The ooma conspiracy -- or why Vonage is ultimately doomed

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Yesterday, I was on the phone with Rich Buchanan, ooma's CMO. It started off as a simple conversation about how the company added on support for Google Voice in relatively short order and ended up into a deep dive conversation which should have everyone in consumer VoIP, home phones, and landlines rethinking their business models.

Buchanan called in from a Best Buy event in LA; ooma was being feted for being one of Best Buy's hot products since showing up on retail shelves in time for the Christmas season. Ooma has sold "north" of 20,000 units to date, but the recent surge in demand has gone crazy. "I can't make product fast enough to satisfy demand," he said.  

The simple--yet game changing--business concept for ooma is that you end up paying for your phone calls up front with the CPE. You pay $250 for the initial customer gear and get "free phone calls forever" in the United States, but what does that mean, exactly?

I'm skeptical of free, but Rich walked me through the numbers. Cost to terminate a VoIP phone call from ooma to the PSTN ranges from 0.2 to 0.5 cents per minute, so worst-case, you're paying a half-penny per minute with a national carrier. Average minutes for ooma usage are around 300 to 350 minutes per month--remember, landline minutes are going down with the ascendance of mobile usage, so worst case you're paying $1.75 per month for phone calls to the continental U.S. Or, $21 a year.  

(Yes, we're ignoring some cost overhead in the core, but I'll get to that shortly).

Assuming a five year plan for the hardware, that runs out to $105 on the typical lifetime of the device with the worst-case cost termination scenarios. So there's $145 for the CPE (Ok, less what you pay Best Buy for stocking and selling), but this is no ordinary CPE. The current ooma device has a 450 Mhz ARM processor onboard running Linux, a derivative version of Asterisk and a routing algorithm to pick the least-cost route for the phone call, be it another ooma (free), a regional carrier, or the best national carrier rate of the day. Route processing is happening at the device--not the core--so there's no need for big iron and expensive solutions.

And the back-of-the-envelope calculation above doesn't take into account 1) The cost of VoIP termination is likely to nudge downward from half a cent a minute on the high end and 2) You can stick the money in the bank in nice comfy CDs and earn interest on it.

Bottom line: ooma is at break-even and/or making money on each unit it sells. Add on about $13 a month for the premium features--software downloads and some core processing. Buchanan says he has been surprised at the 25 percent take rate for premium. And they're making money off of international long distance--since it is already IP, ooma can charge Skype-like rates and still come out ahead.

But that's not enough my friends, no, no, no: Ooma is doing hardware refreshes every 2 to 2.5 years, so when current ooma users upgrade to new hardware with the latest features, the "clock" gets reset and that money on the old ‘ware goes into the bottom line.

What does this all mean? Buchanan says that between marketing and network overhead, Vonage is $400 in the hole per customer over two years, so they don't start making money unless the customer sticks around at least that long. With customer churn at around 3 percent per month, Vonage is running a losing battle even if it does manage to reduce the marketing expense of around $230-250 per customer because it still has all that overhead for routing and core infrastructure.

Ooma's business model also provides interesting insight into the Verizon Hub and other VoIP carriers (i.e. the cable companies).  If it costs as little as $1.75 per month for up to 350 minutes per month of voice, it is a short step for carriers large and small to invert the traditional voice model and simply bundle in service as the cost of buying the equipment, pocketing any leftovers when people upgrade. - Doug

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