. With the installation of a simple enabling CPE device, anyone’s service (and brand) can now be seamlessly inserted into the experience for any existing fixed line user, any telephone number anywhere, without the requirement to partner with the underlying telco. It is a “pay as you grow” model with no requirement for a large initial cap-ex outlay. The footprint is immediately the entire world, anywhere there is broadband internet and POTS service. And it is here now, in use by real customers, and empowering real non-telco third-party services, provided directly to existing telco customers.
Read more »
Vonage acquisition costs
I’m often asked “why does it cost so much for Vonage to acquire a customer?”
The simple answer is that the demand is just not there. At the end of the day, they are selling something people don’t really want or need very badly. Us VoIP geeks assumed “if we build it, they will come.” Reality check time.
Pip Coburn, in his new book The Change Function talks about something he calls the perceived pain of adoption. In the past, we more or less called the same thing “switching cost” but the idea is that the purchaser weighs how much pain will be involved in adopting the new thing and if the benefit outweighs that pain, they buy, otherwise they don’t.
At this point, for a lot of people the perceived pain of adoption of switching to a Vonage-like service outweighs the benefit (what Pip Coburn calls the “crisis”). This perceived pain includes:
- Signing up for the new service, and establishing (yet another) billing relationship
- Switching phone numbers, or transferring their current number to the new service
- Potential quality problems - Will it work? Will my friends know I’m not using a real phone? Will I miss calls?
- Can I figure out the hardware? Will I be able to set it up?
If they are a little bit educated in the VoIP space, they may also ask:
- What’s the deal with 911? Are my kids safe?
- What if it doesn’t work and I have to go crawling back to my telephone company? Will I be able to get my number back?
- Will my Tivo, home alarm system, and satellite receiver work?
- How does the transition work? I’ll need to run two services at once, right?
- I’ll need to factor in the cost of a multi-handset phone
So that’s a lot of perceived pain. The crisis I’m solving is what? These Vonage-like services don’t stress features, so the “crisis” is about how much I’m spending. So if I can save $5 per month, is all that pain worth it? Probably not. So Vonage has to spend a lot of money to talk people into believing they have a crisis - in other words, they have to sell people something they don’t really want all that badly, and that’s expensive.
As Vonage goes, so goes “Residential VoIP”
Vonage invented consumer residential VoIP as most people know it. We have to give them credit for that. Many people as late as 2003 were still saying the Internet could not handle phone calls at all. I think Vonage got people past that.
In 2003, Vonage was the darling of the industry, representing the future glory of VoIP, and it was not very popular to denounce this new wonder as I did here when I declared that the essence of the entire business with all these Vonage-style services (Vonage and the then emerging Vonage-clone services from AT&T, Verizon, et al) was fundamentally flawed. I said:
When I said back then that Vonage-style VoIP was simply a local-loop alternative, using the Internet to reach the new “central office” and that, beyond that, these companies were no different that the so-called century-old telephone system and declared that these services were about as un-Internet as you can get, I was essentially blasted by the blogorati — That was blasphemy back then.
Essentially nothing has changed about what I said in 2003. It’s just that now it has become fashionable to say it. Now, the blasphemy is in not being a Vonage basher.
Stuart Henshall coined a wonderful term for these services: PoIP (Phone over IP), which I have embraced. Consumer Reports reviewed PoIP providers in February 2005 and it was noteworthy that the majority of their testers said they won’t keep PoIP because “the inconvenience outweighed the prospect of lower bills.” This pretty much sums up the PoIP business and explains why the customer acquisition costs are high and lifetime value is under water.
When investors and others asked me to summarize my thoughts on Vonage circa 2002, below is what I told them. These were pretty radical views at the time. You should have seen the way people rolled their eyes when I said these things back then.
1.The revenue strategy is fundamentally flawed
Vonage introduced their service in March 2002 at $39.99 (see press release). My position was minute revenue represented a declining value and could not provide differentiation. I said minutes would ultimately be free, or near free. We all know about SkypeOut and Gizmo offering free calls, but in fact they were not the first. Companies like Voipbuster, SIPdiscount, and others started doing it over a year ago.
Vonage has now had to reduce their price to $24.99 and eat more setup fees, greatly reducing their ARPU, while their costs have actually increased (see below). As price becomes less of a motivator for buyers, a PoIP provider’s economics get even worse, since they have to spend even more to convice customers to switch.
At that time, minute revenue was seen as the holy grail. I mean to say minute revenue was a bad basis for a business back then did not find many supporters. In fact, there are still a lot of people that continue to believe basic minute revenue as the only business.
2. Low barriers to entry will create fierce competition
Like the ISP business of the nineties, there must be literally thousands of PoIP providers now. Anyone even remotely close to the industry can name at least five. There is essentially no differentiation among them besides brand and price. There is even an entire economy now in just helping customers wade through the myriad options in the form of review sites and services.
3. Operating costs are not sufficiently advantageous
Even though it doesn’t take a lot of capital to get started in the PoIP business, it still has relatively high operating costs per user, or in other words, poor operating margins. Anytime you try and do exactly the same thing as some existing system using the Internet, and not change the architecture in some deep way, there is no guarantee the Internet-based version is going to be significantly cheaper or more efficient. To get benefits, you have to somehow leverage what the Internet gives you, not try to make it something it is not. This is where Skype was really something different. PoIP providers appear to be mostly operated by telco-heads: telco-like thinking pervades network architecture, interconnects, bundled products, pricing plans, marketing plans, etc. Whereas Skype took an entirely different approach, from top to bottom.
The result is that the operating advantages of PoIP over traditional telco are minimal, coming mostly from not building a wire plant, and (at least in the beginning) regulatory arbitrage. And since PoIP isn’t leveraging the Internet to differentiate, and instead is just saying “we offer the same thing at a better price”, it makes it easy for the telcos to leverage their significant economies of scale (100 to 1 over Vonage, easy, perhaps 1000 to 1) to achieve better operating efficiency. How bad is that: that the century old telco system can actually have better operating margins than a supposed Internet company.
4. Regulatory issues will be a nightmare
Most the VoIP industry is still playing ostrich on this point, but the writing is on the wall (or at the FCC) and we’ve already seen how PoIP providers will not be able to remain immune to regulatory burdens. As I have already said, if you’re going to stand up and say “we’re just like normal phone service” and then cry when the FCC comes calling, you get what you deserve. This impacts point 3 above and further weakens the operating advantages of PoIP.
Summary
Basically what I was saying back then was that (a) competition and other forces would drive the core revenue down, (b) as a result of that, the entire selling proposition of “cheaper” becomes too weak, (c) this, combined with other switching costs, in turn drives up customer acquisition costs, and finally (d) the operating margins will be worse than a traditional telco. There is nothing good about the PoIP business. Not many people were listening to that story in 2003.
As some of you know, I spoke with my feet, and tried to put something together that really was different and I continue to try to make a go of it.
No business model for standards-based VoIP
Clay Shirky gives us his excellent VoIP - Plan A vs Plan B article, where Plan A is a telco-clone provider (such as Vonage) and Plan B is a more radical alternative, in this case Skype.
Clay makes it clear that Skype is only a metaphor for the Plan B model, but today the only practical Plan B option is Skype. That’s what people are using and some people have become quite zealous in their Skype fervor. Clay says:
On the monopoly control issue, Clay fails to mention that the Plan B Skype option is a monopoly too, and a totally unregulated one. Skype is a closed proprietary system under the control of one private venture capital funded corporation. Skype runs on one platform and one operating system. It does not interoperate with any other products and no other vendors currently offer Skype protocol-compatible software or hardware. No vendor may do so without permission of Skype.
Obviously, real users don’t chose standards-based solutions for open-standards sake alone. There must be some more compelling reason for selecting a standards-based option over a proprietary option. This is what I call natural value.
There are many arguments in favor of standards-based solutions with perhaps the most obvious being multivendor interoperability, giving users a choice in vendors. The natural value of standards-based solutions often win out in the end. A few examples in which standards-based solutions totally obliterated their closed-proprietary competition include:
- 802.11b that rapidly supplanted all other wireless LAN products
- CCITT fax (yes, there used to be proprietary competitors)
- Internet Protocol (instead of IPX, Netbeui, Lantastic, etc.)
- Internet email (replaced closed systems like Lotus etc.)
There are many historical cases of customers becoming locked in to a proprietary solution and subsquently being milked mercilessly by a vendor. Despite this and other seemingly obvious risks of adopting proprietary solutions, users seem to still do it with some abandon. Consider Instant Messaging where proprietary and non-interoperable solutions such as AIM, MSN, and Yahoo! hold a 90 percent share.
So why did standards-based solutions work for Wi-fi, email, and countless other applications, but fail for IM? And where does that leave us for VoIP? Are we simply going to move from one proprietary monopoly (the telphone companies) to another (Skype/Kazaa)?
I don’t begrudge people that use Skype. I am however disappointed that we don’t yet have an open-standards based alternative. Despite the hype from the Skype/Kazza folks, we could build an open-standard interoperable Skype-like application using SIP today, but what would be the motivation? Who is going to pay for it? Skype can fund the development of their application because they know they can apply the old monopolistic squeeze when the time is right. And Skype CEO Niklas Zennstr�m will have to do that when his investors, folks like Bessemer Venture Partners and Mangrove Capital Partners, put the squeeze on Skype. Those guys don’t invest for the public good — they expect a return in cash.
There is some hope. People do like open systems for their extensibility too. I note that a frequently recurring theme of questions on the Skype support forums are those along the lines of “Where is the API?”
