Daiwa Eurotelcoblog No. 6, Tuesday, 9th September 2003: Another piece in the VoIP puzzle (original email blast 5:08 PM Tuesday, 9th September, 2003)

Another piece in the VoIP puzzle
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The background

Readers of our recent output will recall the piece we produced on enhanced instant messaging back in July, in which we stated that we expected this to be another significant source of fragmentation in the voice market. Recent client presentations have included further discussion of this phenomenon in the context of a generational change in communication styles (such as the recent survey of Angelfire users which reported that 45% of these teenagers regularly use instant messaging to communicate with friends outside of school hours, versus only 15% who communicate face-to-face). Another development we have cited as being potentially significant was the recent launch, by Clear Channel's Z100 FM affiliate in New York City, of a branded "affinity" instant messaging service which brings compatibility between the four major IM platforms (AIM, ICQ, Yahoo!, MSN).

Today's news

Just an hour or so ago, one of the many geek e-mail newsletters we subscribe to delivered a new and interesting twist on this theme. The founders of P2P file sharing behemoth KaZaA are launching a decentralized P2P VoIP service under the name of Skype (http://www.skype.com/skype.html). The service is free between registered users anywhere in the world, though the report we saw today suggested that a cut-price service for calls to the PSTN will be launched in future. We think this is significant for a couple of reasons:

Unlike many of the interesting SIP start-ups we have written about previously, KaZaA has a huge established "brand" presence globally. It broke through 230m worldwide downloads of its software in late May, putting it ahead of ICQ, the previous record-holder, and appears to be attracting around 500,000 downloads per day. Its users are tech-savvy, and have a well-demonstrated tendency to seek out free alternatives to traditional consumer transactions (i.e., paying for music). Free voice is a natural extension of this pattern. The Skype technology purports to function behind NATs and firewalls without configuration, which is an advancement over some VoIP solutions we have seen, and will undoubtedly make life even more interesting for IT managers everywhere.

We have seen a number of regulatory barriers and obstacles imposed on SIP services in the US (most recently Vonage battling interventionist pressure from the Public Utilities Commission in Minnesota) and we fully expect more challenges to come at state level, but we think this KaZaA/Skype solution poses even greater challenges for regulators. We think that if the FCC and local regulatory bodies end up definitively labelling services such as Vonage as "telephony services" and attempting to subject them to USO, state and local tax, etc., there is going to emerge an obvious and perverse disconnect with enhanced instant messaging products of this sort. If SIP services offering voice communication are considered to be telephony, then will the same definition extend to the voice instant messaging products coming to market? We think this is highly impractical, though the urge to control (particularly when there is a "national security" angle) is a strong one.

In summary, we think the KaZaA/Skype story is an interesting one, because it combines some of our favorite themes: generational shifts in demand and behavior, price/service arbitrage, brand/lifestyle affinity, regulatory nebulousness. We remain negative on the long-term outlook for the voice market, and see fragmentation as the key trend for the foreseeable future.