The Internet Is Calling

By Jyoti Thottam

Jeffrey Citron might have been prewired to be a telecom mogul. In 1987 he was a know-it-all high school kid in Staten Island, N.Y., restless and bored with his classes, when an economics teacher organized a stock-picking game. Citron was soon hooked. Just after the market crash of 1987, he bought stock in phone upstart MCI at a few dollars a share. It soared. "I don't know if I was smart or I got lucky, but it was one of the few stocks I picked that brought a profit," Citron recalls. After finishing high school, he skipped college and headed straight to Wall Street. "I don't have a lot of patience for things," he admits. "When I see something that I want, I completely go after it."

Aggressive and driven, Citron built and sold two hugely successful financial-services companies within 10 years, netting more than $200 million before he was forced out of finance by an SEC investigation that accused him of stock manipulation. He paid a massive fine--$22.5 million--but admitted no wrongdoing. Instead of slinking into well-heeled obscurity, he plotted his return, this time determined to shake up a new industry. Citron, 33, is now CEO of Vonage, which has become, in 18 months, the leading player in the explosive new market for home-phone service via high-speed Web connections, known to geeks as VOIP (voice over Internet protocol). He isn't shy about his ambition: "to change the entire telecommunications landscape."

That may sound like entrepreneurial bluster, but Citron has set off alarm bells at the big telephone carriers, who proved once already that they weren't swift enough to react when they ignored the challenge of cell phones. Before Vonage, telecom giants like MCI, Verizon and AT&T dismissed the technology for broadband phone service as too buggy and too complicated to bother selling. Vonage has proved them wrong, mostly because broadband phone service has one compelling advantage: price. It's half as expensive as regular telephone service. The company now has 220,000 subscribers, a pittance beside the 112 million traditional phone lines. But Citron's outfit is adding 1,000 new customers every day. "He's been sort of a nuisance and a prod," says Steve Koppman, a telecom analyst with Gartner. "He has proved out the concept in the marketplace before the big players."

The telcos aren't going to ignore an emerging technology twice. They're launching their own services as they try to reach out and crush Vonage before it gains too much momentum. And there's added pressure because cable companies such as Time Warner Cable (owned by the same parent company as TIME) and Comcast are also in the game. With the heavyweights now in the ring, broadband phone service will be making its way into close to 5 million homes within two years, according to Forrester Research. Experts have been saying for years that broadband was the future of landline calls. Thanks to Vonage, that future may be arriving a little sooner than expected.

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.

The phone companies' quick response to Citron's frontal assault "is a sign that they are worried about losing customers," says John Hodulik, a telecom analyst at UBS. There's a risk of cannibalizing their existing business, but it's one they have to take. Cable companies, on the other hand, can go after an entirely new market, connecting Web phone service to existing broadband customers.

Where does that leave Vonage? It could go the way of Netscape and Hotmail, both of which were swallowed up after blazing the trail for larger, less agile competitors. Citron isn't ready to sell just yet. There are about 26 million homes and small businesses in the U.S. with broadband, and Vonage needs to capture only a fraction to build a sizable business. In the meantime, Citron and his investors are laying the groundwork for an IPO. Citron declines to speculate on his or his company's future, but he's certain he has made his mark. "No matter what happens with Vonage, the world will forever be changed because of what we've done," he says. Or your phone bill will be changed, at the very least.