Giving It Away Is Not Enough

SAN FRANCISCO (09/01/2000) - ITXC began life in 1997 as a networking company that carried phone traffic for cheap prepaid calling cards. By late last year, its service had became good enough for second-tier carriers to begin putting some of their international traffic on ITXC's networks, since they were cheaper than old-fashioned phone lines. Now the Princeton, N.J.-based company claims that 13 of the 14 largest U.S. carriers, along with a host of international players, send phone traffic over its networks.

ITXC's growth reflects the anticipated expansion of Web-based telephone traffic, or IP telephony. Slowly and stealthily, the Internet is taking over more and more of the world's phone traffic. Research firm IDC estimates that 300 million people will be making Internet voice calls by 2003. Though less than 1 percent of worldwide phone traffic is carried over the Internet, a host of startups already offer free Net-based telephone calls, undercutting the lumbering incumbent phone companies.

But now companies that rely exclusively on the IP telephony market are watching their growth level off, their access to the capital markets shut down and their business models become open to question.

"In 10 years, phone traffic will have moved off the public-switch networks and onto the Internet," says Tom Evslin, CEO of ITXC. "But just carrying traffic at cut rates for the phone companies doesn't cut it. We need new phone applications."

The IP telephony service providers include networking companies such as ITXC and Burlington, Mass.-based iBasis, plus a handful of established players like Genuity that carry Net phone traffic. More numerous are companies like, Dialpad and Firetalk that buy network capacity from the networking firms and give away phone calls on the Net.

Since April, the stock prices for most IP telephony companies have fallen, and the IPO pipeline has narrowed. Equipment-maker Sonus is one of the few to successfully go public, earning a $10 billion market capitalization in May. Genuity has lost 35 percent of its value since its June IPO. ITXC's Evslin acknowledges that this fledgling industry has entered an early phase of consolidation.

Analyst Jeff Pulver, through his eponymous firm, has been perhaps the most vocal proponent of Internet telephony. But even he is mystified by the business model of many of these companies. "A lot of these people are my friends, but I don't know how they can survive by selling banner ads and giving away phone calls for free," he says. "The only way to make it is to take advantage of the Internet. It's flexible and there's going to be a lot of really cool stuff built on it - applications that appeal to more people."

ITXC and iBasis were once limited to carrying Internet calls from computer to computer, attracting plenty of hard-core computer users but few mainstream callers. Now they've added more sophisticated PC-to-phone and phone-to-phone calling, making IP telephony easily available to less tech-savvy customers.

Companies that give away phone service on the Web find it tough sledding, though. San Francisco's Firetalk announced last week it would start charging subscription fees. Established providers like PhoneFree, which has more than 2 million active users, hope to make money by tacking on value-added features such as unified messaging and voicemail applications to basic services.

Some of these startups may eventually find shelter in the arms of established companies. PhoneFree CEO Jan Horsfall acknowledges he's been involved in acquisition or merger talks with several companies. Horsfall also says he's talked to four struggling IP telephony companies about buying them. In fact, lots of companies like PhoneFree, which has grown by dissing the phone companies, would now welcome their embrace. "There's brackish waters between us and the portals and the phone companies," Horsfall says. "They'll figure out they need us soon enough."

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