Friday, July 03, 2009

Is MagicJack The Next Ma Bell?

The telephone industry is in trouble, we're told. Young people are shunning the traditional landline phone service that their parents and grandparents treated as a necessity of life. The breakup of the Bell System into smaller independent companies serving regional areas says that there will never again be anything like the ubiquitous "Ma Bell" that served every home and business. Clearly, the once proud telephone network is a goner. Or is it?

It's true that cell phones have replaced traditional analog phone service for about a third of the population. Those in their teens and 20's don't remember a time when there wasn't wireless. They got their first cell phone in high school or college, in much the same rite of passage as teens traditionally get their first cars. Once untethered, why go back and pick up something as archaic as a telephone with a wire?

It's also true that the breakup of the Bell System resulted in such an upset in the industry that it will never be the same. For awhile the technology remained the same and only the names of newly competing phone companies changed. The one key resource was the copper telephone cable that had been installed to virtually every home and business over the preceding 100 year build-out of universal telephone service. CLECs or Competing Local Exchange Carriers leased these lines at cost from the ILECs or Incumbent Local Exchange Carriers, who maintained ownership of the wires. That worked just fine until the ILECs persuaded the government to let them charge retail, not wholesale, prices for leasing their lines. That ensured they could easily make a profit. It also changed a competitive playing field to one where the CLECs could no longer compete, and they pretty much all fell by the wayside.

Not being able to compete on analog phone service, savvy competitors found a way to bypass the ILECs and the high lease prices they demanded to use "their" phone wires. Instead, they leveraged another set of wires that came into most every home and business. Those were the wires that delivered broadband Internet service. By piggybacking on the broadband connection that people were already paying for, VoIP phone service providers essentially got their phone wires for free.

That's why VoIP providers can offer such good deals on bundled local and long distance service. They use the Internet to transport digitized phone conversations between your location and their facilities. At those facilities they "terminate" or connect with the traditional PSTN, or Public Switched Telephone Network, so that VoIP users can call landline or cell phone users.

It looked like VoIP companies were in the catbird seat until yet another type of phone company came on the scene. Instead of charging around $20 a month for unlimited local and long distance service, this company was offering unlimited bundled service for around $20 a year, over a 90% cost cut. How can any company offer prices this low and still survive? How can VoIP providers stay in business any more than wireline CLECs could when they lost the competitive advantage?

The company that's causing the latest upset in the telephone business is MagicJack. The secret to their business model is that they are a hybrid between a traditional wireline telephone company and a VoIP provider. The parent company of MagicJack, YMax, is a registered CLEC throughout the country. In essence, YMax is a nationwide phone company in the image of Ma Bell, sans the traditional analog phone wires. They get around this limitation by using your broadband Internet to connect with their central offices.

Owning their own network to carry the calls saves YMax the cost of leasing other people's facilities. They still have to pay termination fees for calls that leave their network, but they also collect termination fees from other phone companies when someone calls a MagicJack number. So if the majority of users had MagicJack, YMax would collect far more in termination fees than they would spend. At some point they would become the default nationwide phone company and claim the title of Ma Bell II. Maybe Momma Jack or MoJo would be more appropriate.

Now you can see the method behind the magic of offering MagicJack phone service for the cost of the USB hardware that connects your phone to your computer so it can use the DSL or Cable broadband line, plus about $20 a year for service instead of a monthly phone bill. The MagicJack is reportedly selling at a clip of 9,000 to 10,000 units per day. If they can keep this up, how long will it be until the tipping point is reached and they own the residential landline business?

OK, but what about those younger and more mobile users who don't want a wire of any kind tethering their phone to a particular location? YMax is getting ready to go after a slice of this market with a new product called the FemtoJack. It will also plug into your computer. But instead of a wire to your home phone, it will connect wirelessly to your cell phone. The idea is that while you are home you'll make your calls over the Femto Jack instead of burning your monthly minutes on the cellular network. If your house has a dead zone for cellular, this will be an even better deal.

The next question is whether YMax will settle for having a major piece of the residential phone service business, assuming an even savvier competitor doesn't come on the market. Or, will they start working their way into the business market or launch a VoIP wireless network to really take on the cellular carriers? Those would be even more ambitious projects, but they are the key to dominating telephone service in the future.

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