For most cable operators, their telephony business is on hold while traditional circuit switched technology migrates to IP-based telephony and myriad operational, marketing and business questions are addressed. For a select few, however, laying down a telephony footprint is a key component to their long-term telephony business models.

Crucial questions about the viability of the telephony business for cable operators, whether circuit switched or next generation Voice-over-Internet Protocol (VoIP), are slowly being answered via trials, and in some cases, through actual deployment by major players such as AT&T Broadband and Cox Communications.

Yet most industry players are wary of the capital costs and wide-ranging operational hurdles associated with their future telephony business strategies. Even with costs trending down for equipment, software and truck rolls, launching a telephony business over cable can cost well north of $1,000 per subscriber, with a palatable return on investment several years away, experts say.

Transforming a one-dimensional business such as cable to a multi-transactional operation is a serious challenge that includes near-perfect network reliability, the integration of intricate back office functions, unfamiliar engineering procedures and a wholesale change in marketing and customer service mentalities. Not exactly a perfect business model.

Despite those daunting tasks, however, most of the larger MSOs (multiple system operators) are building a business case for telephony service and developing the necessary relationships with equipment vendors and software companies, while re-engineering their organizations to eventually deploy various forms of telephone service.

Why not? With nearly 85 percent of the world's telecommunications revenues coming from voice services, and average revenues from the triple play of services–video, voice and data–projected to be well above $120 a month per subscriber, it's no wonder most MSOs are paying close attention to the telephony and data businesses and the spectacular revenue potential they could offer.

"There's lots of interest in the telephone and data worlds via the Internet," says Tom Jenkins, director of convergence for TeleChoice Inc., a media research and analyst firm. "It's unbelievably attractive for operators to add telephone services. Even if they only offer data and increase their revenues from 15 percent of the customers, the revenues are huge. But it's also a huge business decision."

The decision to deploy telephony service entails a series of tough questions and issues, from marketing to operations to corporate culture changes. "The marketing, operational and cultural changes will affect every piece of their business," Jenkins notes. "The architecture isn't significantly different from their current headends and gateways. But, from a marketing, services and support standpoint, they've never done those before. And, the ROI isn't there short-term. They'll have to find a way to bundle the telephone solution and offer new applications because revenues are growing at a slower pace in the local telephone business, and almost shrinking. Basic voice service won't support the business on its own–there must be a bundle," Jenkins says.

With nearly 90 percent of the cost of deploying telephone service coming from just getting a line into the home, most of the revenue, Jenkins adds, goes right to the bottom line. "At that point, voice service is a great way to add to the bundled services. It's all about incremental revenues," he says.

It's all about upfront costs, too. AT&T Broadband, which is far ahead of its rivals with three million paying telephony customers, is paying about $900 per subscriber to deploy telephony service. The cost includes an NIU, switching, transport and headend equipment. That cost is shrinking, however, to around $600 per sub, AT&T says, with significant savings on the network interface side from $450 to $250 and installation times being reduced from three hours to about two hours.

Emboldened by those numbers, AT&T is pushing ahead with its bundled digital phone service. "We now have three basic products and are moving aggressively to collapse them into one business operation. We're hitting high scale numbers, so we have to meet the new economies of scale," says Greg Braden, executive vice president of broadband services and CTO for AT&T Broadband.

Meeting the operational demands is a nagging issue, Braden admits. "Billing and the back office are real challenges. They're much more manual than we would have liked. Getting all the markets on a standard operating platform and flow-through provisioning platform for voice and data services is difficult as well. Getting those platforms is job one, but we have a very aggressive plan for this year. Getting commonality does a lot for your efficiencies," he says.

And efficiencies count. Adds Braden: "As the economies and stability of doing business in the IP environment versus circuit switched improve, we can easily migrate to IP with little capital investment. But we have to change our business and be very good at building and monitoring a reliable two-way network, and that takes time."

For AT&T and other MSOs, timing could be crucial. "We have a sense of urgency for a footprint, but we don't want to overdrive our operational headlights. There's competition out there, so we must build faster and get products like PVR and interactive capabilities out there as fast as we can," Braden explains.

AT&T, he adds, is now providing VoIP service in 17 large markets and its strategy is to "fill out the footprints of markets we've launched and get working on the smaller markets."

Getting a footprint in the local phone business isn't easy, however. "Local phone providers are very good at what they do and have raised the bar for us," says Tom White, director of marketing for Cox Digital Telephone. "It's a very complex business. You have to deal with outside vendors and with phone companies who have to open their doors to you. Plus, new skills are needed on the operations and engineering sides."

Cox currently has 1.1 million phone customers being served by circuit switched technology. Its IP strategy, White says, is to bundle its telephone service with video and data to reduce churn and improve its core video business.

"Our strategy is to launch circuit-switched technology in our markets, and we've done that. It's allowed us to learn how to support a very complex business. IP telephony is nearly ready for prime time. We're watching it very closely," White says.

Cox is also watching the progress of its organization, whose mandate is to manage an unfamiliar set of functions and skills. "We still have to manage the network and develop skilled people," he notes.

Billing is a case-in-point. Says White: "The telephony business is incremental usage-based, and there are regulatory requirements, taxes, surcharges and lots of new billing elements. It's very different than cable."

Cox hopes to roll out IP telephony in two years. "Circuit switched technology doesn't allow us to economically get to small markets, and it's only effective as an element of a bundled product, so the economies wouldn't support it on its own. Our focus is to drive deeper into current markets and watch IP telephony very closely," White adds.

With billing such an important component to the cable-morphing-into-telephone business, challenges are mounting for companies such as Convergys to meet increasing network demands. "The business is driven off usage, not big transactions. You can't be internally focused anymore and must interface with so many different customers. The big impact on operators is supporting the operation," says Curt Champion, senior director of marketing for cable and broadband solutions at Convergys Corp.

ADC, which provides network equipment, software and integration services to the cable industry, faces similar challenges. "We have to help operators fit their services into IP networks and network elements and how they connect to billing systems. This is a key time for them to implement their telephony business plans. In the next 12 to 24 months, most operators will migrate to IP, and the lower costs of equipment will help the business tremendously," maintains Mark Komanecky, vice president of marketing and business development for ADC's Broadband Access and Transport Group.

What will help cable operators move into the telephony business most, and reach an acceptable ROI, is bundling the service with video and data. "At thousands of dollars per subscriber for deployment, operators will never recoup their investments without new services. They're realizing data-only platforms can't support voice, but the business case is there for IP telephony and bundled services with VoIP," says Jeffrey Schmitz, director of HFC marketing for Tellabs.

The case for IP telephony may exist, but some doubt the ability of cable operators to compete head-to-head with local phone companies. "It's not clear why a cable provider would want to make a business of voice services in the traditional POTS (Plain Old Telephone Service) sense. Margins are eroding, and it's difficult to imagine an SBC losing 30 percent of its base to cable provider service. It's almost laughable," says Bob Rosenberg, president of Insight Research Corp, a Parsippany, N.J.-based telecommunications market research company.

Insight's research, Rosenberg continues, suggests that for customers with access to IP packet-based service, a modest 11 percent will migrate from circuit switched service. "Voice is a commodity that grows at single digit rates. Primary voice isn't a viable business option for cable. In certain communities, IP can be a great boon, but getting mainstream to pay is a real challenge," he adds.

Nevertheless, some companies plan to push ahead with their telephony strategies. "We knew competition was coming and thought about the telephone business, which looked appealing in larger clustered markets. It can help complement our other businesses and offer multiple services, which we knew we had to offer," White says.

Cox currently provides long distance service to 70 percent of its local access phone customers. "Our strategy has always been to use services like IP telephony or circuit-switched to increase the value and revenues of each household and decrease churn," he concludes.

AT&T sees the local phone business differently. Says Braden: "It's four times the size of cable, and there are good market opportunities to capture a share of the market where people pay good money for service. It all goes to another wave of service and revenues when we go to VoIP. It's an efficient use of baseline and incremental capital going forward."

Yet carrying out the wide range of strategies that comprise a telephony business model is proving to be cable's latest and greatest challenge to going forward, even for a company with a long history of telephone service such as AT&T. "Most companies (migrating to telephony business) are very large and can justify voice service across the cable medium, but that's tough to prove in a consumer market," Jenkins says.

Proving that it can overcome the operational, marketing, engineering and customer service obstacles will likely determine just how deep cable operators drive their telephony service. In the meantime, most operators are waiting to exhale in their decision to deploy telephone services as they watch the progress of IP telephony.

Capital requirements per IP line
Modem excludedModem included
Packet phone adapter$150$150
Gateway (5.1 concentration)$300$300
Switch (80% of calls to LEC/IEC)$35$35
Source: Cox Communications

Capital requirements per circuit-switched phone line customer
$/line$/customer (1.5 lines/cust.)
Variable total$495$560
Power cost*$125$125
Source: Cox Communications
*Assumes 20% penetration of homes passed.