Fractals of Change

As the Phone World Turns Part 6 – SkypeIn: The Plot Thickens

Skype, which started as free computer-to-computer calls only, is beginning to look more and more like an alternative phone service.  With SkypeIn (now available in paid Beta) Skype users who buy phone numbers from Skype can be called from ordinary phones or from other VoIP services.  Ever since the summer of 2004, Skype users have been able to purchase SkypeOut calls to nonSkype phones.

SkypeIn is as significant for what it ISN’T as for what it IS.  From a user’s point of view, SkypeIn opens up the formerly closed Skype network by assigning inbound phone numbers which can be reached by nonSkype subscribers.  However, any call to a SkypeIn number must go through the PSTN (Public Switched Telephony Network – the legacy phone network).  Even calls originated on the networks of other VoIP providers such as Vonage, AT&T CallVantage etc. must hop off the Internet, traverse some part of the PSTN, and then hop back on the Internet to get to a SkypeIn subscriber!

It’s ironic that the PSTN has become the switching point between VoIP calls from different networks. Just as with a traditional phone company, there is no way to reach a Skype user except through Skype the provider.  Unlike a traditional phone company with a wireless or wireline network, Skype could allow IP access to its users directly since they are physically connected to the Internet and not to Skype. It’s significant that this arrangement puts Skype in a position to collect tolls on inbound calls to its users.

These tolls on inbound calls are called access charges.  They are a huge source of revenue to both wireline and wireless phone companies.  They are an attractive source of revenue because they appear (indirectly) on somebody else’s customers’ bill.  They are also not price-sensitive because they are a monopoly rent.  You can’t reach a Verizon customer, wireless or wireline, except through Verizon, wireless or wireline.  And you can’t reach a Skype subscriber except through Skype.  There is no mechanism for collecting these tolls on true VoIP calls.  But, once the calls pass through the PSTN as SkypeIn calls must, the tolls can be collected by Skype using existing mechanisms at the interface of the PSTN and the Internet.

I don’t know whether Skype is currently collecting these tolls or not.  The way the PSTN works, if Skype is not collecting the tolls for calls to “its” numbers, then some other phone company along the call path is getting to keep the tolls for itself.  As long as the call path to Skype users includes the PSTN, Skype OUGHT to get its share of the access charge revenue.  In fact, there is no reason Skype shouldn’t to continue to charge a toll to traditional phone companies whose customers are calling SkypeIn subscribers; these carriers are charging their customers for the calls and the carriers are charging Skype for SkypeOut calls to their subscribers.

But what about calls from subscribers of one VoIP service to subscribers of another?  These calls are actually degraded by having to pass through the PSTN and, for technical reasons alone, should be routed around the toll booths.  Skype positions itself as saying all calls should be free but, unfortunately, legacy phone companies make that impossible today.  To be consistent with that positioning, Skype would have to make it possible for users of other VoIP services to reach Skype subscribers “free” just as Skype subscribers reach each other at no cost. 

Note that this is not a moral pronouncement by me.  Skype has invested money it raised itself in its business and has a right to charge for its services anyway it wants to.  Since Skype never had the advantage of being a monopoly provider and has neither been awarded rare frequencies nor given permission to dig up city streets, it has no public obligation other than normal commercial honesty.  As impressive as the size of the Skype user network is, Skype isn’t a monopoly so it doesn’t need to be restrained except by its own business imperatives.

However, Skype the company may have made a rare mistake.  Because of Metcalfe’s Law, it is hard to unseat the carrier who has the largest network.  Skype has elected, for the moment, to make its subscribers more expensive to reach from other VoIP services than from its own service.  In the short term, that enhances the value of Skype to its subscribers because there are more VoIP users reachable on Skype’s network than any other.  But it also opens Skype up to competition from a rival who does allow free inbound access from other services to its subscribers.  There is a value to subscribers in being cheaply reachable.

To be fair, with the exception of Jeff Pulver’s FreeWorldDialup, other VoIP services have not made interoperability a priority and you cannot call VoIP-VoIP between them; you have to use the PSTN just as with Skype.  However, most of the other services use an open protocol called SIP so it is fairly easy to see how interoperability can be achieved.  Skype uses a proprietary protocol, perhaps for quality reasons, so it is harder to see how they will become interoperable and very difficult to see how interoperability might be “forced” on them.

These are interesting times.  Will the advent of VoIP break the old model of closed phone networks which are connected only through toll bridges?  The email model says NO!  Email started as a number of proprietary networks.  They were quickly joined because of the huge network value that was created.  The phone model says YES!  People are willing to pay to reach each other so why not charge them for off-net access.

My prediction is that the email model wins, not because VoIP providers are more noble than PSTN providers but because the real power to control VoIP lives with the users out at the endpoints.  Skype is not providing me with any physical pipe; as soon as someone can offer me a better deal. I’m gone.  The SkypIn number I pay for may be a slight barrier to switching, but not much, I’m guessing, because it is unlikely to be primary number – it’s only usable through my computer today – and because I think a rival will offer very good directories.

The features of SkypeIn are interesting.  More on that in a future blog about Skype features.

The first post in this series is everything you ever wanted to know about legacy access charges.

The second is about the cost of “free”.

The third explains Metcalfe’s Law of network value.

The fourth is about how Skype built huge network value.

The fifth is about Skype’s first paid service SkypeOut.

The seventh is a summary of Skype features.

The eighth begins coverage of Vonage’s strategy.

The ninth asks whether we need phone companies.

The tenth asserts that we won’t need traditional mobile carriers either.

A related post contains a very short abstract of what Skype founder Niklas Zennstrom said at VON (Voice On the Net) Canada and a way to download the slides of my talk there.

Fuel Cells

We all know that electric cars would be quieter and less polluting than those with combustion engines.  But we don’t all want to drive golf carts everywhere.  Production of practical electric cars has been stymied by limits of battery technology.  Gas-electric hybrids are a good thing but still burn at least two-thirds the gas of traditional cars to accomplish the same mission.

Fuel cells can be small and light enough to be the energy source for electric cars.  Since fuel cells produce only water as an exhaust, they are nonpolluting and don’t add greenhouse gasses to the atmosphere. This post is about hydrogen fuel cells and the energy generation and distribution systems necessary for their successful commercial use as a substitute for oil-based fuels in cars.

You may remember an experiment in high school chemistry in which the teacher passed an electric current through a test tube of water and split the water into it component elements, hydrogen (H₂) and oxygen (O₂). This process is called hydrolysis. The chemical equation you copied from the blackboard was:

2H₂0 + energy -> 2H₂ + O₂

The principal of a hydrogen fuel cell is to reverse that process.  Hydrogen gas and oxygen are combined to produce water and electrical energy.

2H₂ + O₂  -> 2H₂0 + energy

A combustion engine would combine the two elements in a fire and produce heat.  A fuel cell combines the two elements through a chemical process using a catalyst (usually platinum) and the energy is released in the form of electricity.  The low temperature catalytic reaction has a theoretically higher energy efficiency than a hot process.  To oversimplify, all the heat that your combustion engine radiates into the atmosphere and spills into the exhaust is wasted energy as far as moving the car. Much more detail on fuel cell design and operation is available in wikipedia.

The oxygen for this reaction in a fuel cell comes from the atmosphere just as the oxygen does for a combustion engine. But the hydrogen needs to be carried as fuel just as we carry gasoline today.  We will stop at  hydrogen stations and fill-up.  The important question for our economy and environment is where does the hydrogen we fill-up with come from!

Hydrogen can be extracted from methane, propane, coal, oil, natural gas and a variety of other sources.  However, we don’t reduce our dependence on fossil fuels if they are our source for hydrogen even though we can reduce the amount of CO₂ released into the atmosphere by processing these hydrocarbon fuels centrally, putting the carbon back in the ground, and using only the hydrogen component in cars.

What will really change the world for the better is using electricity to produce hydrogen from water just as in the high school chemistry experiment.  I think the hydolysis will be done locally at or near the hydrogen stations we fill up from.  That means that there won’t have to be tankers full of hydrogen on the road or rails nor explosive pipelines to transport it to where it’s needed.  There just needs to be an expansion of our electric grid to bring the electricity to where its needed.  In this scenario, the hydrogen in a fuel cell is the mechanism for storing the electrical energy that goes into hydrolysis until that energy is needed to move a car.  The fuel cell is a glorified battery whose advantages are light weight and quick recharge.

Wait a minute though, you say, where is the electricity coming from that’s used to split the water in the first place?  That IS the important question.  Some of that electricity will come from wind, hydro, and solar sources.  Creating hydrogen through hydrolysis is a good way to store energy from a wind generator when the wind is blowing hard but the load on the system is low.  Hydropower can be efficiently produced with smaller dams and smaller storage lakes behind them if there is a way to use the off-peak surplus.  If all the hydrogen stations produce most of their hydrogen off-peak, the load on the generation and distribution systems for electricity smoothes out, capital costs per kilowatt go down, and “renewable” source become more efficient.

But a hydrogen economy is not a green panacea.  In order to generate enough electricity to make it the motive power for the world’s rapidly expanding car population, I believe that a significant amount of that electricity will have to come from nuclear power.  Nuclear power plants themselves, like hydropower and wind power sources, can be more efficiently designed if they can run at a constant energy output and if there is a market for off-peak production.  Use of electricity for hydrolysis is that market.  Fuel cells are the mechanism for using that electricity to replace fossil fuels for motive power.

I have blogged that growth of a car-driving middle class in India and China (and hopefully the rest of the world) forces us to reduce fossil fuel dependency quickly and resume the construction of nuclear plants in the US.

I’ve also blogged that China, with its lack of gasoline infrastructure, may lead the way to commercialization of the components of a hydrogen economy.

As the Phone World Turns Part 5 – SkypeOut: Monetizing the Skype Network

Skype built its impressive (some would say “frightening”) network of users by providing free software for free Internet calls between users.  So how do they ever make money?  They’ve begun to answer that question.

Skype introduced its first paid service,  SkypeOut, in the summer of 2004 and claims over 1.2 million users as of April, 2005.  It allows outbound calls from a Skype-equipped computer to ordinary phones at very reasonable rates.  For example, calls to Western Europe or US landline phones are 1.7 euro cents per minute.  Calls to mobile phones in Europe are more expensive.  The markup over the access charges which Skype directly or indirectly pays the owners of the fixed or mobile last mile is consistently reasonable.

I use SkypeOut to avoid paying outrageous phone bills to hotels when I travel. Last year on a trip to Europe I prepaid ten euros to Skype on my credit card and, at about US$.02/minute, have yet to use it up despite lots of calling by me and Mary and some by overjoyed travel companions whom I let call home on my computer.  These are typically calls to the US, UK, and Belgium where my children are plus our business and nonprofit board and conference calls mainly to the US.  If made on a hotel phone or mobile phone, these calls would typically cost over $1.00/minute and sometimes much more.

The quality has always been good enough so that, even on a conference call, other participants are surprised to hear what technology we are using.  The only flaw, and it’s a big one, is that DTMF (touchtones) are not handled well so that is often difficult to check voice mail or do other automated functions with SkypeOut.

SkypeOut only works when there is an Internet connection wherever you are calling from.  It doesn’t have to be a great Internet connection, though.  The software is good at dealing with poor connections.  From an economic point of view, I don’t count what the hotel charges for an Internet connection (the rule seems to be: the more expensive the hotel, the more it charges for Internet access).  I don’t count the cost because I always pay whatever I have to pay for an Internet connection whether I’m going to use SkypeOut or not; but, if you are only paying for the Internet connection only to use SkypeOut, then this cost needs to go into your equation.

SkypeOut also works from WiFi hotspots.  Edward Vielmetti blogs about a Skype-Skype call (I originally thought it was SkypeOut) from an associate aboard an SAS flight equipped with Boeing’s in-cabin broadband Connexion Service but apparently SkypeOut doesn’t work well from inflight broadband yet.   Remember what calls from international flights used to cost?

Note that SkypeOut does NOT include any unlimited free calling to ordinary phones.  That wouldn’t work with Skype’s business model since they don’t charge any monthly subscription fee as Vonage, for example, does.  Free calling is only between those using Skype.  Skype founder Niklas Zennstrom is very clear that Skype’s model is to charge incrementally when there is a significant incremental cost to Skype.  Calls to ordinary phones cost Skype per minute so they charge for them on a per minute basis and use them to earn revenue.  Calls between Skype users have no significant incremental cost to Skype and so they are given away free in order to build the size of Skype’s network and create a market for paid services.

Skype now has two new paid services in Beta:  SkypeIn and Skype Voice Mail.  More about them later.

The first post in this series is everything you ever wanted to know about legacy access charges.

The second is about the cost of “free”.

The third explains Metcalfe’s Law of network value.

The fourth is about how Skype built huge network value.

The sixth is about Skype reproducing the OLD telephony business model with SkypeIn.

A related post contains a very short abstract of what Skype founder Niklas Zennstrom said at VON (Voice On the Net) Canada and a way to download the slides of my talk there.

Globalization and Innovation

In the current issue of Wired, Lisa Margonelli speculates that China may become the alternative fuel capital of the world.  That would be great.  And could be the stepping stone to a hydrogen economy for the rest of us.

Why China?  Well, in 2000 according to sources quoted by Wired, Chinese owned only one percent of the world’s cars.  The rapidly forming middle class there is getting off their bikes and into cars just as Americans and Europeans did.  If only 10% of Chinese citizens have cars by 2020, there will be close to 150 million cars on the road there – 13% of the world’s total, close to the total number of cars currently owned in the EU.  China has already gone from being a net oil exporter to being the second largest importer.  Eighteen of the 25 most polluted cities in the world are in China.  So there is plenty of need to reduce the hydrocarbon burn.

There is plenty of need in the US, too, but we are proceeding at a snail’s pace.  Why?  One reason is because we already have a huge gasoline infrastructure and it works.  But China has no infrastructure of any kind to support the number of cars expected on its roads in the next decade and a half.  There is no legacy favoring a gasoline distribution system.  Greenfields are great for innovation.

If an alternative energy distribution system evolves in China, we all gain.  The obvious gain is that we won’t have to compete as much with China for oil supplies nor breathe China’s increased emissions. But the greater gain is that any technologies which develop to support China’s hydrogen economy, should that come to pass, will be available for us to deploy as well.  The size of the Chinese energy market assures that there will be investment in both technology and manufacturing to support it.  So, by the time, we are ready to deploy a greener and more sustainable energy infrastructure, all the parts we need should be available at commodity prices. 

That’s not a bad thing.  We may get to alternative energy faster and cheaper than we would have otherwise because China, without legacy infrastructure, is better situated and has greater need to take the lead.  I’m not making a moral or political judgment, just pointing out a POSSIBLE rosy scenario which is a side effect of globalization and the growth of nonUS economies.

Just a note on fuel cells: they are really glorified batteries, energy storage devices, not an energy source.  They have to get charged up.  To me that means building nuclear power plants to produce the electricity that charges the fuel cells.  However, since off-peak electricity can be used for most charging, existing hydro and wind energy facilities as well as nuclear can be used more efficiently than they are today.

And a prediction:  when we pull into a service station to “charge up” instead of “fill up”, we won’t really do that.  Charging takes too long.  Instead we’ll swap a discharged fuel cell for a charged one in some automated way, much the way we swap propane tanks when we need more fuel for our outdoor grills.  The discharged cells will be recharged, mainly at night, at the local service stations which will have to be served by a huge-capacity electrical grid.  This is the kind of infrastructure which might evolve in China.

I disagree with Wired’s opinion that the Chinese command economy is better equipped to make the choices needed to move to a twenty-first century transportation energy infrastructure than a free economy.  China’s success has been despite central planning, not because of it.  The Chinese businessmen I’ve met ignore Beijing as much as they can – and that’s pretty easy to do in such a vast country.

Japan and especially Korea have deployed real broadband DSL much faster than the US has.  Is this a bad thing?  Well, I hate not being first as much as any entrepreneur but we have befitted by the commoditization of DSL and home networking components in the markets that developed before ours.  We have learned what works from these markets.  And, despite the foot dragging of legacy carriers and doom and gloom from the pundits, we’re on our way to a broadband economy as well.

Globalization isn’t an option; it’s a necessity.  The poor need to become unpoor.  As they do, they will consume more resources.  As other economies grow, a greater percentage of innovation will take place outside the United States.  Surviving and thriving on a globe which we do not dominate means learning to benefit ourselves from innovation elsewhere.

I also blogged on the need to return to nuclear power in the US.

As the Phone World Turns Part 4 – Building Network Value with Skype

Skype and Vonage are two of the most successful of the new breed of retail Internet phone companies.  Their approaches to the marketplace are as radically different from each other as each of them is from the legacy phone companies whose calls they are successfully diverting.  Today’s post is about Skype’s initial successful strategy to build a huge network of users before looking for revenue from them.

Skype’s success in the eighteen months or so since it launched is so great that the company is being compared to Microsoft and there is worry about Skype “dominance” and serious concern about the implications of Skype protocols being proprietary rather than standards-based.  This is an Internet story somewhat reminiscent of Bubble v1.0.  Skype’s success is not measured by profitability (it is not public so its P&L is not known); its success is not measured by revenue because, until very recently, it had no revenue producing services.  Rather Skype’s success is inferred from the 100,000,000 copies which have been downloaded, from the billion and a half minutes of voice traffic it carries each month, and from the typically more than two million users online at any given time.  These are big numbers even if they’re not in dollars or euros.

As I blogged Friday, Metcalfe’s Law (which not everybody believes in) states that the value of a network is proportional to the square of the number of endpoints.  People are the endpoints of a phone network.  A network with only a few people on it doesn’t have nearly the value of a network on which you can reach and be reached by almost everyone who interests you.  So the dilemma in starting a new network is how to ever get enough initial people on it so anyone will want to join given that the first people who sign up will have almost no one to talk to and therefore very little incentive to join.

Skype’s strategy is simplicity itself; the brilliance has been in the execution.  Calls from one Skype user to another are “free” assuming that both users already have broadband connections which do not charge by the amount of traffic transmitted, computers with microphone and speakers, and Skype software.  The Skype software is downloaded at no charge.  The first Skype users were typically college students who had all the prerequisite equipment and connections.  Groups as small as a pair of separated lovers decided together to download Skype software so that they could coo or fight or dream together without having to pay for a phone call.  The initial success was in Europe where a greater percentage of calls are international and expensive than in the US.

Initial users encouraged their friends with whom they were already in email and instant messaging contact to also download Skype.  The circles of users grew.  Parents got Skype to reduce the cost of calls to college.  As the network grows, network effect takes over.  It now makes sense for a college student, for example, to get Skype as automatically just as he or she would get email software without thinking specifically about whom he or she wants to exchange email.

Skype is providing not only free software but a free service.  It is Skype’s own computers which facilitate the initial connection between two users who want to talk to each other and which provide something important called “presence management” – a display which shows you which of your friends are currently online and reachable.  Providing this software and service free was a necessary prerequisite to building the large network of users Skype has today; people would not have paid for the initial service because there were too few users on it for it be worth much.  Even the free software and service would not have been sufficient for success if the software had not been very easy to use and the sound quality generally very good.  The “price” of a difficult installation or of poor audio quality would have damped growth when the network was small and had little value to a new user.  But Skype executed well.

In order for Skype to succeed in building a network, people had to know Skype service existed.  But Skype didn’t and doesn’t advertise.  Instead it relies on “viral” marketing, users recruiting other users.  Viral marketing is particularly effective for a communication service because Sally has a very good reason to recruit John as a new user if she wants to be able to talk to him free.  In a sense, Skype is overlaid on the networks of people already communicating with each other on the Internet.  Existing clusters of people who already typed to each other now use Skype to talk.  They recruited each other easily because they were already in touch via their computers.

Skype also had a head start in publicizing its service.  The Estonian founders of Skype were the developers of Kazaa, a file (aka music) sharing problem which is a European version of what Napster was in the US – only more successful.  According to Kazaa’s website, over 389,392,921 copies have been download as of today.  Kazaa, which started with no visible means of support, is now supported by ad revenue,  selling some music, and paid versions of the software which are ad free.  Kazaa users made natural early adopters of Skype.  The fear Kazaa caused in the music industry gave Skype credibility as an agent of creative disruption in the phone industry and invaluable startup publicity even in main stream media.  The experience the founders had with Kazaa helped them set up the server farms used to download the Skype software and host the interconnection service.  Skype P2P (Peer-to-Peer) technology and its ability to work despite interference from firewalls are very similar to that in Kazaa.

The Skype strategy of building a huge network fast without revenue and relying on the power of “free” and viral marketing depends completely on the Internet.  Obviously, a lightly funded company with no revenue going after a mass consumer market has to keep expenses extremely low.  They couldn’t have afforded to carpet-bomb potential users with disks and CDs the way AOL does and did. They couldn’t have afforded a serious media campaign

If there were a per minute component to Skype’s cost when two users talk endlessly, free service would have been out of the question.  But Skype’s computers are only lightly involved in making users visible to each other and facilitating the connection; they are not all involved in the actual transmission of voice, that computing power all comes from the users own computers. Since these calls are computer to computer and don’t touch the traditional phone network, they don’t pass the toll booths of the phone companies which control last mile phone connections.

Skype customer service is pretty much nonexistent but the software is usually easy to use and our expectations for a free service are less than if we’re paying good money. (note that poor customer service could, however, be an Achilles’ heel as Skype expands beyond the tolerant early adopter market.)

Skype now has a commanding position in the nascent peer-to-peer voice market.  Would-be competitors are disadvantaged by the fact that their users cannot communicate with Skype users because Skype has used proprietary rather than standards-based technology to connect its users.  In other words, the founders of Skype have reserved the benefits of the network value they created for themselves – fair enough since they have made all the investment in creating this network value.  The fact that so many people are already on Skype makes it hard for a competitor to explain to a prospect how it is to the prospect’s advantage to connect to a new network that no one is on yet.  A competitor can’t attack Skype’s Peer-to-Peer calling service on price unless the competitor intends to pay its users for calling (don’t laugh, this will happen in one form or another).

The closed network strategy has its disadvantages as well.  A user who can get close to critical network mass and is open can attract industry support and offer users future value that a closed network can’t.  Skype’s potential competitors include Microsoft – no slouch in either proprietary or standards-based solutions itself.

Future posts will be on Skype’s expansion into revenue-based services, closed vs. open networks as a business strategy, and Vonage’s very different model for a VoIP business.

The first post in this series is everything you ever wanted to know about legacy access charges.

The second is about the cost of “free”.

The third explains Metcalfe’s Law of network value.

The fifth is monetizing Skype’s network value with SkypeOut.

The sixth is about Skype reproducing the OLD telephony business model with SkypeIn.

The seventh is a summary of Skype features.

The eighth begins coverage of Vonage’s strategy.

A related post contains a very short abstract of what Skype founder Niklas Zennstrom said at VON (Voice On the Net) Canada and a way to download the slides of my talk there.

As the Phone World Turns Part 3 – Metcalfe’s Law

Bob Metcalfe, the inventor of Ethernet, is also credited with Metcalfe’s Law: the value of a network is proportional to the square of the number of endpoints.  Making Metcalfe’s Law work for you (or not) is the key to success (or not) in establishing a communication services company. A network with 50 endpoints is 100 times as valuable as a network with only 5 endpoints.  Huge networks have huge value.  But, and this is the problem, small networks have infinitesimal value.

The success of Internet phone companies like Skype and Vonage depends on how successfully they harness network effect so it’s important to understand how Metcalfe’s Law operates before looking at these two companies’ very different strategies.

Suppose you invented the world’s first phone.  Who’s your first customer?  There’s nobody to talk to.  This was a real problem after Alexander Graham Bell’s invention.  The first market for phones was the kind of closed network that a company might establish to link its offices because a single purchasing decision to buy a bunch of phones established an instant network and instant value.  A residential market didn’t develop until there were already some phones to talk to.  Then it developed a town at a time.  But value mushroomed when the towns were interconnected through a hierarchy of human operators and switchboards.

The math is intuitive.  The value of a network is actually proportional to the number of connections you can make using it.  To keep things simple, let’s assume these are all two party connections between people.  If you have one person in your network, she has nobody to talk to and the network has no value to her.  If you have two people, they can talk to each other so that’s one possible connection.  If you have three people, there are three possible two party connections.  But, if you have four people there are six possible connections; with ten people, 45 possible connections, 100 people means 4950 possible connections and so on.  If you like formulae, the number of unique two-party connections is (n)(n-1)/2 where “n” is the number of endpoints.

It took one hundred years between the time that fax was invented and people started asking “what’s your fax number?” rather than “do you have a fax machine?”  It took that long because of Metcalfe’s Law.  Fax machines can only talk to other fax machines and so there had to be lots of small networks set up before there was any value in buying a single fax machine.

It took roughly 20 years to go from “what’s email?” to “do you have email?” to “what’s your email address?”  Evslin’s corollary to Metcalfe’s law is that network nirvana is reached when it is assumed that everyone you meet will have an address on that network.

THE reason for the enormous value and success of the Internet is that it is a network of networks.  When networks are connected, there are huge increases in network value.  We can prove it with Metcalfe’s law.  If there are 10 networks with 100 people (endpoints) each which are NOT connected to each other there are 4950 possible connections on each network or 49,500 possible connections altogether.  Now suppose you connect these networks so that everyone can reach everyone else regardless of which network he or she is attached to.  Now there are 499,500 possible connection.  There is a ten-fold increase in value from connecting the networks even though NO new subscribers were added!  That’s what the Internet did by connecting tens of thousands of networks for email and other functionality.

Let’s get back to starting a communication company.  You cannot escape Metcalfe’s Law so you have to figure out how your service can get to having a large enough number of possible connections to attract anyone as a customer.

The easier approach is to make sure your network connects to an existing network.  That’s what mobile phone people did, for example.  It was relatively easy to sell the first mobile phone because it could connect with everyone who had a landline phone.  You didn’t have to wait until someone bought the second mobile phone to have someone to talk to.  Notice that features like text messaging and picture phones couldn’t evolve until there actually were a critical mass of mobile phones which supported them. (Why such features never evolved on landline phones is all about monopoly and regulation, the world’s most effective antidotes to innovation.)

Instant messaging, on the other hand, was an entirely new network.  ICQ (I Seek You), the first Internet instant messaging network, was invented in Israel by Yossi Vardi.  The software was available for free download and enough people downloaded it to create network value.  Yossi is famous for saying ''creating revenue is a big distraction."  He sold his company Mirabilis to AOL for close to $400 million at the beginning of the first dot.com boom.  It had never had a penny of revenue but it did have network value.

The first approach, add on to an existing network, is the safer one and can have revenue immediately.  But it doesn’t create any proprietary network value.  The second vendor of mobile phones used to connect to the landline network is not disadvantaged by the fact that the first vendor already has some subscribers since those subscribers can be reached from any phone.  That’s why mobile companies have to create artificial network value by providing “free” onnet calling.  This approach is the one Vonage is taking.

The second approach, create a new network, is far riskier.  If you want to reach critical mass within a single lifetime (unlike fax), you have to give initial access away since it has so little value when the network is new and small.  The Internet does, however, make it very, very cheap to distribute whatever is needed for access and MOST IMPORTANT, allows a new network of clients to be connected without any incremental investment in infrastructure. Successfully creating a network with millions of users who can all connect to each other is a home run because of the enormous value of the billions of possible connections.  This is Skype’s approach.

More specifics on Skype and Vonage strategies next week.

The first post in this series is everything you ever wanted to know about legacy access charges.

The second is about the cost of “free”.

The fourth is about Skype’s success in building a closed network.

The fifth is monetizing Skype’s network value with SkypeOut.

The sixth is about Skype reproducing the OLD telephony business model with SkypeIn.

The seventh is a summary of Skype features.

The eighth begins coverage of Vonage’s strategy.

A related post contains a very short abstract of what Skype founder Niklas Zennstrom said at VON (Voice On the Net) Canada and a way to download the slides of my talk there.

It’s Time to Go Nuclear

Breaking liberal ranks, columnist Nicholas Kristof wrote in last week’s New York Times that Nukes are Green.  He’s right: nuclear power is a green option that it is irresponsible both socially and environmentally for America not to take.

As China and India come charging out of poverty, their newly minted middle classes are doing exactly what we do here in America with our money – buying things like cars, furnaces, and air conditioners which consume energy.  It is a great thing, a wonderful thing, that we’ve gone in two generations from having our mothers remind us of “the starving children in China” when we didn’t finish our peas to worrying that, if we don’t work hard enough, the Chinese will eat our lunch.  But there is no questioning the fact that “they” are consuming “our” energy.

Over the past forty years the price of oil has gone up and down with the vagaries of international politics.  Inflation-adjusted, it has actually gone down once you smooth out the graphs. The latest increase in energy prices is not a spike but a reflection of permanently greater demand relative to supply.  And, the more of the world that escapes poverty, the greater the demand is going to get,

It is an annoyance to those of us who can afford to blog to pay more at the gas pump.  It is a looming disaster in the parts of the developing world that are not developing at the same pace as India and China.  Mary and I were recently in the central Philippines where a generation of painful economic progress is in danger of being completely wiped out by the recent doubling of oil prices.  Here at home, the real burden of higher fuel prices falls disproportionately on those who can least afford to pay.

Yes, we can conserve better.  In fact we are, largely thanks to microelectronics.  We can all drive hybrid cars and perhaps we will.  Wind and solar have their place.  In fact, they would have more “place” if it were not for NIMBY (Not In My Back Yard), the same force that stymies a new generation of nuclear power plants in the United States.  But demand for energy is going to keep growing no matter what we do in the US.  One of the corollaries of globalization is that we are NOT the world.

Fortunately, the rest of the world is not indulging its political correctness to the same extent that the US is.  France, not a country I usually want to emulate, generates a huge proportion of its power from a set of one-design nuclear plants with an excellent safety record.  China is nuclear in a big way.  (Certainly there are countries which we wish didn’t have nuclear power plants; but they haven’t stopped building them just because we don’t.) Our nukes, now all aging and obsolete, are a series of one-off designs because of a permitting process that forced engineers to negotiate design one plant at a time with the local opposition.  We are not building new nukes and the old ones will eventually have to be decommissioned.

Clearly we would like to get to a “hydrogen economy” for at least environmental reasons.  But fuel cells need to be charged electrically; they are a storage device for energy, not a source; really just more efficient batteries.  So the hydrogen economy is an electricity economy.  We could – and we are – generating more electricity from coal more cleanly than we used to.  But nuclear power is the only available option if the next generation pulls its cars into a service station to charge up rather than fill up.

There are two problems with nuclear power: safety and waste.  Of course, the same problems exist with fossil power as well.  Many people still die every year from the air pollution generated by burning fossil fuels.  Coal mining is safer than it was but still a hazardous occupation.  Foundering oil tankers aren’t a good thing, either.  Although some of the science of greenhouse gasses and global warming is suspect, it’s a dangerous experiment to keep changing the mix of the atmosphere.

It’s important to look at the risks of the alternatives so that we don’t set an impossibly high safety bar to the use of nuclear power.  One of the most effective tools of Luddites has been to insist on absolute safety.  Once that standard is established, nothing is possible.

Three Mile Island scared us for a while although evidence is pretty good that there were no casualties (except US nuclear power itself).  Chernobyl was clearly a disaster whose dimensions we’re still not sure of.  Bad design compounded by politicized and corrupt management is a dangerous thing, no doubt about it. As the Iron Curtain lifted, we found that much of Eastern Europe is an environmental disaster which still waits to be cleaned up.  I believe that we can design, build and operate nuclear power plants with less death and injury per kilowatt generated than the use of oil, coal, or natural gas.  That’s the criteria we have to use.

We do have to face up to the waste problem.  Right now most waste from US nukes is stored onsite  because we haven’t followed through on building a repository in Nevada.  Obviously, this onsite storage is a bad idea.  It is not long term containment.  It leave us with lots of locations where terrorists might try to obtain nuclear material.  The site in Nevada is REASONABLY safe (absolute standards aren’t appropriate; consider the alternatives).  Disposing safely of nuclear wastes is the US is a political, not an engineering, problem.

As long as I can remember, people have been saying that the US can’t go on being the world’s largest energy consumer.  Well, they’re right, not because we’re cutting back but because emerging giant economies in countries with huge populations are starting to consume their share.  It’s time for us to stop indulging a politically correct but scientifically absurd opposition to nuclear power.  It’s time for us to be socially and environmentally responsible by generating our fair share of clean energy.

VON Canada

Andy Abramson points out, correctly, that not much hard news is coming out of VON Canada.  SkypeJournal is doing a good job covering, however.

Skype is the talk of the show and the talk by Skype founder and CEO Niklas Zennstrom was well-attended.  He showed the high adoption rate of Skype and SkypeOut, talked about open APIs, treating customers well, no to regulating VoIP, yes to regulating the traditional carriers (some sign that he may be worried about Skype-blocking; the traditional carriers should be worried about Skype), the need to be honest about what E911 can and can't do and to extend beyond traditional 911 services.  In other words, not much new.  Nevertheless, all eyes there at least and I expect in much of the telephony world are deservedly on Skype.  More blogging by me on them to follow.

The slides from my presentation at VON Canada are available Download von_toronto.ppt .  Lots of opinion but no hard news from me either.

As the Phone World Turns Part 2 – The Meaning of Free

Yesterday I blogged that we can predict the future business model of voice calling by observing the past of email.  One implication of this analogy is that voice will be free regardless of where in the world the parties to the call are located, how far apart they are from each other, and how long they talk. In fact with Skype or Vonage or a number of other services, calls between VoIP users are free today.  But what does “free” mean?

“Free” is a great marketing word but it’s not completely accurate when applied to either email or phone calls.  If email were free, there’d be no such thing as the digital divide because poor people would be able to afford it.

In order for you to use free email, you or someone else needs to pay for:

1. Internet access
2. Hardware
3. Email software to run on the hardware
4. A host service which is willing to let you use its mail server to send and its storage to receive and save

Each of these four elements costs somebody something.  Yahoo or Google or MSN/hotmail will host your email “free”, for example, but they expect something from the relationship.  They know you are a qualified prospect because you have a computer and an Internet connection.

What is important is that there is no incremental cost for sending (or receiving) a second email once you have the capability of sending the first message.  And, if you already have a computer and Internet connection for other purposes (or because your employer provides them), there may be no incremental cost at all for email.  So, not surprisingly, email usage has gone though the roof and become a mainstay of communication on the wealthy side of the digital divide.  There is a downside to “no incremental cost”: the same economics apply to spammers as to the rest of us. A torrent of email can be supported by an infinitesimal rate of return.

Now what do you need to make “free” Internet phone calls?

1. BROADBAND Internet access
2. Hardware
3. VoIP software to run on the hardware
4. A host which is willing to let you use its VoIP server to locate the people you want to talk to and perhaps provide other services

Again, if this were “free”, we could abolish the Universal Service Fund in the US and the equivalents around the world and be comfortable that vital communications services are available to everyone regardless of income.

As with free email, what really mean when we talk about “free” phone calls between VoIP users are calls that are free of any incremental cost once the initial investment has been made.

But I’m going to keep writing “free” rather than “at no identifiable incremental cost given certain prerequisites” because my blog would be unreadable otherwise.  Besides, we act as if email were free and soon we’ll be able to act as if phone calling were free.

The first post in this series was everything you ever wanted to know about legacy access charges.

The third is about Metcalfe’s Law.

The fourth is about Skype’s success in building a closed network.

The fifth is monetizing Skype’s network value with SkypeOut.

The sixth is about Skype reproducing the OLD telephony business model with SkypeIn.

The seventh is a summary of Skype features.

The eighth begins coverage of Vonage’s strategy.

A related post contains a very short abstract of what Skype founder Niklas Zennstrom said at VON (Voice On the Net) Canada and a way to download the slides of my talk there.

As the Phone World Turns Part 1 – Legacy Access Charges

We are not at a tipping point in how we make and pay for phone calls; we are at a FLIPPING point.  The AT&T band, if there still were one, would be playing “The World Turned Upside Down” like General Cornwallis’s band at Yorktown as the British surrendered their arms to the rag-tag colonials.  I’m not talking about SBC buying AT&T: that’s just rearranging the deckchairs on the Titanic.  I’m talking about real change.

I’m indebted to Gordon Cook, author of the Cook Report which you can preview free but have to buy if you want all the riches, for forcefully reminding me that it’s all software now.  Telephony, like email, is moving out to the endpoints. It is exploding at the endpoints largely because of Skype’s successful software distribution model. The middle, where the huge carriers provide overpriced services, is hollowing out.

There is no one who charges you for each email you send.  There are no monopolies in email.  Looking at how email works and is paid for is a great way to figure out how voice calls will work and how voice calls will be paid for.  I’ll be blogging on this for a while but intermittently so that neither you nor I get bored with the subject.

Most of today’s post is about legacy access charges.  They are what local and wireless phone companies charge people to access you on the line you are already paying them for and the equipment you own.  Access charges as a revenue source for phone companies are on the way out – faster than I ever thought would be possible.  Something rather wonderful may happen with them in the future.  I’ve blogged about this speculation and am speaking about it at VON Toronto today.

If you are already a telephony expert – or if you don’t want to learn about legacy access charges just in time for them to disappear – you may want to skip the rest of this post.

Suppose your ISP wanted to charge the sender for each email YOU receive.  You’d say that was absurd and you’d quickly get a new ISP.  But in the United Sates your friendly local phone company gets to charge per minute for each incoming call to you.  These charges,  which are called “access charges” or “reciprocal compensation” depending on how local a call is, are an arcane holdover from cost and revenue sharing after the breakup of monolithic AT&T in the 80s.  They are the pathetic remnant of internal cost allocation within the old monopoly.

Local phone companies love this revenue.  Even nasty public service boards rarely complain about it because most of it is paid by out-of-state callers.  You never see the amount somebody pays to call you on your bill so you don’t complain about it either.  Of course, when you make a traditional “long distance” call, you are paying to “access” someone else.

On a national level, phone companies charge more to terminate an international call than a domestic one.  Obviously, their costs are the same to reach their subscriber no matter where the call originates but the politics are different.  Out-of-country callers don’t have any in-country political clout.

Part of the historic reason that VoIP calls have been cheaper than POTS (Plain Old Telephone Service) is arbitrage against these arbitrary rate structures.  From a POTS point-of-view, an Internet call “originates”  wherever it hops off the Internet and onto the POTS network.  So, suppose you can make a VoIP call from the United States to a POTS phone in Timbuktu.  The call travels from the US to Timbuktu on the Internet.  It is “reoriginated” as a domestic call in Timbuktu and the amount your carrier and eventually you pay for that call is determined by the domestic and not international rate in Timbuktu.  In some cases there is a regulatory distinction between VoIP and POTS calls; in others there is just the practical distinction that VoIP calls look to POTS like they originate where they hop from the Internet to POTS.

Similarly, VoIP providers in the US typically don’t pay interstate access charges for domestic calls which they terminate to the PSTN; this reduces the costs to a VoIP provider and has helped make services like Vonage, AT&T CallVantage, Lingo, Packet8 and others available at attractive unlimited-usage prices.  The regulatory jury is still out on this.  AT&T drew an adverse ruling from the Federal Communication Commission when it asked for a declaratory judgment that even POTS-to-POTS calls which have an IP hop are exempt from access charges.  But the FCC was careful to limit the scope of its ruling so this does not apply to services like those I listed where the calls start on the Internet; their status is unclear at the moment.

But what if a call never touches POTS?  What if it goes from one Skype or Vonage subscriber to another?  These calls are free today to Skype subscribers and are bundled with the subscription price for Vonage subscribers.  The calls are free no matter where in the world the two (or more) people who are talking to each other are located. Hmmm…  Just like email. 

At the same time the FCC ruled against the AT&T petition, it ruled in favor of a petition by Jeff Pulver’s Free World Dialup saying that the free calls FWD provides between VoIP endpoints are immune from access charges.  Hard to even know who would get the access charges but there are certainly some local phone companies who would like to. Not gonna happen, though, says I.  Even with huge lobbies, phone companies aren’t going to get the right to charge tolls on “free” calls that don’t touch their POTS networks.

And now with Skype surpassing 100,000,000 downloads and with millions of subscribers online at any time, the VoIP-to-VoIP calls are becoming very significant.  That’s why we’re at a FLIPPING point.

The second post in this series is about the costs of “free”.

The third is about Metcalfe’s Law.

The fourth is about Skype’s success in building a closed network.

The fifth is monetizing Skype’s network value with SkypeOut.

The sixth is about Skype reproducing the OLD telephony business model with SkypeIn.

The seventh is a summary of Skype features.

The eighth begins coverage of Vonage’s strategy.

A related post contains a very short abstract of what Skype founder Niklas Zennstrom said at VON (Voice On the Net) Canada and a way to download the slides of my talk there.