Vonage: From darling to disaster

VoIP experts weigh in on what went wrong and what's left to do

With a series of high-profile lawsuits, a bungled initial public offering (IPO) and a regulatory melee over its E911 efforts, voice-over-IP pioneer Vonage Holdings Corp. is looking more like a lost cause than a cause celebre, according to industry experts.

"Vonage has had serious problems. It's a shame; they could have done a lot more. They just haven't been able to execute as well as they should have," said William Stofega, research manager for VoIP services at IDC in Framingham, Mass.

Stofega is not alone in his harsh criticism of the Holmdel, N.J.-based company, which was founded in 2000 and provides fixed monthly fee-based broadband phone services to more than 1.6 million subscribers. Founder, Chairman and Chief Strategist Jeffrey Citron and his executive team are accused of poor decision-making, which experts believe has led the stock to tumble from its IPO debut in May of around $17 to just below $7 this week.

Shareholders, feeling similar frustration, filed two class-action lawsuits in June against the company, alleging, among other things, that certain facts regarding the Customer Directed Share Program were omitted or misstated and that the IPO prospectus contained misrepresentations or omissions concerning Vonage's products.

Timeline of Troubles

March 2002 The company officially launches its service.
May 19, 2005 The FCC rules that VoIP carriers will be required to provide enhanced 911 emergency calling service within five to six months; that deadline is later extended.
Feb. 17, 2006 Vonage announces that almost all of its customers have basic 911 service and a majority of them has enhanced 911.
May 24, 2006 Vonage files IPO at $17 per share; price quickly drops, and was less than $7 this week.
June 2, 2006 Lawsuit filed alleging IPO misdeeds. A second shareholder suit soon follows.
June 12, 2006 Verizon Communications Inc. files patent-infringement lawsuit.
July 10, 2006 Klausner Technologies Inc. files patent-infringement lawsuit.
July 18, 2006 Newsletter links company advertising to spyware.

"Vonage is a great case study of how you can have a great service, but a terrible stand-alone product," said Eric Paulak, managing vice president of network services and infrastructure at Gartner Inc.

Paulak said the writing has been on the wall for Vonage since its early days. "You can't ask what went wrong. Nothing suddenly went wrong. Vonage has had problems since Day One," he said.

It's the platform, stupid

Danny Briere, CEO of TeleChoice Inc., a consultancy in Mansfield Center, Conn., agrees. "The business foundation for Vonage is a failed premise. You don't found a company on a technological advancement you don't wholly own."

That delivery platform has put Vonage, which charted $269.2 million in revenue in 2005, in the news this month, as VoIP technology patent holders Klausner Technologies and Verizon Communications filed lawsuits against the company for infringement (see "Vonage sued for patent infringement"). Vonage scrambled to fight back, announcing it had acquired three VoIP patents from Digital Packet Licensing Inc.

Paulak said Vonage faces other significant problems because its services need carrier networks for delivery. "The company relies on too many other factors to be successful, including someone else to provide the broadband connection," he said.

Stofega pointed out this is a catch-22 for the company. "One of the things that came out of the technology bubble bursting is that everyone can't go around and build their own network," he said. "Networks are resource-intensive and expensive. No one can afford them. However, if, like Vonage, you don't own the network, then you have a problem. You have to buy capacity and transit from the long-haul carriers. The irony of this is often lost."

The art of innovation

Although Vonage had a first-out-of-the-gate advantage in the burgeoning VoIP market, it quickly squandered its lead, Stofega said. "They have not been able to differentiate fast enough, and their innovation fell off," he said.

One of the areas where Vonage lost its potential for success is in the enterprise, Stofega said. "They had good plans in terms of enterprise deployments and new products -- wired and wireless -- but nothing ever happened," he said.

He attributed this to the company's laser-like focus on the consumer market and voice services rather than using voice as a jumping-off point. "They could have attracted the day extender, small office/home office and start-ups, but they stuck too much to their consumer image," he said. He also noted that this rigidity has allowed companies such as Skype Technologies SA, which requires only a small downloadable application, to penetrate the consumer and enterprise markets.

The company was also derailed by the Federal Trade Commission's 2005 inquiry into 911 compliance. That investigation was dropped last month -- but not without taking its toll. "To build out an E911 system is expensive. They did a good job on compliance, but certainly at the cost of innovation," he said (see "Some VoIP providers miss FCC 911 deadline").

Adding to the company's woes, a researcher just last week reported that Vonage advertisements were linked with spyware (see newsletter "How Vonage Funds Spyware" by Ben Edelman). And the company appears to be suffering from technical difficulties: One subscriber has noticed that call activity reports have been unavailable intermittently for weeks.

Sacrificial lamb

For Briere, the true problem with Vonage has been its refusal to broaden its spectrum away from regional Bell operating company territory. "They offered a temporary price benefit in an age where everyone is looking for bundles -- they were bound to lose," he said.

He said telecommunications companies were just waiting for the right time to pounce. "The telcos sat back until they saw something that made them viable [in the VoIP world]. Vonage did all the advertising, vetted all the issues, crossed all the chasms and laid out the technology road map for the telcos to follow."

Rather than fighting a no-win situation, Briere said the company should have gone in a different direction. "Vonage should have taken a cue from billionaire Richard Branson and what he did with Virgin. Its customer base wants to be known as 'bleeding-edge technology leaders.' They should have owned that image," he said.

Briere said there's still time for the company to move past voice to combine voice, video, data, gaming, e-commerce, cell phones and other hot consumer tools over broadband. "There's a million-plus subscriber base willing to deploy new stuff, and they will put up with beta and technology problems," he said.

Marketing missteps

Maintaining its customer base has been one of Vonage's chief fiscal obstacles, according to Paulak. He said the company's churn rate has reached 2% per month, which has left it losing 24% of its customers on an annualized basis.

"This means Vonage has to spend a lot more money to attract new customers," he said. According to the company's latest financial reports, the cost to acquire a customer was $221, he said.

"This is a company that is spending more money than they're taking in or likely to take in soon. They've just been an absolute money pit in terms of what they've been doing with marketing," Paulak said.

He attributed the high churn rate to several factors. "People aren't saving the money they thought they would, so they're not getting rid of their traditional phone lines -- their services can experience problems when the user's network connection isn't good enough, and they have the novelty problem. Their ads for the lobster in the revolving door are cute, but they're a novelty," he said.

Ironically, as speculations arise over whether Vonage is seeking a buy, it's the company's customer base that could be its greatest asset. A recent survey by Telephia Inc. said Vonage continues to have the largest market share of pure-play subscription VoIP consumers, with a 53.9% share (see "Survey: Home VoIP use grows in U.S."). "The only reason to look at buying Vonage is for its customers. Buying Vonage to buy their customers is cheaper than acquiring customers yourself," Paulak said.

Gittlen is a freelance technology writer in the Boston area. She can be reached at sgittlen@charter.net


Copyright © 2006 IDG Communications, Inc.

7 inconvenient truths about the hybrid work trend
Shop Tech Products at Amazon