The Internet Is Calling

JONATHAN SAUNDERS FOR TIME
On the Lines: Vonage CEO Citron wanted to rattle the phone giants. Mission accomplished

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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.