Technology - Reuters

Internet Phones Likely to See Price Competition

Wed Mar 23, 3:18 PM ET

CHICAGO (Reuters) - The booming market for phone calls using Internet technology has created a bonanza for telecom gear makers such as Cisco Systems Inc. (Nasdaq:CSCO - news), but aggressive pricing could squeeze profits.

Price competition for so-called corporate VOIP products, particularly among the three big North American players -- Cisco, Avaya Inc. (NYSE:AV - news) and Nortel Networks (Toronto:NT.TO - news) -- may be intensifying, prompted by lackluster information technology spending and moves to capitalize on a replacement cycle for phone systems, analysts said.

Concerns about aggressive price discounting by Avaya, among the largest makers of VOIP, or voice over Internet protocol, equipment, has weighed on the company's stock.

"The heat is on," said Jeremy Duke, chief executive of Synergy Research Group, which focuses on network technology. "It's sort of a clobbering over the head with pricing; it's a very competitive trio with Cisco, Avaya and Nortel."

Duke expects that mid-single-digit price declines of recent years will continue for the next 12 to 18 months, driven more by more competitive pressures than before.

Representatives for Avaya and Cisco declined to discuss their pricing strategies. Nortel, which has been besieged by accounting problems, was more forthright.

"We find that pricing pressures on VOIP are a reality; it's a factor of competitive markets," Nortel spokeswoman Ann Fuller said. "Customers are looking at pricing costs," she added, without providing specifics.

The market for VOIP equipment sold to corporations and other enterprises, including phones, hardware and software, grew 78 percent to $3.07 billion in 2004, according to Synergy's data, and is seen rising to $4.42 billion this year. By 2009, it should represent nearly $11 billion in sales.

Price is especially important as companies install VOIP systems in hopes of saving money in the long-run on their phone bills. Synergy estimates it costs about $100,000 for a mid-sized U.S. company with 200 work stations to replace its traditional switchboard phone system with VOIP equipment. Beyond costs, customers demand intelligent VOIP features such as sophisticated call tracking and inventory management.

Besides the North American players, the global VOIP market includes names like Alcatel (CGEP.PA), Siemens AG (news - web sites) (SIEGn.DE) and Mitel Corp. (Toronto:MLT.TO - news), as well as a host of smaller companies such as 3Com Corp. (Nasdaq:COMS - news) and SpectraLink.

As the technology of making IP phones becomes simpler and more Asian rivals enter the fray -- at least a few years away -- prices for the phones themselves, which average around $250 for a unit, will become even more aggressive, analysts forecast.

A HIGH-MARGIN BUSINESS, BUT CISCO SEEN AS THREAT

They said price promotions have become a matter of course in the Internet telephony market, sometimes used as strategic move to sell other networking products.

A recent Lehman Brothers report suggested that Avaya was offering price cuts of 30 to 40 percent on products targeted at small-to-mid-tier U.S. companies as a means to offset weakness in March sales and gain market share. Several competing investment houses have since said the report was overblown.

Analysts stress there is room for some flexibility on price, as gross profit margins on VOIP equipment run in the mid-50 percent range or higher.

But it remains to be seen how long the wiggle room will last as aggressive newcomers such as Cisco gain traction. Cisco, whose sales in VOIP equipment are approaching the $1 billion mark, has marked IP telephony as a hot growth area.

"You often hear ... that Cisco is heavily discounting its systems, that sometimes the IP phones they'll give away for free," said Brian Riggs, principal analyst for market research firm Current Analysis.

Synergy said Cisco's share of revenue from enterprise VOIP equipment stood at about 23 percent of the worldwide market at the end of the fourth quarter, neck and neck with Avaya, which was 24 percent. Nortel had about 13 percent.

"I think what we have overall is people trying to protect their market share in the face of Cisco winning," said CIBC World Markets analyst Steve Kamman. "The problem is you've got a new player who's actively taking chunks of share and changing the rules of the game."