Voice Over Internet Protocol
Stirs Up Regulatory Showdown

Michael L. Smith

Public Policy Research Paper
XMIT 694 Capstone Course
April 2003

University of Maryland University College
Graduate School of Management and Technology

Abstract

Voice over Internet Protocol or IP Telephony has been around for almost a decade, but only recently has it begun to emerge as a viable, cost-effective technology that can challenge the prevailing system of circuit-switched phone services. However, recent improvements in the technology have turned it into a challenger to the entrenched regional Bell operating companies (RBOCs) even in consumer markets. Because VoIP services have been considered nascent industry, they have not had to be tightly regulated as the RBOCs are. Now the Federal Communications Commission is being asked to spell out the regulatory framework that VoIP services will operate under. This paper examines several petitions, from the Free World Dialup service and AT&T, as well as the position of those companies and institutions that oppose continued unregulated status. It also explores issues related to requirements to ensure eavesdropping capacity for the FBI that are imposed on conventional systems. It will also examine a related issue concerning the limited pool of available phone numbers. It also looks at broader issues about what the shift from the 100-year-old switched circuit networks to data network-based systems and what it will mean for business models.

Public Policy and Voice over Internet Protocol

Introduction

VoIP was a system that only a ham radio operator could love and, in deed, many of the early adopters were just that.

In 1995, the first geekie pieces of software began appearing on pioneer web pages on the World Wide Web that promised to permit two people to converse to each other. The software required the user to buy a special soundcard, speakers and a mini-microphone. The voice quality ranged from poor to atrocious. It was a system that only a ham radio operator could love and, in deed, many of the early adopters were just that. At the time, the applications and services were deemed so experimental that the U.S. government and other regulators classified Voice over Internet Protocol (VoIP) or IP Telephony as worthy of a kind of regulatory incubator.

It would take more than five years to erase that scratchy, hoarse reputation. Now the regional Bell operating companies (RBOCs) are taking stands how to exploit it or hold it off from encroaching on their domains. Even the venerable AT&T has become an advocate for the technology. IT hardware manufacturers and software application providers are looking to VoIP as the killer application that will lift them out of the wreckage of the dot.com bust. Corporations are looking on how convergence will impact on their bottom line and make them function more efficiently. At the same time, the performance of the Internet in the United States and other industrialized countries has improved to the point that it can handle voice data streams with acceptable quality.

Up until now, the Federal Communications Commission (FCC) has treated VoIP telephone services the same as they have other enhanced and information service providers (collectively called ISPs) until the Internet market moves beyond its nascent state, becomes a mature market and generates sufficient cost accounting to determine if access charges, taxes and other fees were warranted. But there is a growing chorus - far from harmonious - that is calling for the FCC to lay down the law, either with clear ground rules for this emerging industry or bring the services into line with convention phone services.

RBOCs'investment in wires seems to lead into the sunset.

This paper proposes to explore a couple of petitions that are waiting for a hearing from the FCC that have to do with the regulatory treatment of VoIP. We will also explore some of the players that are prospering in the gray areas of this technological shift.

High Stakes

At first glace, it might appear that the regional Bell operating companies are sitting pretty in the wake of the telecommunication industry's implosion over the past three years. But Daniel Briere, a telecom consultant, maps out a threatening horizon for the regional Bell operating companies (2003, p. 37):

Biere concludes that the RBOCs are confronted with tough issues and require investment, creative and differentiated services and swift, reactive decision-making.

Historically, telephone calls were made through public switched telephone networks (PSTN) that establish a closed circuit between two points. In a VoIP system, the analog voice signal is converted to a digital format and transmitted as a stream over a packet-switched data network. The IP networks let each packet independently find the most efficient route to the destination. At the destination, the packets are put back in order if they arrived out of sequence and then converted back to a voice signal. Over the past few years, VoIP has predominantly been adopted by corporations that take advantage of their heavy investments in data networks and also save on long-distance calls by routing phone traffic over their wide area networks (WAN).

A Yankee Group study (Gagan, 2003) says:

"IP telephony is the long-range answer to lowering service and intra-office toll charges. Spending on phone systems will now shift toward IP telephony, replacing money spent on traditional circuit-switched PBXs. IP telephony lets enterprises manage all offices over the corporate WAN from a central location. Using the WAN to connect offices also eliminates usage charges for intra-office calling."

Since the switch over to VoIP is practically guaranteed, the question is when and how the switch should be carried out. In fact, now a traditional circuit-switched PBX is considered "dead-end technology" and no further improvements will be made to this equipment (Krasnoff 2002a). Companies like Cisco Systems Inc., Nortel Networks Corp., and Avaya Inc. promise that putting phones and computers on the same network can cut costs and give employees new options like reading voicemail or listening to e-mails. However, this is not the kind of technology that you can turn on one day and then throw out the old PBX (Carew 2003).

Although corporate VoIP implementation has been predominant, it has not threatened the role of the RBOCs as the backbone of the public telephone system. What has happened recently is that consumers are finding out that VoIP solutions for their homes are available, easy to install and attractively priced.

Internet calling has improved in quality to the point where analysts expect the industry to soar over the next few years. TeleGeography, a phone industry analysis firm, estimates that there were 18 billion minutes of VoIP phone calls in 2002, or about 10 percent of all the calls made. Elka Popova, an industry analyst with Frost and Sullivan, predicts that consumer and enterprise VoIP will grow at over 100 percent annually for the next few years, becoming a $100 billion industry by 2007. (Charny 2003)

Free World Dial-Up

A petition for a declaratory ruling filed by pulver.com on behalf of its Free World Dial-up peer-to-peer voice service was put out for public comment in March. CEO Jeff Pulver said the petition's intent is to state for the record that telephony over broadband, a service that never touches the legacy public switched network but uses the public Internet, should not be regulated. At the FCC, there are 40 documents filed. Specifically, it asked to declare that FWD is not either "telecommunications" or a "telecommunication service," as defined in the 1934 Communication Act of 1934, as amended.

Free World Dialup has been called "Napster for Phones." It's a free service aimed at developing Internet telephony as a mainstream alternative to the public switched telephone network. After an initial investment of about $250 for a Cisco SIP telephone -- a device that functions much like a conventional analog phone, but plugs directly into an IP network -- users can "dial" each other over the Internet anywhere in the world at no cost. Another supported hardware device, the Cisco ATA-186 connects to both the broadband internet access and either a regular telephone or a cordless telephone. A user can also employ a software application, like Microsoft Windows Messenger 4.6 or 4.7 to access the voice network. Since it was launched in November, the service has gathered over 13,000 users from 65 countries.

The FWD service functions much like instant messaging. Free World Dialup provides a directory service that assigns each user a virtual telephone number, and sets up each phone call. What's more, instant messaging companies, like Yahoo and MSN Messenger, are offering voice and webcam communication as part of their services that duplicate phone services, but require a computer equipped with either a headset or speakers and a microphone.

On one side, Qwest, WorldCom, Global Crossing and Cisco have supported the FWD petition. On the other side, SBC, BellSouth, Verizon, the Federal Bureau of Investigation / Department of Justice and the United States Telecom Association (where is the verb?). Some of the comments state that FWD is not a good example for a ruling because it is atypical of VoIP services. Instead, the FCC should either ruling on petitions already in hand that are related to the VoIP issue or carry out a mega-proceeding to evaluate all forms of voice over IP (Free World Dialup 2003).

Pulver, who have served over the past five years as an IP telephony evangelist and promoter, has admitted he is being a bit of a provocateur: "I figured that the time was right to be proactive for a change."

FBI Worried About VoIP

But there are additional factors that complicate the deliberations. The Department of Justice and the Federal Bureau of Investigation (FBI) are concerned that VoIP might prove to be a difficult medium to eavesdrop on. Under the Communications Assistance for Law Enforcement Act (1994), frequently known by its acronym CALEA, phone companies are required to build in surveillance capabilities. But the lawmakers did not anticipate the emergence of Net-based voice calls and exempted information services like the Internet (Jesdanun 2003).

Privacy advocates are concerned that because online eavesdropping technology is only just getting off the ground, tapping into the data stream for voice means getting more than what a court order might cover.

Privacy advocates are concerned that because online eavesdropping technology is only just getting off the ground, tapping into the data stream for voice means getting more than what a court order might cover. The Electronic Privacy Information Center < > points out that some court orders cover only call information (who called whom and when), but FBI eavesdropping could scoop up call contents and other data from other subscribers.

VoIP companies, like Vonage and Net2Phone, says that they are working to incorporate surveillance capabilities even though they believe they have no legal obligation. However, many companies question why they should assume the burden of developing and deploying the surveillance technology (ibid.).

Pulver told Security Focus (2003) that it's the government that misunderstands the situation: "My hope is that the DoJ/FBI did not take the time to fully understand what Free World Dialup is and isn't, and after some proactive education it will be clear that we don't fall under the definitions. It is much easier to build the wiretap function into the access method, which is infrastructure based, rather than on every Internet application that comes along." Other security experts point out that if users were determined to skit FBI surveillance, they could easily set up their own alternative directories. It's much like a buddy list in instant messaging. A more appropriate approach would be for the FBI to focus on the target's Internet access. In deed, the FBI already had submitted petitions to the FCC to broaden CALEA's reach to include DSL and cable modem services and also to permit access to raw data communication.

Other concerned parties

Other interests that will be affected by an extension of an exemption to FDN and other VoIP services are the institutions that depend on the income flowing out of traditional phone services. As phone usage is diverted to VoIP, that trend would dent universal service funding. In addition, because Internet business ventures have, for the most part, been exempt from sales taxes and other charges, state and local governments are increasingly pressuring to apply taxes to Internet transactions as well as apply levies that apply to phone services. The National Association of Regulatory Utility Commissions' Telecom Committee passed a resolution in February 2003 asking the FCC (2) confirm its tentative 1998 conclusion that some phone-to- phone calls placed with voice-over-Internet protocols (VoIPs) were telecom services and (2) convene a joint conference to address the impact of VoIP on jurisdictional rate and separations issues and on intercarrier compensation regimes (State Telephone Regulation Report 2003).

New Kids on the Block

The Cisco ATA box plugs into an Ethernet connection and an analog phone.
 Cisco ATA box
While FDN is a not-for-profit venture, there is real competition out there for the RBOCs. Vonage is offering an all-you-can-eat VoIP service for $40 a month. Users must have a broadband connection and a hub or router. Vonage provides a Cisco ATA (Analog Telephone Adaptor) 186 that is plugged into the router/hub and then to a standard analog phone or wireless phone. Vonage had has earned headlines recently because of its VoIP products for the residential and small-business market because of its feature set and ease of implementation. With the service, users get to make long distance calls within the United States and Canada free of charge. International rates are lower than conventional phone services as well. One of the disadvantages of VoIP as implemented by Vonage is that emergency services are not available, but the company recently assigned on Intrago to route 9-1-1 calls to the right geographic area.

For the monthly charge, a user gets online account management with real-time billing, caller ID, call forwarding, call waiting, call transfer, voicemail and online voicemail retrieval, call blocking, and call return. For a more modest monthly charge of $26, the user gets the same features, but domestic long-distant calls are limited to 500 minutes a month before per-minute charges kick in. There are also small business plans that range from $40-70 a month. For an additional charge, users can get additional virtual phone numbers outside their area code that are routed back to the primary number.

[I should note that I have been a Vonage customer for the past two months. I have used the service not only at my home, but also plugged it into the network in the UMUC Shady Grove classroom and at my workplace at the Organization of American States in downtown Washington. In both case, the dial tone started up right away and I was able to make and receive phone calls. I have the $40-a-month service and use it mainly for long-distance calls within the United States. I have turned off a second landline that I had from Verizon. I still have a Verizon line. Since I wrote this piece John Dvorak wrote a column on using Vonage from his hotel. He sounds like a convert.]

Another company that has been around for a long time is Net2Phone. Vonage also has two direct competitors: iConnectHere from Deltathree of New York, and Packet8 from 8x8 of Santa Clara, Calif. [Since I wrote this article, an interesting software package came out, Skype, brought to you by the same folks that created KaZaa. However, it can only be used among other Skype users, so it's similar to Free World Dialup or voice mode with IM clients. It's had nearly a million downloads, as of end-September.]

AT&T Petition

In October 2002, AT&T petitions the FCC for a ruling that "phone to phone" IP telephony over the Internet are except from the access charges applicable to circuit switched calls. AT&T says that it needs this ruling to end disputes with LECs over the applicability of interstate access charges and as guidance to state governments who follow the Federal rule in assessing intrastate access charges. AT&T's petition is an in-depth explanation of the issues facing VoIP and the reasons for its peculiar status. The FCC's 1998 Report to Congress provides most of the reasoning for giving VoIP services an exemption (AT&T 2002). The petition has stirred up more than one hundred responses from competing companies, allies and telecom kibitzers alike.

Phone Number Crunch

On another front, the North American Numbering Council (NANC), chartered by the FCC to develop policies for distributing phone numbers, received a report from BellSouth, Qwest and Verizon that warned that VoIP providers were causing difficulties in the way the telephone industry allocated and tracked numbers and this trend might lead to a scarcity of phone numbers. The report said that VoIP did not follow geographic rules in offering area code numbers to their customers. In other words, a company could request a number for New York even though it is physically located in Chicago so that it gives the appearance of having a local office in New York (Telco Business Report 2002).

Roger Atkinson, chairman of the North American Numbering Council, says the transfer to a new number scheme, whenever it happens, might cost as much as $150 billion in current dollars. He says that the current stock of numbers could run out by 2015. At the height of the dot.com boom, predictions pointed to 2009 as the doomsday, but the collapse of the telecom industry pushed that date back to 2031. Approximately 1.3 billion telephone numbers currently remain available. Spokepersons for VoIP companies say that they are highly conservative in handling out phone numbers, and a more likely cause of a run on phone number is coming from the wireless companies. Many users are replacing a second land line with a VoIP number or transferring their old number to the new service. (Di Justo 2003).

Pulver management sees this initiative as a spoiler tactic in a "clash of technologies" to hide the phone companies' intentions to impede small VoIP players.

Pulver management sees this initiative as a spoiler tactic in a "clash of technologies" and a "smoke screen" to hide the phone companies' intentions to impede small VoIP players or at least give the RBOCs time to get their own VoIP product into place. Pulver and other VoIP advocates argue that the real culprits in draining the pool of available numbers are wireless carriers, in which the RBOCs have a large stake (Telco Buisiness Report 2002).

A Changing Paradigm

Clay Shirky thinks that most phone companies have missed the point.
Clay Shirky - photo

Clay Shirky (2003) sees in the emergence of new VoIP and Wi-Fi services a shift in the network market. He recalls that back in 1984 FedEX thought that it had the perfect extension of its delivery service - a facsimile service based in their installations and then messages delivered by hand within 2 hours via its fleet of bicycle couriers. It was called Zapmail. The mutli-million dollar venture turned out to be a flop. FedEx did not realize that customers would prefer to purchase their own fax machines and install them on their own phones. Shirky says that FedEx did not understand that fax was a product, not a service; it did not see that users were willing to underwrite the costs of building a new network themselves; and it thought that UPS and DHL were its direct competitors; in fact, the competition was its customers themselves.

Skirky says that the phone companies are committing the same error that FedEx did two decades ago. In the case of Wi-Fi, the proliferation of hot-spots, both intentional and accidental, means that the access point will become the equivalent of the fax machine. Today, you can walk around Manhattan and have wireless Internet access. University campuses and even towns are laying out wireless networks as a convenience for their constituencies.

"According to Metcalfe's Law, the value of an internet connection rises with the number of users on the network. However, the phone companies do not get to raise their prices in return for that increase in value. This is a matter of considerable frustration to them.

"The economic logic of the market suggests that capital should be invested by whoever captures the value of the investment. The telephone companies are using that argument to suggest that they should either be given monopoly pricing power over the last mile, or that they should be allowed to vertically integrate content with conduit. Either strategy would allow them to raise prices by locking out the competition, thus restoring their coercive power over the customer and helping them extract new revenues from their internet subscriber.

"However, a second possibility has appeared. If the economics of internet connectivity lets the user rather than the network operator capture the residual value of the network, the economics likewise suggest that the user should be the builder and owner of the network infrastructure."

If Shirky is right about this technological shift, it will take a while for the market to catch on to this new reality and even longer for the legal and regulatory framework for adapt to the parameters. In a sense, the U.S. government's policy of holding back on changing regulations until industry catches up to technology.

International Implications

The market trends have an impact well beyond the confines of the United States, especially since the Internet has spread around the global and many countries are in a position to adopt new technology without the hindrance of vested interests or investments in existing hardware. On the other hand, in many markets, VoIP deployment runs into roadblocks that would be unimaginable in the U.S. For instance, Panama attempted to block all use of VoIP technology. Phone services in Panama are provided by Cable and Wireless in an exclusive contract, a similar arrangement that C&W has throughout the Caribbean. It successfully brought suit against Net2Phone in the Cayman Islands in 1998 (Hansen 2002).

In many of these countries, the state may hold a monopoly of all telecommunication service and do not want to accept new competition. In other case, like those companies that have recently sold off state telecom companies to private (usually international) investors and they may have made long-term of long-distance services so that investors could be sure of the return on investment.

The International Telecommunications Union and its many of its members have made a huge political and financial investment in the 3G technology. However, VoIP and Wi-Fi are seen as a threat that could undercut the viability of this initiative (G. Piedras, personal communication, April 1, 2003).

What is striking, however, is how broadly IP telephony is stirring interest internationally. In a recent trip to Peru, I saw scores of cybercaf´┐Żs in practically every neighborhood of Lima. These installations charge Internet access at an hourly rate and openly advertise that they have IP telephony applications on their computers.

With a Vonage phone service, a user can plug in the ATA device at any Ethernet high-speed connection anywhere in the world and make local calls as if it were still back in a U.S. area code. A New York Times reporter based on Paris, France gave a glowing review of the service.

In Japan, Yahoo broadband had signed up 1.8 million VoIP users by February this year (Converge Networks Digest 2003).

Conclusions

The FCC does not have to make a ruling on any of the petitions currently awaiting scrutiny. It's clear from its most recent rulings concerned long-distance and broadband services that there is no clear consensus about how to proceed, even signaling a division between the Republican appointees. With so many issues and petitions simmering on the regulatory stove, the FCC may just let the petitions of FWD and AT& T simply sit in the docket. That in itself is a decision because it continues the regulatory limbo that permits all services unencumbered except those explicitly regulated.

The diverge forces bearing down on the VoIP issue may end up nullifying each other. The RBOCs are not united behind a single position, while TV cable companies and other Internet service providers stand to gain a lot from offering VoIP services in addition to TV feeds and Internet access. For the FBI and surveillance concerns, there are probably technological solutions that can satisfy eavesdropping requirements, but they may not be satisfactory to privacy advocates.

But VoIP deployment is not going to wait for a bureaucratic ruling, in part because the technology is so compelling and practically pre-ordained for adoption by all phone providers. In combination with Wi-FI and associated technological innovation, VoIP may gain additional features and cost advantages that make it a no brainer about which phone system should prevail. Although the FCC's Michael Powell may be a change from previous Democrat-appointed FCC chairmen, he is clearly decision-maker who has a nose for technology.