May 2002

By Brian Strachman, Cahners In-Stat

It finally happened. In 2001, the U.S. market for LAN (local area network) telephony reached the billion dollar range. Well, almost. The actual number was $976 million, but given the typical margin of error analysts work under, it's close enough. Considering the current state of the U.S. economy, and the fact that the LAN telephony market almost didn't exist as little as three years ago, this is a remarkable feat.

LAN telephony sales in 2001 (tracked by stations and revenues) were approximately triple what they were the prior year. LAN telephony exploded onto the scene a little over two years ago and has been one of the hottest markets ever since. The market really began when NBX (since acquired by 3Com) began shipping the first packet-based handset on Halloween, 1998. In a substantially less-publicized move, Siemens also began shipping a similar product just a few months later. Shortly thereafter, Selsius (since acquired by Cisco) also entered the market, and with that, the race began.

In the beginning of 2000, most vendors were only beginning to ramp up their sales and there was little actual revenue to speak of. Yet, amazingly, the U.S. market reached one billion dollars in end-user revenue in 2001. What accounts for this dynamic change and what have the vendors done to create this market?

• Cisco, now the vendor with the greatest market share (34.4 percent), grew their sales by 140.9 percent in 2001 over 2000. Cisco's sales in 2001 actually exceeded the sales of the entire market in 2000. LAN telephony has become a major priority for Cisco, and their efforts are showing. The 800-pound gorilla of the data networking world now has a similar foothold in enterprise voice communications. Originally, Cisco was thought to have several holes in their offering in terms of features (the average PBX has over 500 while the average IP PBX has about 20.) However, Cisco seems to have figured out the demands of the voice buyer and corrected their product accordingly.
• Nortel and Avaya, two leading PBX vendors that in 2000 had only announced their strategy, entered the market in 2001 and finally began shipping products. Although many of these shipments are add-ons to existing PBXs, they still count as station shipments, and thus revenue. These two legacy PBX vendors have a real opportunity to capitalize on this market, if they don't blow it. They understand the needs of the voice buyer, where many data vendors don't. Nortel and Avaya also have an installed base to be envied. They simply need to migrate their current customers and suddenly they have a new billion-dollar revenue stream. It remains to be seen if they can do it.
• 3Com, which arguably was first to market in any significant fashion, still has a sizable market share, selling almost 200,000 stations in 2001. It acquired NBX (the first real LAN telephony product vendor) several years ago and never looked back. Without exception, the NBX product has been the longest shipping, fully functional LAN telephony solution in the industry. Unlike the legacy players such as Nortel and Avaya, its network is pure IP. These are not just PBX line cards to enable IP. Every 3Com system is a full transition. 3Com still has lower average system sizes than some of its competition because in the past its systems didn't scale and the company didn't target the large installations such as call centers. All this has changed. Expect 3Com to enter the large system market in the coming year.
• IP is no longer scary. Concerns about network reliability have come and gone. Customers have realized that the technology is there to reliably transmit voice over an enterprise data network. However, the market is not overly exuberant about IP the way it once was. Customers are no longer buying IP simply for the sake of IP ' they want results such as ROI and enhanced features.
• The economy wasn't as bad as it seemed. For most vendors, Q1 and Q2 of 2001 were quarters of substantial growth in the LAN telephony market. Although many saw declines in Q3, vendors again reported gains in Q4. So far, 2002 is looking up and hopefully the sales will continue to increase.
• System size grew. The average number of stations per installation grew in 2001 to 67.5. This is almost double that of 2000 and indicates a trend of more confidence. Instead of the 'toe in the water' strategy of using LAN telephony on a very limited basis, it is now being used for entire offices and expansions to existing buildings. The simple fact that LAN telephony is becoming a large enterprise product rather than simply a toy for small or remote offices means that the market is poised to grow exponentially.
• ROI figures are coming in. After a year or two of being on the market and only having a vendor's word that LAN telephony saves money, there are now clear facts and figures that LAN telephony is a cost saver. Most large enterprises are getting a return on investment in 18 months. Both Cisco and 3Com have ROI calculators, marketing tools to demonstrate the potential savings of moving to a LAN telephony solution. While these are surely tailored to prove a savings, a visible ROI still goes a long way to prove the viability of a product.

The Future Of LAN Telephony
I believe the future will be equally bright and have been predicting a hockey-stick-like growth curve. To begin to forecast the LAN telephony market, you must look at the total enterprise switching market, which includes both LAN telephony and traditional circuit-switched technology. While the market is moving downward somewhat, there were still 6.2 million enterprise voice stations sold in the U.S. last year. Next, consider the rate of migration toward voice on the LAN. Drivers such as lower equipment costs, simpler administration and enhanced applications will move buyers in this direction. Forecasting the number of enterprise voice stations in the U.S., multiplying by the percentage of voice on the LAN, and applying a price per station, you can extrapolate a forecast of over 4 billion dollars in U.S. revenue by 2006.

I predict a high rate of migration toward LAN telephony in the future. The market was very good this year and there is no reason the trend cannot continue into the future.

Brian Strachman is senior analyst, Voice and Data Communications, Cahners In-Stat Group. He may be contacted at [email protected].

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