The Internet Is Calling

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Just what you need, another technology choice to make, right? Here's how Web phones work: you still need a phone, but instead of hooking it up to a jack, you connect it to a small modem-like box that in turn is hooked up to your cable modem or DSL line. The device translates between the home phone and the broadband connection, transforming your voice into data packets and sending it along the Web. Internet phone service treats a phone call just like e-mail or any other packet of data. Some Web phone services use private Internet connections, but Vonage uses the public Web, so phone calls travel alongside messages, digital photos and online shopping orders. Traditional phone service, on the other hand, creates a dedicated circuit between you and whomever you're calling. That century-old system is darn near perfect--while Web calls are prone to background buzz--but not nearly as efficient as the Web. Because Vonage can route calls at a lower cost and does not face the fees and taxes imposed on regular phone service, monthly bills are typically half what you would pay the phone company.

Vonage is likely to lose some of that price advantage eventually, as the Federal Communications Commission figures out how to regulate Internet phone service. What Citron is desperately trying to avoid is a patchwork of state regulations--a logistical nightmare for Vonage. Since Vonage customers can select any area code they want and use their service not just at home but also anywhere they have a broadband connection, tax collection gets tricky. "How do I know where you are?" Citron says. "How do I know who to give the money to? I can't possibly get it right."

Citron says he is spending at least a quarter of his time on regulation. Having run spectacularly afoul of regulators once, he has hired an army of lawyers to avoid doing so again. They must spend a lot of time telling him to zip it because Citron's fast-talking, hyperconfident style doesn't always sit so well with regulators. "It depends which ones you talk to," says Harry Weller, a partner at New Enterprise Associates, a venture-capital investor in Vonage. "He'll either drive you crazy, or you'll really like him." To neutralize Citron, the company allows him to control only one seat on the board (his own), even though he has put up more than half the $100 million invested so far.

Federal regulators may turn out to be the least of Vonage's challenges. AT&T launched its competing CallVantage service in March, Verizon rolled out VoiceWing in July, and Comcast and Time Warner Cable plan to have their offerings by the end of the year. These companies will seek to exploit Vonage's Achilles' heel. Because Vonage relies on the public Internet to route its calls, it cannot completely control traffic and its effect on call quality, says Lisa Pierce, an analyst at Forrester Research. AT&T, on the other hand, has its own network. Over time, she says, Vonage will lose out to the telcos' marketing muscle and deep technical expertise. "It's a question of being passed in the far left lane," she says.