White Paper: The Future of Online Communication Section I: The Evolution of Internet Telephony H. Mine, Executive Vice President, Probe Research, Inc. Section II: AT&T’s IP Telephony Initiatives October 1998 Section I: The Evolution of Internet Telephony Hilary Mine Probe Research, Inc. Three Wing Drive, Suite 240 Cedar Knolls, NJ 07927 www.proberesearch.com Tel: 973-285-1500 September 1998 TABLE OF CONTENTS VOICE AND DATA – CONVERGENCE HAS BEEN A LONG TIME COMING .4 EMERGENCE OF THE INTERNET 6 INTERNET TELEPHONY - MARKET EVOLUTION AND DRIVERS .8 HOBBYIST PHASE - IP TELEPHONY AS HAM RADIO SUBSTITUTE 9 TARIFF ARBITRAGE - CALLING CARD REPLACEMENT .9 TARIFF ARBITRAGE - ENTERPRISE TRUNK REPLACEMENT 11 FEATURE PARITY 11 NEW APPLICATIONS .12 Conferencing Applications .12 Call Center Applications 13 IP Messaging 14 IP Call Waiting .14 COST PARITY 14 MARKET AND TECHNOLOGY BARRIERS TO INTERNET TELEPHONY AND THE NEW PUBLIC NETWORK 15 INTEROPERABILITY CHALLENGES 15 QUALITY OF SERVICE .16 COST TO DEPLOY IPT 17 OPERATIONAL SUPPORT SYSTEMS 17 REGULATION - THE VERY REAL THREAT 17 SERVICE MARKET OPPORTUNITIES IN INTERNET TELEPHONY 18 THE VALUE OF EARLY MARKET LEADERSHIP/ TODAY’S INTERNET TELEPHONY SERVICE PROVIDERS .20 AT&T IP TELEPHONY INITIATIVES .23 CONSUMERS .23 CARRIERS .23 BUSINESS CUSTOMERS 24 RESEARCH INITIATIVES .24 AT&T ADVANTAGE .24 SUMMARY 25 Voice and Data – Convergence Has Been A Long Time Coming The promise of a single network carrying both voice and data is as old the first data networks themselves. The fundamental notion that a single network offers economic advantages, both in terms of upfront equipment costs, and with respect to management and administration costs, goes back literally decades. Perhaps the most famous failure of convergence was ISDN (Integrated Services Digital Network, or “It Still Does Nothing” as it is colloquially referred to), which is finally beginning to be deployed today, but which has been available to service providers since the mid 1980s. Just as its name implies, the idea behind ISDN was integration of voice and data over the public network. The expectation was that a customer would use one 64 Kbps B channel for voice, and the other for data. But carriers did not deploy the technology in any significant way in the U.S., largely because their business structures prevented them from being able to prove in business cases. In addition, as is generally true of new technologies, the developments of true interoperability and standards, as well as the cost of early customer premise equipment (e.g., modems) were also significant barriers to the success of ISDN. Finally, however, there was a lack of mass market demand for data networking. This particular market barrier remains, of course, subject to much debate. Despite the fact that 45% of US homes have at least one PC in use, and the majority of those are Internet subscribers, there are still those in traditional carriers (e.g. BellSouth) who remain convinced that end users are not willing to pay the true costs to provide data network services, with the exception of a few large business customers. With the advent of the Internet, there is little doubt that end users in both the consumer and business markets are very interested in data services. Willingness to pay has still to be proven in, since the mass market Internet is arguably being subsidized at this time. Nonetheless, data traffic even prior to the rise of the Internet, has been growing dramatically faster than voice traffic, and this pattern is at the crux of the integrated network dream. Terabytes/Yr 1997 1998 1999 2000 2001 2002 2003 2004 2005 Figure 1: GLOBAL NETWORK TRAFFIC PSTN VOICE PACKET & PRIVATE WAN VOICE PSTN DATA PACKET & PRIVATE WAN DATA Source: Probe Research, Inc. estimates Figure 1 shows Probe's estimates of total global communications traffic. PSTN refers to the public switched telephone network, or the traditional telephone network. Private Wide Area Networks (WANs) refer to leased line and virtual private networks (VPNs) that large companies and institutions use for internal communications. Packet refers to packet network based traffic. Today, over 70-75% of this traffic is still voice, but as we have observed, data is growing much faster. By the year 2005, data will account for nearly half of global traffic. It is critically important to note, however, that voice traffic will be growing as well over this period, and will still be the bulk of traffic on many routes. A few service providers have begun to observe portions of their networks reaching the magic 50% data traffic threshold, and anticipate that on some segments (particularly international routes), data traffic will account for as much as 80% of traffic within the next 5-7 years. This is generally true of routes (e.g., Tokyo to London) that are dominated by business traffic. As a rule, the more local the traffic, the more it is dominated by residential and small business traffic, and consequently, the more it is dominated by voice versus data traffic. In the long run, multimedia applications that are targeted to consumers, such as interactive video, Internet TV, videoconferencing, and more, will radically alter the mix of voice and data. Once the standards, customer premise equipment, applications, and above all the economics come together, then voice traffic will indeed be eclipsed. Based on Probe's ongoing analysis of bandwidth to the home and small office, and all of the associated terminal equipment, standards, and other issues surrounding the take off of residential multimedia, we remain convinced that mass market adoption is at least five years off even in the best of circumstances (e.g., in the heart of Silicon Valley). This is not to say that there are not already many households that generate more data than voice traffic (e.g., in Silicon Valley), but rather that it will be some time before early adopters give way to mass market consumers. For most communities, mass market adoption is even further away (7 years or more). Emergence of the Internet The overwhelming driver of data traffic today is the Internet, as well as wide area private/virtual private IP networks (e.g., Intranets and Extranets). While global voice traffic continues to grow at less then 8% annually, data traffic is growing at roughly 35%. Although the Internet Protocol has been defined for decades, its use became widespread only recently. The market for Internet services was born in great part due to the privatization and commercialization of NSFnet. Indeed several key players, including BBN Planet, MCI, Sprint, etc., originally became involved in the Internet as government contractors. Others, including UUNet and PSINet, launched commercial services in 1991, as soon as the NSF allowed it, and were founded and staffed by NSFNet veterans. While proprietary online services and Bulletin Board Systems (BBS') attracted aficionados and hobbyists for over a decade, the audience for these services remained limited due to constraints on content, incompatibility between networks, and exceedingly slow access, as well as the basic issue of limited PC deployment. In the early 1990s, however, several factors coincided to cause the Internet to become a viable commercial platform: 1991 - NSF allowed commercial use of the Internet, and the first Commercial Internet Exchange was launched; 1992 - The number of Internet hosts reached 1 million (largely academic and military); 1993 - WWW and the Mosaic browser were introduced; and 1994 - The penetration rate of PCs in US homes reached 33%; 28.8 Kbps modem standard was approved. By year end 1998, PC penetration amongst US households is approaching 45%. Importantly, this figure takes into account households with multiple PCs, and excludes those with inactive PCs. - 500 1,000 1,500 2,000 2,500 3,000 1991 1992 1993 1994 1995 1996 1997 FIGURE 2: INTERNET TRAFFIC: 1991-1997 (Terabytes/Month) Sourc e: NSFNet ac tuals to 12 /94; Pr obe estimates after 12/94 NSF Allows Commercial Internet Use Global Internet Users pass 50M Internet Users Pass 10M PC Penetration in US Homes reaches 33%; 28.8Kbps Modem Standard Approved WWW and Mosaic Introduced OSP business model fails; OSPs become ISPs By year end 1998, there will be an estimated 100 million Internet users worldwide (including business, consumer, students, etc.). See Figure 3. For perspective, there are well over 600 million telephone users worldwide. Nonetheless, the Internet has proven to be the clear technology winner as a user interface to a global public data network. 1997 1998 1999 2000 2001 2002 - 50,000,000 100,000,000 150,000,000 200,000,000 250,000,000 300,000,000 Internet Users 1997 1998 1999 2000 2001 2002 Figure 3: Worldwide Internet Users: 1997-2002 Europe/Middle East/Africa Asia/Pacific North America Latin America/Caribbean Source: Probe Research, Inc. estimates Internet Telephony - Market Evolution and Drivers In its brief life, IPT has already seen two distinct phases of market evolution, and is on the verge of a third. In this section we describe the expected development of IPT as a market, and explore the factors that will drive each phase of adoption of the technology. Figure 4 provides a general overview of the evolution, including Probe's projections of global voice and fax over IP in minutes of use. 0.0000 10000.0000 20000.0000 30000.0000 40000.0000 50000.0000 60000.0000 70000.0000 80000.0000 90000.0000 Millions of Minutes 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Figure 4: GLOBAL VOICE/FAX OVER IP TRAFFIC AND MARKET DRIVERS Source: Probe Research, Inc. Tariff Arbitrage Feature Parity New Applications Cost Parity Hobbyist Hobbyist Phase - IP Telephony as Ham Radio Substitute In late 1995, a few technologists and hobbyists recognized the potential of the Internet to carry voice traffic. Companies such as VocalTec, NetSpeak, Quarterdeck, and others developed a new class of software that enabled any two Internet users to talk to each other from their PCs. This approach, which relied entirely on the PCs at each end, required not only soundcards and high speed modems at each end, but also that end users use the same software. Each solution was proprietary – a VocalTec user could not talk to a NetSpeak user. Nonetheless, the draw of free phone calls was compelling. By year end 1996, over a million copies of this class of software had shipped, and players like Microsoft and Intel had jumped in to develop standards-based client software as part of their larger vision of using the Internet as an alternative voice and conferencing platform. Not surprisingly, early adopters of this technology largely treated it as a chat room alternative. VocalTec and other companies set up Internet relay chat rooms (IRCs), where users could go to find other users with the same software, or where users might set up private meetings. Despite all the awkwardness of this form of communication, literally millions of conversations were completed between PC users over the Internet in 1996. Tariff Arbitrage - Calling Card Replacement The long distance communications market is extremely price elastic. This is important because it is currently the underlying market driver for Internet telephony, and will remain so for the next three to five years. To support this statement, consider the impact of competition on the US long distance market in the 1980s. Figure 5 shows indices of price per minute versus minutes of use of interstate long distance in the US during the period 1981 to 1993. As prices fell, traffic grew considerably. Indeed the highest rates of traffic growth occurred during the period 1984 through 1988, when prices were falling their fastest (an average of 7.3% annually). Figure 5: Price Sensitivity in Long Distance 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 Annual Percetnage Increase in Minutes of Conversation -12.0% -10.0% -8.0% -6.0% -4.0% -2.0% 0.0% 2.0% Annual Percentage Change in Price per Minute Source: FCC and Probe Research, Inc. estimates Price Traffic Early adopters of IP telephony quickly realized that the initial acceptance of the technology hinged on its ability to bypass regulatory regimes and tariff structures. International call back service providers, such as IDT, were among those most threatened. Their customers are amongst the most price sensitive, and are willing to dial additional digits or suffer other inconveniences to save money. Consequently, these types of service providers were the first to develop IP telephony services. Other service providers, such as AT&T, Sprint, etc. also paid early attention to IPT as a threat and therefore also an opportunity. Simultaneously, vendors such as VocalTec, Vienna Systems, and Clarent Corp. recognized that while the PC hobbyist market was a nice start, the installed base of multimedia computers was rather limited compared to the installed base of traditional telephones. Moreover, the biggest problem with IPT, the quality of the voice, was seriously affected by the end user’s own ability to configure their system (the PC, the software settings, etc), and the reality is that non-hobbyist users are more interested in communicating than in understanding the finer points of codecs. The market potential of phone-to-phone and PC-to-phone IPT drove the development of first [...]... dialing for their choice of carriers that competition took off New Applications While price is the key driver of the IPT market today, most observers agree that extending end user feature control and functionality are the real benefit that will drive the IPT market in the longer run Indeed the very future of IPT depends in part on the development of compelling applications There are a variety of potential... meaningful analysis of the loaded cost of operating and maintaining a circuit switched voice network versus an IPT network As we discussed in the previous section, the true cost of an IPT network with quality of service, billing mechanisms, and all the other paraphernalia of the traditional PSTN added in may well be greater than the cost of today's PSTN for the same capacity Unless the IP model is proven... MPLS are all moving forward The real story about IPT in 1998 was the fact that quality is no longer the huge barrier that it was in 1997 By the year 2000, it will not be a major topic of discussion However, the price of establishing quality of service on IP networks that meets the requirements of toll quality voice may well be that the economics of IP lose to the economics of circuit switching for years... pull down all of these from the corporate web page IP Call Waiting Replication of traditional PSTN-based services in the IP network is a increasingly perceived as key to the widespread adoption of IPT Clearly, to achieve feature parity, a user must be able to get all of the features they are accustomed to from the new network that were provided by the old network The benefit and promise of IPT is that... to packetize the voice signal on the originating end of a call so that it can be transported over an IP network At the terminating end of the call, another gateway converts the packets back, and re-assembles the voice signals for the traditional telephone network In the past year, voice over IP has eclipsed the Internet itself as a source of hype There is little question, however, that this market is... where the real network value and intelligence resides Quality of Service In the early days of IPT, sound quality was a huge and overriding problem In part this can be attributed to the fact that most calls were PC-to-PC, and therefore required the end user on each side to have proper equipment, and to optimize their software for each individual call The quality of a voice conversation over the Internet. .. elimination of technology barriers to IPT Today, the entire IP telephony industry is being funded and driven by a tariff arbitrage business case as we described above Either of two opposing forces could throw a wrench in the development of the IPT market If either scenario plays out, then feature parity and compelling enhanced applications become much more urgent In the first instance, if pricing of the PSTN... is the hope of unified messaging For the business traveler, this is an especially important offering Consider the activities of the average business traveler trying to keep in touch from the road, repeating the following process 2 to 3 times each day Check the corporate e-mail, pager, voicemail, and a fax service or, more commonly, a helping hand who will forward faxes to the user’s hotel room or other...generation of IPT gateways And service provider fear of lost revenues provided the demand that has fueled the next generation of IP telephony platform, the gateway IPT gateways, which enable end users to make IP calls from traditional wireline or wireless telephones, can be deployed in an end user or service provider network The function of these gateways is to packetize the voice signal on the originating... closed rather than open telecom sectors around the world In particular, there is the very real threat of a global recession as the economies of Japan, Russia, and most of Asia suffer from their respective financial crises In times of economic uncertainty, we often see a shift in the political environment, and we almost always see a return to nationalism Consider the recent election in Germany, which replaced . analysis of bandwidth to the home and small office, and all of the associated terminal equipment, standards, and other issues surrounding the take off of residential. IPT, the quality of the voice, was seriously affected by the end user’s own ability to configure their system (the PC, the software settings, etc), and the