Vonage - Blood from a Stone

If there's one thing that a VC can get behind, it's the idea of the virgin market. Being the first entrant into a sea of untapped, not-yet-tapped consumers gives the possibility of actually owning a whole market. Be the first with the new widget and everyone's catching up with you, fighting for your marketshare and feeding off the scraps you left behind.

There's an old business axiom that fits this model: "Those that lead, bleed".

I bet you thought that I was going to say "With risk comes reward" or "Building the market is the best way to own the market" - which are all great, but the vast majority of companies that are started with the concept of doing something brand new fail miserably.

Let that sink in for a minute.

There's a reason it's called the bleeding edge. Regardless of how ripe a new market is for the picking, when you're the first ones out of the gate, you have to build the market - new products, consumer education, heavy sales and marketing. In the case of Vonage, they figured that with the massive deployment of broadband to the home, coupled with a more tech-savvy market and a real lack of competition from the cable companies - the market was ready for consumer-grade Voice over IP.

The promise of VoIP was cheaper calls, and the promise of Vonage was simple implementation that was as easy as plugging a box into the router and a phone into the box. Vonage contracted with hardware manufacturers to sell ATAs (the phone to VoIP converters) and VoIP routers - purchased them in bulk, set up automatic provisioning services and then launched a massive advertising campaign to get people to switch.

However, within months of Vonage's business taking off - first-followers started to emerge. These were essentially copy-cats - offering essentially the same service as Vonage but with small key differences. Since they could use Vonage as a business and architectural reference, startup was faster and cheaper, with less of the technology dead-ends and false starts that plague most startups.

As the largest player in the VoIP space, Vonage had the benefit of a good revenue stream which brought a decent amount of funding. However, being the prime mover in the market turned Vonage into a lightning rod. Key components of VoIP, VoiceMail, IVR and other technologies have been patented by the telcos that Vonage was poaching customers from. Though the patents are poorly conceived and never should have been approved by the USPTO, until a successful challenge is made, the telcos had a way to make Vonage pay. Verizon extracted $66 million and Sprint approximately $80 million - and a new broad reaching AT&T lawsuit could end up in the same region. With only 2.5 million subscribers, that's a cost of approximately $80-$90 per subscriber in penalties.

This leads to the hard lesson of Vonage.

Vonage didn't get to where it was by creating a new market. Vonage simply sold a cheaper method to do the same thing that the big, well funded carriers were doing. As soon as the media started reporting that Vonage was doing damage to the Telcos, it didn't take a rocket scientist to figure out that the Telcos would strike back - and with a legitimate stockpile of patents to pull from, all the carriers have essentially banded together to "put the smackdown" on Vonage.

Unfortunately, if Vonage fails, it's the death knell for the VoIP providers who are simply looking to be cut-rate telcos: selling transport and basic features to consumers. Thankfully, we're certainly not trying to become a telco.