Internet Phone Start-Ups Look Past Low Prices

By Ellen McCarthy
Washington Post Staff Writer
Monday, March 20, 2006

Internet phone service -- it's a hot idea and it has a strong selling point: It's cheap.

Hundreds of new companies have cropped up to sell the service in the past few years, and venture capitalists are pouring hundreds of millions of dollars into the industry. All that was appealing enough to entice former America Online Inc. executive Lisa Hook out of early retirement and into the job she started last week as chief executive of SunRocket Inc., a two-year-old Vienna firm offering phone service over the Internet.

And the prospects sound promising, except for one word creeping into the vocabulary -- bundling.

That's the term describing the way communication services are expected to be sold in the future. Rather than buying cable from one company, long-distance phone service from another and Internet access from a third, customers are increasingly able to buy all three from a single provider. Many analysts say large telecom and cable companies that already have relationships with huge groups of customers -- companies such as Verizon Communications Inc. and Comcast Corp. -- have a big advantage in the market.

That doesn't scare off Hook and SunRocket's investors, who are betting that if the firm acts quickly to build a loyal base of customers, it will be able to survive the pressures of bundling.

The companies springing up to sell Internet phone services are reminiscent of the hundreds of dial-up Internet firms that emerged in the late 1990s with hopes of becoming kings of the industry -- or at least growing big enough to fetch a decent price in a sale. Of course, most of those companies simply fizzled as a handful of giants came to dominate the market and broadband superseded dial-up service.

Analysts say companies like SunRocket that offer only Internet phone service -- and there are at least 1,100 of them according to Sandvine Inc., an Ontario firm that sells equipment to broadband companies-- may face a similar fate.

"Over time, this type of service is likely to be absorbed by the larger vendors," said Bern Elliot, an analyst at Gartner Inc. who studies the telecom market.

But Hook, who made a name for herself as an executive skilled at marketing new technologies to consumers, is betting there is room for both.

"We're at the very front end of this market," she said last week. "We can be one of a handful of new brands that are winners in this category."

At AOL, Hook, now 48, led the company's broadband division, which went from 300,000 subscribers to 5 million in two years. Before her four-year stint at AOL, she was a partner at a private equity firm focused on the telecom and media industries.

"We were looking for an executive with experience in the consumer marketplace," said Joyce Dorris, SunRocket's co-founder.

SunRocket has about 80,000 subscribers, making it a leading Internet phone service company in the Washington area. But its success is dwarfed by that of Vonage Holdings Corp., a Holmdel, N.J., firm with 1.5 million business and household Internet phone lines in service.

Dorris and Paul Erickson, veterans of the telecom industry who spent more than a decade together at MCI Inc., founded SunRocket in 2004. To get the company off the ground, the two attracted more than $34 million in venture capital from funds like Baltimore-based Anthem Capital Management and BlueRun Ventures of Menlo Park, Calif.

The company has tried to differentiate itself from the pack partly through its pricing, offering a year of local and long-distance service for $199, or more limited monthly service for about $10.

Hook said she was introduced to SunRocket as a potential board member but agreed to lead the firm after trying the service and meeting with some of its 125 employees.

The company's mission now is to snap up new customers willing to trade in their traditional land lines for Internet phone service. It's an effort that does not come cheap -- to build its customer base, rival Vonage spent $232.4 million in marketing its brand during 2004 and the first three quarters of 2005. That company has raised $394.5 million in venture funding from investors including Baltimore-based New Enterprise Associates and in February filed to raise as much as $250 million through an initial public offering.

Forrester Research Inc. estimates that about 1.5 million homes are using Internet phone service today, but the number is expected to grow to 12.3 million by 2010.

Despite the rapid growth, some analysts say it could be tough for companies like SunRocket and Vonage to compete against brands like Comcast, Verizon and AT&T Inc. with their packages of services.

"They're all going to offer that killer bundle, and that's what people are going to buy because the pricing is better," said Jeff Kagan, a telecom analyst.

Kagan added that independent Internet phone companies like SunRocket will have a chance to succeed, "just in a smaller universe" than previously perceived.

Hook believes that universe will be large enough to build a thriving company.

"Obviously there will be people who choose buy their services in bundles, but there have always been people who will purchase best-in-class service from stand-alone providers as well," Hook said. "I'm voting with my feet by climbing out of my swimming pool and coming to SunRocket."