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Summary:

GigaOM readers in a poll earlier this month have spoken – Vonage stock is a sucker’s bet and is headed down. The stock market seems to agree. The odds are against the company. Daniel Berninger, senior analyst with Tier 1 Research thinks otherwise, and believes that […]

GigaOM readers in a poll earlier this month have spoken – Vonage stock is a sucker’s bet and is headed down. The stock market seems to agree. The odds are against the company. Daniel Berninger, senior analyst with Tier 1 Research thinks otherwise, and believes that like MCI that put the squeeze on old AT&T, Vonage can put the squeeze on its bigger, more well funded rivals including the Bells and Cable Companies.

Berninger, who was involved with Vonage in the early days, but does not own any stock in the company told The New York Times, that the stock is going up, and Jeffrey Citron could be the new Bill McGowan, the maverick who started MCI and took on the old Ma Bell. He might be in a minority (only 15% of 663 who voted in our informal poll thought that the stock will go higher than the IPO offering price of $17 a share.) Andy Kessler wasn’t too impressed by Vonage’s business model. Neither was I. Still, Berninger paints a pretty compelling case. He has been around in the telecom industry to see the parallels. Read for yourself … after the turn.

By Daniel Berninger

In the tradition of no good deed going unpunished, Jeffrey Citron’s attempt to break 130 years of telephone monopoly means he deserves a broken IPO. Rather than cheering Vonage’s 30% valuation decline in the first week of trading, we might consider the larger implications of Citron’s success or failure. With communication like energy an input for the entire economy, the prospect of a failure to reduce communication costs hardly seems like cause for celebration. Citron’s effort to give customers an alternative to AT&T and Verizon arises after a complete reversal of MCI CEO Bill McGowan’s achievements with the Bells back in control of long distance.

The demise of the long distance industry traces directly to McGowan’s death in 1992, because defeating monopoly requires a unique set of talents. Fortunately for the communicating public, Jeffrey Citron looks as much the antidote to monopoly as Bill McGowan. As with MCI’s IPO in 1972, the Vonage IPO represents only the beginning of a story. Citron uses the Internet where McGowan’s took advantage of advances in microwave technology, but both invent and dominate categories avoided by most rational entrepreneurs. The description of MCI as a law firm with an antenna on the roof was more true than not, because regulatory and antitrust considerations shaped the landscape. The success of Vonage owes to full throttle marketing even while navigating the regulatory pitfalls.

Anyone that thinks competition represents the main challenge for Vonage has not been paying attention. Vonage faces anti-competition from the new AT&T, Verizon, and the voice dreams of Comcast et al. The Bells and cableco’s have no intention of competing with Vonage in the sense of delivering better value for a better price. Both set their price points at almost double Vonage’s. The feature lists of Verizon VoiceWing and Comcast Digital Voice fall short without the virtual numbers and mobility offered by Vonage.

Skype and the voice offers of Google, Yahoo, and Microsoft do not represent competition as they do not offer a substitutable service. Their existence provides a net benefit in contributing to customer awareness. The competitive challenge from other independents already played out with Vonage building a customer base 10 times the #2 player. There does not even exist a Sprint as in the case of MCI.

The various tactics for defeating Vonage come from the monopolist handbook. The Bells and cablecos target only customers where they can leverage existing billing relationships and tie voice to other offers (aka bundle.) The Bells focus their resources toward manipulating the regulatory process and very little to make service offers more compelling. The Bells and like minded cableco’s still control last mile facilities. They will scheme to raise Vonage’s costs and disrupt the company’s relationships with customers. They will not compete for customers on the merits.

Vonage’s telecom costs remain at 30% of revenues even as economies of scale have cut other costs in half. The fact DSL and cable modem offers include limited upstream bandwidth serves to reduce the number of people that can use Vonage’s service. The Bells continue to tie their DSL offers to traditional telephone service. Customers trying to move their telephone numbers to Vonage wait weeks as an error prone manual process grinds away at the same time wireless numbers get ported in a few hours. The fact AT&T CEO, Ed Whitacre, mentions Vonage by name in his famous “my pipes” BusinessWeek quote vowing to unwind net neutrality does not represent an accident.

The tricks of the monopolist trade proved sufficient to defeat the post McGowan MCI, the wannabe’s created by the Telecom Act of 1996, and even bested AT&T itself with SBC acquiring Ma Bell for 50 cents per revenue dollar. The track record might rightly make CEO’s Whitacre and Seidenberg confident in the outcome unless they notice Jeffrey Citron shares many of the same characteristics that allowed Bill McGowan to make MCI under his leadership an exception to the rule.

The ugly landscape suits Jeffrey Citron as well as it did Bill McGowan. The inability of less hardy competitors to keep pace ended price competition in 2004 as well as any need to split the eventual treasure. SBC saved Vonage the trouble of dealing with a serious challenge by the old AT&T. Survival represents no small matter, but Vonage need only peel off a small percentage of the $200bn in annual Bell company revenues to generate a substantial business not to mention win the right to pursue a piece of the larger $1 trillion global voice business.

Jeffrey Citron’s Vonage has already pushed Bill McGowan’s cause further than any of the companies funded in the cycle of monopoly bashing launched by the Telecom Act of 1996. Vonage will hit the $600mn annual revenue milestone by the end of 2006 at the same pace as $100bn market cap Google. Even the so called failed IPO serves to build customer awareness not to mention provides $531mn in funding allows Vonage to grow into its marketing budget.

Consider a quote from AT&T CEO Robert Allen at Bill McGowan’s funeral: “Bill McGowan will go down in business history as one of America’s foremost entrepreneurs. Probably more than any other single person, he helped to reshape the long-distance business from the monopoly that it had been for so long to the highly competitive industry that we know today.” We may all reach a different conclusions about the prospects of Vonage’s long term success and, hence, the proper value of Vonage’s stock, but no matter the outcome Jeffrey Citron deserves the appreciation of everyone that receives a telephone bill (i.e. everyone).

Daniel Berninger is a senior analyst at at Tier1 Research.

  1. Dan’s assessment of Bill McGowan and the future of Vonage don’t ring true to me. I knew Bill McGowan – and worked along side of him early on in the efforts to break the ATT monopoly. There are two observations from Breninger that don’t hold up:

    1. McGowan, had he lived, would have changed everything. Well I sat next to Bill McGowan over nearly a ten year period, and watch him go from taking me, this poor 32 year old Nader’s raider to lunch to the cheapest spot in town — to sitting there figuring out how the staircase he order from France for his new Georgetown mansion was going to look. Rather than having tea with me after we shared a panel, he had to get in his corporate jet and fly off to some new place. Bill McGowan was pretty co-opted long before he got sick. He was going for the money.
    2. Long Distance. Why does Breninger think there is a long distance business any more? Distance has been dead for years. It wasn’t the 96’ Act the screwed things up; it was the original 1984 break-up that was wrong. It should have created 3 or 4 totally integrated companies – local and long distance – and spun off Western (now Lucent). That would have created a more likely scenario for a more competitive environment.

    Vonage is no MCI. And hopefully Jeffery Citron is no Bill McGowan, and keeps up the fight for competitive services. But here’s the rub. Vonage is making a strategic mistake today. Rather than recognizing the hurt being felt by its customer base around the IPO, it’s talking about suing them. In an era where it is widely believe the real differentiator is going to be customer loyalty, Vonage just shot itself in the head.

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  2. lets see, 10,000 out of 1,700,000 Customers BOUGHT into the IPO and you think Vonage is going to worry about 10,000 out of 1.7 Million??????? Sorry, I got to disagree with ya and OM’s readers dont make a market just like Cramer calling Vonage a Dog every day…
    THE Customer amount they have signed up is truly phenonmenal despite spending too much money per customer aquisition=======now, its time for those signed up customers to be happy and recommend Vonage to their Freinds!
    Skibare

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  3. my two pennies with respect to Vonage and MCI analogy; the important thing is to see what is different rather than what it is like. The important difference here is that MaGowan used regulation as a strategy to fight MaBell.

    For years, he had the regulatory protection where AT&T could not match his prices which gave him an opportunity to build a base, Vonage, looks like has no regulatory protection what so ever. In fact, the Bells and Cable have the upper hand. There is a huge difference between breaking up a Monopoly and getting into a market where is a well established multi-modal competition, especially for voice: wireless, telco and cable.

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  4. Brian Horey Friday, June 9, 2006

    Berninger’s prior affiliation with Vonage may be clouding his judgement about the company. The regulatory environment that Vonage faced was nothing like the one that MCI faced (a half century of government sanctioned monopoly with no competitive precedents and a hostile regulatory environment vs a significantly deregulated business with regulators sympathetic to VOIP as a competitive prod). Vonage’s aggressive marketing of VOIP probably hastened a competitive response by a few quarters, but they weren’t the only firm using VOIP as an alternative voice platform.

    As for how the LECs are competing now, even the lead-footed mastodon Verizon has a VOIP plan at the same price point as Vonage with no sign up fee (though you can call a few countries in Europe on the Vonage plan that aren’t part of the Verizon offering). It is a recent conversion to aggressive pricing, but one senses that Verizon has grasped that the POTS value proposition doesn’t cut it anymore.

    Writing off Skype and GYM as competition is naive. Yes, they are not perfect substitutes for Vonage, but to say that they do not represent competition is laughable. Vonage is not a perfect substitute for a POTS line, nor is a cell phone a perfect substitute for a POTS line, yet both have had a dramatic impact on access line counts at the LECs. Most adults in their 20s have decided that cell phones are “good enough” and never get a landline and many consumers will find Skype “good enough” and pass up Vonage’s more expensive solution.

    With regard to the difficulty of porting numbers from the LECs, based on what I have read around the web, Vonage is starting to resemble a roach motel for phone numbers itself. They need to think hard before they pick up that particular rock and start throwing.

    Finally Vonage got the IPO it deserved. The company knew it would have difficulty selling the stock to institutions due to the competitive threats it faced in the business. It picked underwriters with big retail customer bases, shamelessly flogged the offering to its customers – most of whom wouldn’t know any better, and upped the size of the deal so as to raise as much money as possible. If Vonage was really concerned about the aftermarket performance of the IPO, they would have cut the size of the deal and priced it much lower. This was a “do or die” deal for Vonage – their marketing programs would soon have come to a halt without it. Nothing in their behavior suggests they had any concern about where the stock traded post deal.

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  5. While the merits of Jeff Citron’s track record for innovation and disruption cannot be argued, this article is very hard to agree with. The early MCI was a company of attorneys, not product engineers or marketers, who created a market for themselves via litigation. This ultimately led to the 1984 consent decree which allowed a judge to create false markets by regulation. Those artificial markets are being reassembled as we speak, and a new form of intermodal competition across different facilities is now doing what the 1984 and 1996 acts were intended to do. MCI’s legacy is over 20 years of regulatory failures. Citron, on the other hand, introduced us to not only mainstream Internet based phone service, but electronic clearnghouses that disrupted the floor specialists, as well as online stock trading for retail consumers. Citron is actually mentioned in Andy Kessler’s book “How We Got Here” for his innovative use of technology in the financial industry, McGowan was no technical innovator or market disruptor. He simply used litigation to offer consumers the same product that AT&T offered. If Vonage ever truly threatens telco’s, all they have to do is drop the price. Cable companies are the biggest threat to telcos, and to Vonage also. Vonage is a national product and if you measure their performance against the cable companies as a collective whole representing the same footprint, Vonage is being creamed. Vonage made a mistake when they arrived at a fork in the road and decided to use Internet technology to be a telco and not an open Internet communications company like Skype that can create true market disruption.

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  6. Om, you have got to be kidding right?

    Have you actually tried using Vonage? I mean really…before you post some B.S. opinion – you might at least TRY the service first.

    Or at least TRY calling their customer service number…

    Before you can have a comparison to a company like MCI – you have to achieve a comparable level of SERVICE and QUALITY.

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  7. I think that everyone here, including Mr. Beringer, might be forgetting what made Microwave Communications Incorporated a real competitor to ATT. They owned a layer 1 infrastructure that was a completely separate way for customers to transmit their traffic. Vonage owns nothing except the customer, so they will always be beholden to the companies that own the physical infrastructure that connects to the customer’s home or business. Anyone with a few million dollars can start a Vonage competitor tomorrow and offer the same services.
    Ed Whitacre likes to say “We own the wires” and he is right. If someone really wants to compete with AT&T/Verizon, they need to build their own network that connects to the customer’s premise. There is nothing keeping anyone from doing this except the huge cost of building such a network. Think WiMax or something comparable.

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  8. The problem with the MCI comparison is that MCI (and Sprint) actually had to spend money on infrastructure to provide their service. Whatever the regulatory environment, there was a serious buy-in to provide their service. The buy-in for VOIP is very, very low. That’s why the company is essentially worth nothing. It’s a Brand, pure and simple, and not much of one.

    When it works, Vonage’s call quality is fine. But if you need support, just forget about it. That’s how they lost me. I’m paying substantially less for Broadvoice and quality is just as good.

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  9. Our office has been using Vonages in each office and among office for a couple years. After buying one, each additional one costs less. I have not seen any cableco offerings to compare to such low pricing with so many features. We picked up additional plans for our remote offices, and interoffice calls are free. In each location we disconnect the telco at the wiring panel, and jumper the Vonages in instead, thus wiring the premises with multi-lines just like copper would have supplied. Voice Quality is fine, though when I upgraded my home cablemodem to test their VOIP, the Vonage on the same cablemodem experienced packet loss problems more frequently.

    I can use any of these Vonages anywhere I can get a connection, not just on my local cableco. But more importantly, the management tools for the multiple phone and multiple lines with their call ring groups and follow-me forwarding and ring-everywhere capabilities simply blow the other national VOIP services out of the water.

    If Vonage would get this message out there, the public would realize there is no useful and convenient competitor. Say, free installer to activate the house wiring with Vonage. If every jack in the house is on Vonage, instead of just one cordless handset, people will realize it’s not one o’ them Innuhnet thangs.

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  10. After the bad service that I have received from Vonage I have switched to another VOIP provider.
    http://www.undesignatedblog.com/archives/000389.html

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