It sounds like an overheated press release from the late-'90s tech boom: A cable-TV operator offers customers digital TV, high-speed Net access, and Internet phone service over a single wire into their homes. In the process they usher in a new era of falling prices, rising innovation, and growing competition. The service, though, is real for about 75 Comcast Corp. (CMCSK
) employees in Coatesville, Pa. That's where Comcast is testing a new kind of Internet phone service, side by side with its TV offerings. The service chops telephone calls into bits of data, sends them over the Internet in packets like e-mail, and reassembles them into natural-sounding speech at the other end of the line.
Comcast is just one of many cable-TV operators around the country experimenting with technology known as Internet cable telephony. In the last few weeks, Cablevision Systems Corp. (CVC
) has started to offer such a service to select customers in the New York suburbs. Cox Communications Inc. (COX
) is also experimenting with the technology.
Internet cable telephony isn't quite like any other form of phone service. For one thing, companies such as Comcast and Cox don't route calls the way phone companies do, opening up a separate circuit for each call. Their approach more closely resembles so-called voice-over-Internet efforts dating back to the mid-1990s.
There are other differences, too. For example, Comcast's customers won't need to download software or even sit in front of a PC. Instead, they will plug a phone or digital device with a handset and a regular keypad into a wall jack linked to the TV cable. The quality of calls will be as good as regular phone calls because the voice packets will mostly travel over a private Internet backbone. Cable companies will also offer add-ons, such as second household lines. And their new services will likely be priced lower than normal phone service. PC-based Internet telephony is usually free, albeit more cumbersome than the cable variety.
The idea of phone calls traveling over TV cable isn't new. A few cable operators, such as Cox and AT&T Broadband (now owned by Comcast), jumped into the phone market years ago using excess capacity for telephone calls. But most big cable operators, such as Time Warner Cable (AOL
) and Cablevision, chose to wait on telephony until they had upgraded their cable gear with digital technology.
Today that transition is far along and Internet cable telephony is nearly ready for prime time. It works better than the old cable phone systems and the capital cost has fallen to about $600 a household, less than half what it was in the 1990s. "These next six months will be crucial," says Blaik Kirby, senior vice-president of the Carriers & Infrastructure Practice with telecom consultant Adventis Corp. in Boston. "If the test goes well, it will lead to much wider commercial deployment in 2004."
Indeed, cable's penetration of the phone market could soar. Using the older technology, cable operators in the U.S. have already amassed 2.2 million phone lines, or about 2% of the market. In cities where the service has been heavily promoted, such as San Diego, Omaha, and Phoenix, Cox has taken 30% of the market. Cable could take 10% of the national market in six years, Kirby says.
This would be a disaster for the Bell telephone companies, which are already feeling pain from other competition. Cell phones and e-mail are cutting into their business. And resellers such as AT&T (T
) and WorldCom Inc. are stealing many of their best residential customers. Bell companies' telecom revenue fell 4.7% last year, after growing 1% in 2001 and 4% in 2000, according to UBS Warburg LLC. On average, Bell stock prices are down 3% for the year, while the Standard & Poor's 500 stock index is roughly flat.
The Bells are already planning their counterattack. SBC Communications Inc. (SBC
) is mulling a bid for Hughes Electronics Corp.'s DirecTV Inc. (GMH
) satellite-TV service. That would allow SBC to jump quickly into the video business, so it could compete head-to-head with cable operators. And Verizon Communications Inc. (VZ
) is planning to extend high-speed fiber to all its customers, so it can offer a broader range of services. "I think cable companies are very significant competitors. My assumption is that they will offer cable telephony across the board," says Bruce Gordon, president of Verizon's retail markets.
While Internet telephony has been used mainly to supplement normal phone service, the cable guys view their offering as a full-blown alternative. To ensure quality and reliability, Cox and other cable companies intend to keep Internet voice traffic entirely on their own networks everywhere except in the "last mile," where calls get handed off to the local phone company so that people who aren't equipped with cable gear can receive calls from those who are. As the technology spreads, fewer calls would need to be completed by the local phone company.
By keeping the traffic on their own networks, cable players should be able to match the 99.999% reliability the phone companies deliver. The cable players are also likely to provide their phones with an independent power system, so they would work even if a customer's electric power failed. "We're interested in the primary-line business. We're specifically not interested in secondary-line phone service," says Comcast General Manager Rian Wren.
This is all a far cry from other Internet phone applications, which are also growing in popularity. In the 1990s, companies offered phone cards that allowed users to tap into the Internet to make cheap calls by dialing a special access number from a regular phone. Companies such as Net2phone Inc. and PhoneFree offered software that allowed users to make cheap phone calls from one PC to another. But the quality was unpredictable. During the past year, Vonage Holdings Corp. has started selling phone-like Internet devices that plug into a broadband connection. It has signed up 15,000 customers, and a new distribution agreement with Internet service provider Earthlink (ELNK
) could drive sales much higher. Still, even this service is mostly for use as a second line.
For cable companies, the phone gambit could pay off big time. Cox's rollout of phone service using the older technology is going better than expected, said Sobani Warner, an analyst with Williams Capital. Profit margins, calculated before the payment of income taxes or depreciation, were 38% for the fourth quarter and averaged 35% for all of 2002, Warner writes. That's up from 25% to 28% in 2001. Those margins are comparable to the Bells' -- a benchmark no rival has ever been able to achieve in residential phone service.
Even at the height of the tech boom, cable companies often met with derision when they talked about barging into the local phone business. How ironic that in the sobriety of the crash, they actually have a better chance of making their dream a reality.
MARCH 24, 2003
By Steve Rosenbush in New York, with Ron Grover in Los Angeles and Charles Haddad in Atlanta
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