News Analysis: Untangling Internet Telephony

A hodgepodge of regulatory rulings could curtail the growth of voice-over-Internet technology.

By Eric Hellweg

May 28, 2004

For a technology whose acronym reads like a sound effect from a videogame, voice over Internet protocol, or VoIP, is on a roll. This Wednesday, Comcast announced it would offer VoIP phone service to 40 million households in 2006. Just two days before that, Lucent Technologies announced its acquisition of Marlborough, MA-based Telica, a maker of back-end VoIP gear, for roughly $295 million. Vonage, a leading VoIP provider, recently struck a distribution deal with Radio Shack.

But amidst all this good news about VoIP, a significant variable remains undefined: its regulatory status. Federal and state authorities have taken positions that have run the gamut from no-touch to heavy handed. The most recent ruling came last week, when the New York State Public Service Commission declared that Vonage is a telephone company-not an information service-and is thus subject to state regulation and taxes. The ruling muddles a February decision by the Federal Communications Commission, which stated that "pure" VoIP calls-those that take place entirely over the Internet-are immune from government rules and requirements. Friday, May 28 is the deadline for comments on the FCC's notice for proposed rulemaking.

Though we're clearly in the early stages, VoIP technology will be implemented by businesses and consumers alike-the advantages are simply too strong to pass up. Businesses are leading this first wave. The market research firm IDC estimates that business usage of VoIP is growing at 71 percent per year, primarily due to the cost savings associated with the technology, according to IDC senior analyst Will Stofega.

Consumers also seem enticed by the technology. Many are signing up through services such as Vonage (which says it is adding customers at a rate of 20,000 per month). Others are getting Internet telephony through packages offered by the major cable or phone carriers-all of which are implementing VoIP services. The transition under way could be massive. "Over the next five to 10 years, all our calls will be over VoIP," says Jeff Kagan, an independent telecommunications analyst.

But the pace of VoIP adoption depends largely on the decisions of state and federal regulators, who must determine just how to classify this many-armed VoIP beast. Some observers already lament the molasses effect of New York's ruling. "It's unfortunate if the states attempt to assert jurisdiction over VoIP services," says Randolph May, a senior fellow at the Progress and Freedom Foundation in Washington, DC. "It may slow the introduction of the new technology."

Further clouding the VoIP regulatory picture are the differing opinions held by various states. A judge in Minnesota last year overruled a decision by that state's Public Utilities Commission to regulate VoIP, whereas New York has determined that regulations are the correct approach. California and Florida currently are mulling rulings on similar VoIP petitions before them.

The confusion surrounding the regulatory status of VoIP will likely shape the competitive landscape. Large companies such as Comcast and Time Warner have declared themselves phone companies, and have offered to pay taxes and fees on their VoIP calls. Smaller companies, such as Vonage, are trying to compete on price and can't as easily afford to pay fees and collect taxes. A nationwide ruling that VoIP calls are phone calls and not data transmissions would favor the big players, squashing or severely curtailing the newer entrants.

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"If the New York ruling stands, it puts us on an interesting slippery slope," says Michael Robertson, CEO of SIPphone, a "pure" VoIP company based in San Diego. "What about the Microsoft XBox game system that allows players to call each other over the Internet? What about when voice features are added to every instant messaging client? Are those phone calls? I don't think the legislators have thought about it."

Lawmakers probably have too many near-term considerations on their plate to think seriously about videogames and instant messages. But with a technology such as VoIP, legislators that ignore these far-reaching, "what if" implications risk handicapping the success of a technology that's a boon for consumers and businesses alike.