The U.S. “Subsidy” Game is Up – The End of “Free” on the PSTN

Ever wonder how those “free” conferencing services work? Why did Magic Jack offer such a low price compared to legacy landline service providers? And why did this only work in the U.S.? Yet, how can Skype and other IP-based communications service providers continue to offer “free”?

Seem like the U.S. had developed subsidy programs, of which the Universal Service Fund (“USF”) was the main culprit. Idealistic politicians wanted to ensure universal access to a variety of constituencies including “High Cost” rural markets such that small service providers could offer conventional phone services at rates comparable to urban rates. So they came up with this Universal Service Fund whereby the “large” carriers would collect an additional fee (or tax) which was then paid out to the hundreds of smaller service providers in “rural” states such as Iowa and Minnesota.

But then some smart people in Iowa caught onto something. The 150+ small carriers in Iowa formed a co-operative that applied for and obtained $80MM of USF monies to set up one of the most powerful fibre networks in the U.S. Of course this meant Iowa had significant extra capacity for terminating calls.

But there was another catch.

The North American numbering system means that a minimum of 10,000 numbers had to be tied up with each “exchange” or central office (the first three digits of the local telephone number). But some of these rural service providers, each of which was assigned an “exchange”, may have had a very low number of actual customers (as low as 150) and certainly many fewer than 10,000. So they ended up with a huge surplus of unused numbers that could, however, be used to collect revenue through access charges and they had the call load capacity due to the fibre installation.

Basically if a caller made long distance calls into these “excess” numbers, the local “rural” service provider could collect, from the larger carriers, termination fees (access charges) which they, in turn, supposedly would collect from the call participants. However, the larger carriers had invoked fixed price, unlimited minutes North American calling plans; this limited their additional customer revenue while driving up their costs. Not a great business scenario.

Once the “local” providers received their funds, they would pay a portion to the conferencing service providers. Effectively it was these access charges that would generate revenues for the “Free” conferencing services. There was one major problem; suddenly larger carriers such as AT&T were getting bills for several million dollars per month; they objected and took their case to the FCC.

And the gravy train has run off the tracks … largely at the behest of the FCC according, in one case, to the Telecom Law Monitor. Two stories corroborate this:

Calliflower, a conferencing service which I have covered often, has eliminated their free calling option. According to a recent post:

There’s an old saying that you have to break an egg to make an omelette.  Today I have some sad news as well,  which is that that we are eliminating our free conference calling offering on March 25th. Eliminating the free offering has been a tough decision, and one that we’ve given a lot of thought. We’re doing it because it is simply impossible for us to continue to offer that service reliably in the face of continued opposition at the FCC in Washington DC from larger, incumbent carriers.

You’re probably asking “what do these carriers have to do with anything?” A lot, it turns out. We were able to offer Calliflower at no charge by sharing a portion of the long distance fee you paid to your carrier in order to access the conference service. Those carriers don’t want to pay anymore. In fact, we haven’t been paid by them in two years. Unfortunately, we can’t operate the service any longer without any ability to recover our costs. That’s the reason we made this very difficult decision.

And this past Monday it came out that Magic Jack is in a position to lose its “Magic” because their parent was providing services not listed in their tariffs filed with the FCC. To quote Andy:

Basically  YMAX, the CLEC, was planning to make money on access charge compensation. AT&T said, we’re not paying the rates you want to charge. Well it seems the FCC agreed. That means that MagicJack’s model of cheap no longer means, almost free or at breakeven to them, and brings to light the fact that they may now see the possibility of losing money on every call without their sister company making a profit on the access charges which subsidized what they have been doing.

Read the posts for more details. But the bottom line is that, if you want to host a conference call, you’ll pay. However, even at the rates charged today – and most are at fixed monthly rates — conference calls are orders of magnitude less expensive than ten to fifteen years ago when the telcos would charge $0.50 to >$1.00 per participant per minute.

Nobody in his right mind is going to start a service today that relies on these “subsidies”. The dilemma for Magic Jack and their parent is that they have effectively offered one year contracts to their customers and must deliver on them or otherwise compensate their customer base. It will be interesting to see how this plays out.

And how can Skype continue to offer free Skype-to-Skype calling? Because at the most basic level Skype calls are peer-to-peer between or amongst participating PC’s (or other Skype-enabled devices) with no intermediary beyond a directory service to establish the initial connection – and no termination charges. The “carrier” is essentially your Internet connections which see voice “packets”, prioritized but on a peer level with the data packets that deliver web pages or your email. But then they add in – at no cost to the user – chat and multi-party voice calling along with other services such as one-to-one video calling and file transfer. And it’s all encrypted. The user’s real costs are your local PC or other terminating device hardware cost and having a broadband or faster Internet connection. Other than for directory servers and, as a result of a recent Skype outage, super node servers, Skype has very little capital costs associated with these services.

Bottom line: even at today’s rates hosted and managed conferencing services are a bargain compared to a decade ago or earlier. But, without the cost drivers, it appears that Skype can continue to offer all its services with the only costs being for connections to the PSTN and multi-party video calling.

So where does Skype gets its revenues? Check out the most read Voice On The Web blog post (even after two years): Skype Business Model Revealed at eBay Analyst Event.

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About Jim Courtney

Bringing over thirty years' experience in the sales, marketing and management of cutting edge technology businesses.

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