Internet Phones in Spotlight
Companies face more scrutiny by U.S., state agencies

Verne Kopytoff, Chronicle Staff Writer

Regulators in various states, including California, along with the Federal Communications Commission, are reviewing whether Internet telephone companies should pay the same fees as telephone companies that use traditional lines, such as SBC.

The states are concerned that the increasing popularity of routing calls over the Internet will eventually decimate funding for programs that help the deaf and disabled, connect schools and libraries and pay for 911 service. But Internet telephone companies are fighting vociferously.

How the issue is resolved promises to greatly affect the landscape of Internet telephony, or voice over Internet Protocol, as online telephone calling is sometimes referred to. At stake are questions about competition, innovation and the promise of reducing consumer telephone bills.

The issue was at the forefront Thursday during a state Public Utilities Commission hearing in San Francisco. Regulators listened to a staff report and testimony from industry representatives about what course the state should take.

"We are hopeful that you will develop pro-competitive and pro-consumer policies,'' said Michael Sloan, an attorney for Vonage, an Internet telephone firm based in Edison, N.J.

Internet telephone service makes up only a fraction of overall telephone use with about 100,000 residential subscribers in North America, according to Frost & Sullivan, a market research firm. But the number of users could grow to 9 million by 2009, according to the company.

The lure is cheaper prices. The technology allows calls to be transmitted over Internet lines more cheaply than over traditional wires.

For example, Vonage, the most popular consumer service, with about 50,000 subscribers, offers unlimited local and long-distance in the United States and Canada -- where service is expected to start soon -- for $34.99 a month. International rates can be a third of what AT&T charges.

The big telecoms are also trying to expand into Internet telephone calls. Many already route some calls at least partially over the Internet, and some plan to offer consumer services.

Depending on the Internet telephone service used, calls can be made from telephone to telephone, computer to telephone, telephone to computer, or computer to computer. Users speak into either a telephone or a microphone.

The quality of the sound varies. Early versions of the services were spotty, with echoes and cut-off voices, but newer technology has brought quality up so it is roughly on a par with wireless telephones.

Since their inception in the late 1990s, Internet telephone companies have been considered information services and are therefore not regulated. Unlike the Baby Bells, information services don't pay fees to the states for subsidy programs, known collectively as Universal Service.

More people using Internet telephone calling will mean fewer traditional telephone subscribers, and therefore less revenue for Universal programs. Jack Leutza, PUC telecommunications director, told the commissioners Thursday that Internet telephone calls could reduce the fees collected for the Universal Service programs by $183 million to $407 million in 2008. Those programs are expected to spend $939 million for fiscal year 2003-04.

"This is a very big issue to the staff," Leutza said.

Last month, the PUC sent letters to five Internet telephone companies that asked for applications to do business as telephone companies. All the recipients refused to fill out the paperwork and responded with letters asserting that they are not subject to oversight.

In a closed-door session Thursday, the PUC discussed what to do next. No details were released.

Bryan Martin, chief executive for 8x8, an Internet telephone and video company in Santa Clara, said that he would support paying fees to the state if the money went to expanding the use of broadband or enabling 911 operators to take calls from Internet telephone users with video capabilities. He estimated that his company would pay only a few hundred dollars in fees because it has only about 10,000 subscribers.

"The tax issue is insignificant,'' Martin said. He added that regulation would probably require him to hire a paralegal or two to take care of the extra paperwork.

Internet telephone calls are also an area of interest to the Federal Communication Commission. It said it will study the issue Dec. 1 as part of a yearlong inquiry.

Last month, a federal court in Minneapolis ended Minnesota's attempts to regulate Internet telephone companies. The judges said Vonage is an information service and doesn't need a telephone operators license.

Jon Arnold, an analyst for Frost & Sullivan, the research firm, said that regulation could keep the industry from innovating and perhaps put it at disadvantage to the much larger and established telecoms.

"Don't regulate something that is going to be so key," Arnold said. "Give it some breathing space. It's not going to go away."

Tom Valovic, program director for Internet telephony for the research firm IDC, raised the possibility of states adopting different rules.

"We could end up with the patchwork quilt of regulatory approaches, which would definitely be an obstacle," he said.

Valovic also pointed out that designating Internet telephone companies as telecommunications firms could open the door to them paying fees for using the lines of big carriers.

For example, calls between a Vonage subscriber and a non-subscriber would have to travel at least partially over a big carrier's lines.

For now, Vonage doesn't pay the big carrier.