Vonage is sinking

Submitted by acohill on Thu, 06/01/2006 - 08:54

Vonage may be the first big casualty of the "Web 2.0" craze. While Voice over IP is technically not a Web 2.0 application, we can use Web 2.0 as shorthand for the same kind of hysteria we saw in 1999 and 2000, when a lot of really bad ideas (from a business perspective) got way too much venture capital funding.

Proving that there is still a sucker born every minute, investors poured nearly half a billion dollars into the VoIP firm's IPO--even though the company has never had a single profitable quarter in its five year life, and in fact has lost nearly half a billion dollars in that time.

The problem for Vonage is that they set the stock price too high (well, the company has lots of problems, but I'm talking about the IPO). The $17 initial price has dropped below $15 in just a few days, and some are predicting it will fall below $10. High flying tech stocks are supposed to shoot upwards in value and make early buyers of the stock big profits.

But wait! There's more!

Vonage offered users of their telephone service an opportunity to buy stock at the initial opening price. That's an attractive offer if the stock value shoots up quickly; you can buy the stock and immediately know you are going to make a profit if you sell right away. But what if the stock price drops? Now you have to buy shares at $17 that the market says are only worth $14.50. What some subscribers are saying is that they are going to renege on their agreement to buy. And Vonage is now suggesting it will force subscribers to honor their purchase commitments.

It can't get much uglier than that.

Stepping back, Vonage has two structural problems. First, the business model for Vonage, in which you can make free calls to other Vonage users and pay to make calls to people not on the Vonage network, is not working--the company is losing money every day.

Second, the big access providers have started playing games with VoIP data traversing their networks so that the quality of the phone calls is much reduced. This is part of the "two tier Internet" issue, where the big providers first "prove" extra fees are needed by monkeying with the way their competitor's data traffic is handled, then claim special fees are needed to make the network work better. Vonage is an early victim of this because they have so many people using their service.

And in fact, heavy VoIP traffic can and does affect networks. But the solution is not to start charging companies like eBay, Vonage, and Google special fees to carry their traffic. The real problem is that the bandwidth model of selling Internet access that we have used for the last decade is badly broken. The two tier Internet "solution" is like putting a band aid on someone having a heart attack.

We need open access digital road systems where bandwidth is free and you pay for services. This allows everyone in the service chain, from customer to service provider, to price or pay for services based on the value of the service, and not on some completely artificial cost of some increment of bandwidth that has no relationship to what people and businesses actually do.

Some communities are already planning open access systems. As they become operational in the U.S., we'll see more and more movement toward them, because they are the only ladder out of the hole we are in. In the meantime, we have to hope our state and Federal legislators don't cave in to the two-tier Internet crowd and really screw things up.

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