January 2000

Market Outlook For The Millennium

BY LAURIE GOODING

IP telephony offers consumers and enterprises an unprecedented opportunity to bypass long-distance toll charges, but lingering concerns about quality and reliability slowed end user adoption in 1999. As we enter the new millennium, I predict that IP telephony’s primary beneficiaries will still be service providers and equipment vendors, although more end users will migrate toward innovative new applications such as IP Centrex and IP single number services.

END USERS
In the “early days” (about a year ago), PC-based calling was the predominant form of Voice over IP (VoIP), and considering the sacrifices in voice quality and reliability, was largely the realm of hobbyists. The IP telephony landscape is changing rapidly, however, and phone-to-phone services are readily available in most markets. Consumer awareness and usage is on the rise, thanks to the innovative marketing efforts of retail service providers such as Net2Phone, deltathree.com and ICQ (owned by AOL). Aplio reported that the monthly average VoIP communications via its Aplio/Phone reached five million minutes in May of 1999, representing 20% growth since the company launched its flagship product in March, 1998.

Consumers will benefit in the near-term from flat-rate long-distance calling and in the long-term, from more choices in services and vendors. Although the cost-savings for small- and medium-sized companies with high volumes of international voice traffic is potentially thousands of dollars per month, a Cahners In-Stat survey of IT professionals indicated that service quality (65%), security (56%), and voice quality (54%) are still key concerns. The combined capital investment, in-house network management capabilities, and troubleshooting savvy required are all costly demands in the enterprise and as a result, Cahners In-Stat believes that many will wait for carrier-based services.

MARKET OUTLOOK
Systems vendors will have sold nearly a billion dollars of VoIP gateways in 1999, primarily to service providers. Founded in 1996 and having 450 VoIP gateways, deltathree.com is currently the largest international Internet telephony service provider (ITSP). Their average monthly run-rate at the end of 1998 was 3.5 million minutes, and they had expected this number to swell as high as 11 million minutes per month by the end of 1999. Most ITSPs are planning for rapid growth and that means equipment vendors stand to make a bundle as carriers build out their infrastructures to support VoIP.

Cahners In-Stat Group separates the VoIP gateway market into two primary categories: The first category includes gateways based on an existing router or remote access concentrator (RAC) platform, and the second category comprises server-based gateways that are designed from the “bottom up” to support VoIP. This segmentation also separates the traditional data networking vendors, such as 3Com, Cisco, Lucent Internetworking (formerly Ascend), and Motorola, from telecom solution vendors such as Ericsson, Lucent, Nortel Networks, VocalTec, Clarent, NetSpeak, and Nuera.

RACs and routers will represent the majority of VoIP gateway sales through 2000, at which point, sales of server-based gateways will start closing the gap between these two types of gateways. This inversion in growth rates will occur due to several dynamics:

• ISPs are buying gateways at a faster rate in 1999, based on a significant wholesale opportunity to larger carriers. As the incumbent equipment suppliers to ISPs, data networking vendors are capturing the larger percentage of these sales. However, the millions of minutes the ISPs are after will begin to dwindle as incumbent carriers (their clients) deploy more server-based gateways in their own networks.
• As incumbent carriers increasingly migrate their networks — especially during 2001 — they’ll buy more server-based gateways with extensive call server and signaling capabilities.
• More mergers and acquisitions will lead to blended solutions, and the distinction between different types of gateways will begin to blur. RAC- and router-based gateways will take on more enhanced call server characteristics.

Component vendors are second-hand beneficiaries of gateway sales. What all VoIP gateway vendors have in common is their need for DSPs and embedded software solutions that provide for silence suppression, compression/de-compression, echo cancellation, DTMF signaling, and packet management. This translates into new revenue streams and corporate repositioning for leading component vendors.

Texas Instruments and Broadcom are emerging as the leading vendors of programmable DSPs for VoIP gateways. TI’s recent acquisition of Telogy, and Intel’s acquisition of Dialogic Corporation, will extend each of these vendors’ ability to provide combined hardware and software development platforms for VoIP. Broadcom’s acquisition of Telogy’s primary competitor, HotHaus, positions them to do the same.

Analog Devices and a couple dozen other DSP vendors will likely follow suit, leading to more acquisitions and integrated solutions.

MARKET DRIVERS
Steady, high-volume growth will characterize VoIP gateway sales through 2003 as quality, interoperability, and billing capabilities improve. Cahners In-Stat Group predicts VoIP gateway sales will reach $3.7 billion by the end of 2003, provided that manufacturers continue making quality improvements in the underlying technology and assuming they achieve the following milestones:

• Interoperability between different gateway vendors’ equipment so that carriers can effectively hand off traffic to one another and bill fairly for calls. Equipment vendors must be capable of supporting various standards and protocols, especially H.323, the Media Gateway Control Protocol (MGCP) and the emerging Session Initiation Protocol (SIP).
• Improvements in the trade-offs between cost, function, and quality. Cost will continue dropping and consumers will no longer accept the trade-off in quality and complexity. By the end of 2000, innovation will be the only differentiator left.
• Single-stage dialing and the ability to dial from any telephone. This “transparency” will be a key requirement in most carrier networks, and calls for significant improvements in achievable voice quality.

Laurie Gooding is a senior analyst at Cahners In-Stat Group. Cahners is a high-technology market research firm covering the consumer and convergence, networking, wireless, telecommunications, Internet, and semiconductor markets. For more information, visit their Web site at www.cahnersinstat.com.