IP Phone/Fax Rates—Rarely a Real Bargain

from the August 1999 issue of Business Communications Review, pp. 55–58

Practically any long distance service looks good when per-minute rates are compared with the highest in the industry — typically AT&T's full fare. But we were surprised to find so few bargains among the 22 new IP phone and fax services we examined while preparing this article. Considering the inferior sound quality of Internet-carried voice conversations, and the potential disruption of faxes by Internet delays, it is astonishing that these services continue to attract so much attention.

Perhaps the new "next-generation" telcos who offer these services are counting on upcoming improvements in IP telephony and fax technologies to improve quality, and on the development of ancillary services—like Web-enabled call centers and audiotext chat offerings—that could become viable businesses at some point in the future. Today, however, IP telephony and fax traffic constitute a small fraction of the worldwide total.

Nevertheless, many forecasters are still predicting astounding growth. Some say IP phone services will carry 5 to 10 percent of all voice minutes in five years. Others say IP telephony will replace traditional phone services altogether and a paradigm shift is under way. We just don't see how that can happen — and certainly not at the prices we found in our recent study.

Basic Comparisons

We started by gathering the per-minute rates of the 22 IP phone service companies we found that could deliver a call from a U.S. phone or to a U.S. phone, using the Internet in between. We looked at both phone-to-phone and PC-to-phone services. An important distinction is that the latter is potentially available worldwide; anyone who can connect to the Internet and download and install the software, can use a PC-to-phone service. Rates for PC-to-phone calls are determined based on where the call terminates, which reflects the IP service provider's coverage area.

We chose Sprint's 10 cents a minute, "pin drop" quality as our reference point. Maybe it's because Candice Bergen so successfully drummed Sprint's "dime anytime" domestic U.S. rates into our primetime attention spans. Maybe it was that other well-known Sprint icon, the pin drop, which touts Sprint's crisp, clear, fiber-optic lines. But we think it's safe to assume everyone can agree that 10 cents a minute and excellent quality constitute a reasonable U.S. benchmark.

We did not include monthly service charges in our calculations. Instead, we assumed heavy usage, so all minimums are met and all service fees are spread among numerous calls. To average out a per-call fee charged by one IP phone service, costs were calculated based on a 10-minute call duration.

We were shocked to find that only nine of the 22 IP phone services we found are charging less than Sprint Sense's 10 cents a minute for calls within the U.S. — and the savings we did find weren't that dramatic. For comparison, Table 1 shows both AT&T and Sprint's full-fare rates and their respective discount plans. As shown in Table 2, seven IP phone-to-phone services cost less than a dime a minute, but three cost more. In Table 3, two IP PC-to-phone services cost less than Sprint Sense, but two cost more and Delta Three's match Sprint's dime-anytime rate.

The best U.S. rate we found was 5 cents a minute: Iscom's PCCall Dialer rate for calls from a subscriber's PC to any U.S.-based phone. Qwest's Q.home service matches that rate, but only if the called number is "on net," within its gateways' local area. Outside these local calling areas, the "offnet" rate for Q.home is 9 cents a minute. (Meanwhile, Sprint Sense is charging only 2.2 cents a minute for all U.S. long distance calls on weekends.)

Internationally, regular direct dial rates are, of course, higher, but the IP phone discounts aren't any better, as shown in Tables 2, 3 and 4. In competitive and heavily trafficked phone markets, such as the U.S., UK, Germany and Japan, the best prices for IP phone services were about 30–50 percent off the direct-dial discount rates available from the U.S. The best discounts available for services from the U.S. to the UK, Germany, and Japan were 31 to 35 percent savings from Qwest, Iscom, Delta Three and IDT.

While those bargains are significant, they're hardly compelling given the inferior sound quality. In fact, such discounts would be expected in other industries for merchandise with slight imperfections.

Of the seven countries we studied, India was the only case in which no IP phone bargains could be found. Qwest Q.home was the closest to a bargain, but it was a penny more per minute than Sprint Sense, which had the lowest rate of all.

What's Going On Here?

Anyone willing to pay AT&T $1.48 a minute, or Sprint $1.49 a minute, for full-fare calls to Germany, is probably a dummkopf who is not in the market for either a personal computer or an Internet connection. (They may still be using a wall-mounted, rotary-dial Trimline^TM in the kitchen.)

Just for the asking, Sprint will give a 90 percent discount off its full fare rate (Sprint Sense at 15 cents a minute), and AT&T will give an 80 percent discount (OneRate International at 29 cents a minute). If you don't know that, then the IP phone service companies that are charging 25–35 cents a minute for calls to Germany might look good at first glance. But AT&T's own Connect 'N Save IP phone service is actually a penny more than its OneRate service to Germany. In fact, only four IP phone services to Germany save money compared to Sprint Sense, one cost the same and 14 cost more.

Are people dumb enough to think that Qwest's 33 cents a minute rate to Germany is a bargain? Maybe they'll feel smarter if they find out about Qwest's better deal: 20.5 cents a minute to Germany, if customers pay a $3 monthly service fee. But 20.5 cents is still a nickel higher than Sprint Sense! Oddly, Qwest's Q.biz is a deal to the UK — 31 percent lower than Sprint Sense — but Qwest is no bargain to Japan, Germany or India.

Most rates to the UK also fail to beat Sprint's dime anytime. Sprint Sense shaves 92 percent off the full fare rate of $1.29 a minute to the UK. Three IP phone services cost less than Sprint Sense, three cost the same and 13 IP phone services cost more.

To Japan, Sprint Sense shaves 85 percent off AT&T's full fare rate of $1.73. However, 11 IP phone services cost more, and of the eight that cost less, two are available only to domestic callers within Japan. In short, heavy dialers to Western Europe and Japan don't need IP phone services if they want to slash their rates by 80–90 percent (off full fare) and still hear a pin drop.

90 Percent Off What?

Some of the new IP phone companies are competitive with today's discounted direct-dial services, i.e., 30–40 percent off the Sprint Sense rates, but they are no bargain. If the cost of calling Germany had been cut from $1.48 to 15 cents a minute by the IP phone service companies, that would be compelling. But the traditional long-distance companies did that years ago.

Put another way, IP telephony is an 80–90 percent discount off AT&T's full fare, but so is Sprint Sense. IP phone vendors who compare their prices to AT&T's full fare are comparing the cost of a bench seat in a cargo plane to a first class ticket in a 747, and pretending there's no such thing as an economy airfare. They should instead be comparing their rates to Sprint Sense, or to the numerous other cheap dialing plans on the market. Every corner shop sells calling cards, and every third TV commercial is for some 10-10-XXX alternative dialing plan that shaves the cost of long distance by 80–90 percent off full fare without involving the Internet or computers. To get people's attention, IP phone services should be 80–90 percent off Sprint Sense rates—or a few pennies per minute worldwide.

Is a 90 percent discount too much to ask for? Not when you compare what the Internet has already done for email. Almost as soon as the Internet wave first hit four years ago, the cost of electronic messaging services began to plummet. Email users who had been paying $1 per message up until 1995 saw their real costs slashed to a couple of pennies per message by 1998. Such a compelling discount caused a revolutionary shift from proprietary email to Internet email.

The bad news for IP phone carriers is, if they want the IP telephony revolution to take place, they will have to slash 90 percent off 10–15 cents a minute, not off $1.48. People already can hear a pin drop for 10 cents a minute. They won't pay more than a few pennies a minute to hear the pin echo.

Breaking the Rules

Nearly all the IP phone services break both the Internet model of flat rate access fees and the American telco model of flat rate local calls. For example, say an IP phone call lasts for 30 minutes and costs $1.50 (at 5 cents a minute). That's half as much as the call would cost with Sprint Sense (at 10 cents a minute). But if the IP phone carrier makes a local call from its gateway to the called party, and pays 10 cents total for that unmetered local call over the last mile, its cost will be 10 cents, and its revenue will be $1.50. The IP phone carrier pockets the extra $1.40, having charged their subscribers by the minute and having paid the local telco a flat rate.

A notable exception to this phenomenon is Access Power Inc., which is the only provider we found that retains the Internet's flat-fee model. But only its PC-to-phone service is priced at a flat $10 a month for unlimited usage. Its phone-to-phone plan costs 7 cents a minute. We found no nationwide, flat-rate, phone-to-phone IP services among the 22 surveyed offerings. (Some IP phone carriers do offer special discounts for calls among their own subscribers, calls during non-peak hours, calling card calls and for new customers in certain local calling areas.)

We also found that some IP phone services are unprofitable. One of the larger IP phone companies, IDT Corp.'s Net2Phone subsidiary, grew 174 percent to $20.8 million in the nine-month period between July 1, 1998 and Apr. 30, 1999, compared with the nine months between July 1997 to April 1998. That's good news, but the company also stated in its stock offering prospectus that losses attributable to IP phone services swelled more than tenfold to $4.7 million over the same period.

Granted that IP phone services are in a growth period, so of course investments outpace revenue — but what Net2Phone is saying is that its 10-to-17-cent rates for PC phone calls to the U.S., UK, Germany and Japan are below the cost of doing business. In other words, the service isn't profitable at a dime a minute. How can it become profitable at a penny a minute?

PC-to-Phone vs Phone-to-Phone Services

Recall that the rates for PC-to-phone services depend on the called party's location, not on the caller's location. In most cases, all calls that terminate in country X cost Y, no matter where they originate. For example, the Budget Call service sold by Telia AB in Sweden is available to anyone in the world (but billing will be calculated in Swedish kroners, for all you international currency exchange buffs). Telia Budget Call can do business anywhere it can place IP telephony gateways, or contract for their use with local gateway providers.

In contrast, phone-to-phone IP services are closely tied to geography at both ends. Service availability depends on the presence of IP telephony gateways at both the originating and terminating locations. Both the caller and the called party need to be within a local call of a gateway, otherwise the network provider will have to pay for a long distance call. The whole point is to use the local loop but substitute the Internet for the long distance network.

Some carriers, such as ICG and Net2Phone, have as many as a hundred gateways strategically distributed across the U.S. to be within a local call of all the markets they want to serve. Others, such as Access Power and Inter-Tel.net, have only a handful of gateways in a few cities and states, although Inter-Tel.net also has a nationwide access priced at 15 cents a minute.

Numerous Internet service providers are banding together into coalitions to pool their points of Internet entrance and exit, thereby creating worldwide networks. In fact, some of the so-called next-generation telephone companies, such as the Internet Telephony Exchange Carrier Co., the ISPtel.com Network, Networks Telephony Corp. and OzEmail Interline Pty Ltd., are nothing more than the negotiation managers of these coalitions, who arrange for revenue splits and oversee the recruitment of new gateway operators and sales agents. These wholesale companies do not provide services to end users. Others, such as NKO Inc. and Pacific Telekey Network, merely print the calling cards and issue the PIN numbers that allow consumers to make discount overseas calls.

Conclusion

IP phone services tout their big savings over long distance. While technically accurate — if the frame of reference is AT&T's full fare rate plan — these claims are misleading because they ignore other readily available discounts. The plain truth is that rates between the major markets have already fallen, and it had nothing to do with the Internet.

In the 1980s, traditional long-distance providers like AT&T, MCI and Sprint laid so much fiber individually in the U.S., and via consortia under the oceans, that they can make a profit charging 10–15 cents a minute, even for international calls. In addition, FCC policy in the past few years has also pressured PTTs to cut their accounting and settlement rates whenever possible.

The inevitable conclusion is that Sprint Sense deserves its name. It's not Sprint's lowest rate, but the prices are reasonable for both domestic and international long distance and the sound quality is excellent. By comparison, we found only a handful of IP phone bargains, but their discounts are modest and their quality is inferior. In the case of fax or business phone calls, especially for professionals conducting international business, it doesn't make sense to use second-quality lines.

Calls to the Third World might be an exception, because in some cases IP phone services are much cheaper and may offer better sound quality than direct dialed calls. For example, full fare to Chad is $5.94 a minute; full fare to Myanmar (Burma) is $7.13. Even Sprint Sense is more than $2 a minute to each.

Direct-dial calls to such areas can suffer poor audio quality, because these developing markets are likely to use satellite or terrestrial radio channels. So IP phone isn't at a quality disadvantage. It's possible that IP phone may actually sound better, and some IP phone services deliver the discounts (see Tables 2, 3 and 4). So next time you need to call Chad or Myanmar, consider an IP phone service.

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