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Scenario - Phone Depot
TRANSCRIPT
DKW Perella: Telecom Retail 2010
Panel Session
Phone Depot:How Telecom Became a DIY Market
Panelists:
- Robert L. Nardelli – Chairman and CEO, Home Depot, Inc. (NYSE: HD)
- Patrick C.S. Loh – Chairman and CEO, NetGear, Inc. (Nasdaq: NTGR)
- Diego Piacentini – CEO, Phones.com (Nasdaq: PHON)
Moderator: (applause) “Gentlemen, welcome to this first-of-its-kind conference focusing on telecom as a huge and growing retail category. On this panel, we’ll explore the transformation of consumer and small business telecom into a ‘do-it-yourself’, or DIY, market analogous to home improvement and home computing. Gentlemen, I’m delighted to have you here today.
“The conference theme – telecom retail – reflects the sea change that has taken place in how telecom offers are packaged and sold, and where the communications services now come from. On this panel, I’d like to explore the emergence of new category-killer stores, combining both ecommerce and bricks and mortar, into a vibrant retail category.
“Pat, let me start with you because, for once, supposedly ‘disruptive’ technology really fulfilled it’s promise here, enabling the kind of DIY distribution now dominating retail telecom.”
Patrick Loh: “Yes, I believe it really has. Voice over broadband was a very important step, but basically the attraction of VoIP, initially, was the price. It forced all-you-can eat, flat rate service into the wireline market, taking already very cheap LD out of the equation entirely, just like US wireless carriers did years before.
“Anyway, VoIP was cheap, but what didn’t change was that obtaining phone numbers, dialing and completing calls, the extra features you were used to at home like call-waiting, etc., these all still came via telecom carriers, now including your cable company, or small independent broadband phone companies. Phone service became just another application that shared a broadband connection with other internet-related activities. The technology and pricing had changed, but the service was basically just the same.
“The real ‘disruption’ happened when people realized what endpoint devices built to an open standard called SIP could do to, and with, voice over broadband.”
“The real ‘disruption’ happened when people realized what endpoint devices built to an open standard called SIP could do to, and with, voice over broadband. And then they started doing it. Now, not only had voice service been commoditized, but the elements of voice service started disaggregating even further, enabling about half-a-dozen different business models for the voice business. You could make a modest business just out of selling phone numbers linked to an IP address, for example.
“The primary catalyst of the disruption was the emergence of what’s called ‘peer-to-peer’ telephony, or P2P. P2P as a concept, you’ll recall, started with Napster and music around a decade ago, and kind of got a bad rap – it’s about free, it’s about stealing, it’s about low quality, it’s about hobbyists, etc. Skype, one of the first P2P voice services was initially perceived somewhat in that way.
“About six years ago, at NetGear we watched the emergence of peer-to-peer telephony enabled by middleware like Popular Telephony’s Peerio, and Nimcat Networks’ nimX, which was acquired by Avaya (NYSE: AV). What was happening was that call processing – the ‘smarts’ – was being taken away from network owners, carriers in other words, and being embedded in phone systems – or even just a single phone – for small and medium-sized businesses in a way that was very powerful, yet easy to use and administer – much more so than any legacy systems. The disruptive effects were manifold and mutually reinforcing.
“First, everything was 50 to 90 percent cheaper than traditional solutions, and the costs scaled linearly – have an employee, buy a phone. There was no up-front investment in a centralized system and maintenance contract followed by per employee expenditures.
“Second the system was semi-open. ‘Open’ in that SIP created many interfaces and services from many vendors that could be mixed and matched, ‘semi’ because the secret sauce peer-to-peer software was partly proprietary. But you certainly weren’t locked into an Avaya-only solution, for example, for the rest of the life of the system.
“Third, to put it somewhat simplistically, phones within your peer-to-peer system, within your business, say, talked to each other for free. So a small company with offices in multiple locations had no communications costs for talking to each other, beyond the DSL or cable connection they already paid for. And much, if not most, company phone traffic is internal, even for small businesses.
“Fourth, as I mentioned earlier, the idea of ‘phone service’ itself kept disaggregating. Already internal calls were free, very good if you’re not in the same office, or have teleworkers, or whatever. But what about calling outside the office, or outside parties calling you? Instead of paying Vonage for a bucket of monthly VoIP minutes for your business lines, you could now simply purchase and register a bunch of phone numbers with an ENUM service and arrange for cheap inbound and outbound termination of calls to those numbers without buying minutes. It was no longer a ‘minutes’ service, just a number registration and VoIP termination business. Just a couple of dollars a month flat fee per number. And for 20 phones, maybe you’d have one basic PSTN line at $15 per month, just in case, for 911, or whatever.
“The carriers were almost entirely cut out of the equation, other than providing basic transport services.”
“So all of a sudden you could have an inexpensive multi-line phone at home, or full-featured PBX in your small business at half to one-tenth the total cost of prior solutions, without the single point of failure of a central box, or one telco being where the service came from. The carriers were almost entirely cut out of the equation, other than providing basic transport services.
“At NetGear, we looked at this market and concluded we had the expertise, the installed base, product mix, and very importantly the brand and distribution channels that could really step up to peer-to-peer call processing as the next big thing in voice infrastructure. We’d already done very well with ‘industrial-grade’ networking products for the home and small businesses. So, we saw the new generation of VoIP phones as perfectly suited to our strengths and our market.”
Moderator: “Would you say you’ve displaced a lot of traditional phone systems, especially at businesses?”
Patrick Loh: “To some degree, but we’ve primarily tapped markets that wanted rich functionality, but for reasons of price, complexity, whatever, didn’t have any of it. What we’ve done is take functionality that is as good, in many ways better, than big company PBXs, and make it available to teleworkers, small businesses, and larger or more affluent households. Keep in mind with IP PBXs five or seven years ago, ‘displacement’ of the old stuff wasn’t really what was happening, more like nibbling around the edges.
“Generally what happened is large enterprises slapped a media gateway behind the existing PBX to trunk internal calls over their existing data lines – toll bypass. Later they began routing all calls to semi-private peering points optimized for VoIP. This saved a lot of money. The Cisco (Nasdaq: CSCO) and Avaya type of IP PBX business models were still driven by handset sales, though. Remember, from the beginning PBXs have been a razor, i.e. the switch, and razor blade, i.e. the handset, kind of business. Without $400 to $600 handsets and software-based feature add-ons per seat, and rich maintenance contracts, they couldn’t make money on the product. Maybe not a problem if you’re Cisco, but certainly a problem if you’re Avaya and that’s all you do.
“Most companies didn’t buy into these ‘mainframe-like’ IP PBX solutions since they saw little economic value in the added features at those kinds of prices, despite the sexiness of the new phones. They picked the low-hanging fruit of VoIP toll bypass and waited.”
Moderator: “So your success was to be the first to really commercialize these ‘peer-to-peer’ technologies, as they’re called, in a big way, but not for large enterprises?”
Patrick Loh: “Yes. NetGear was the first to make an ‘industrial grade’ version of peer-to-peer SIP phones, including easy-to-use administrative interfaces, and gateways to the PSTN so you could use a regular phone lines if the broadband connection failed, and/or as inbound numbers for the ‘outside’ world, etc. Our expertise was in simplifying the technology a bit further and improving its usability. Also, our ability to manage a high-quality manufacturing supply chain overseas at very large volumes vs. small competitors with P2P phones as their only product.
“It took a while for our customers to get used to the idea that in a peer-to-peer model, despite the richness of functionality, there was no central point of control – for example, they’d ask ‘well, where’s the voicemail stored?’, a logical question, and had trouble understanding that the ‘secret sauce’ of peer-to-peer makes these resources entirely distributed. They’re nowhere and everywhere.
“Keep in mind too that this market is somewhat self-defined. The lack of central point of control or resources, the very thing that’s a huge advantage, can be a disadvantage in controlling very large systems. A CIO at a Fortune 500 company is unlikely to allow a peer-to-peer implementation for an entire corporate phone network. So, anyway, this model is perfectly suited to our core small business, SOHO, teleworker, etc. base, and we have a lot of marketing experience there too. Just as with WiFi, where we had tremendous success in home and small business networking, it turns out that the biggest market and fastest adopters are consumers and small businesses, not large corporations.”
Moderator: “Pat, you said you made ‘industrial grade’ phones. But on the theme of our conference, you helped change and revitalize the entire way voice communication is sold and distributed, didn’t you?”
Patrick Loh: “Well, I’m sure Diego and Bob will get to this in a minute, but, yes, the entire marketing, sales, and support process was re-engineered, and we were a part of that. We can hardly take credit for restructuring the industry, other than using our influence as a large manufacturer already successful in exactly the target market this new technology was best suited for. What we saw was that there was great harmony between the technological characteristics of the product and its ease of use, and lower-cost, simplified forms of marketing and distribution.”
Moderator: “Pat, thanks, and thanks for paving the way for a nice transition to Diego. Diego, Phones.com has become the premier distributor of this new generation of communications technology. Tell us about your business model, and what Phones.com does.”
Diego Piacentini: “I’d be happy to. Well, as you know, a few years back I left my role as head of worldwide retailing at Amazon (Nasdaq: AMZN) to run Phones.com. The founders there made a compelling business case around three major trends in telecom.
“First, that phone service itself would keep commoditizing – there would be plenty of competition, be it in broadband-delivered VoIP, or in wireless. As Patrick has already pointed out, even Vonage found itself offering a lower-end product as demand for full-featured calling services shifted away from carriers.
“Second, telcos – that is, carriers – would fail to capture any additional value through service differentiation. If you looked at the wireless industry, amazingly, all the added value was either coming directly from, or centered around the handset, it’s features, downloadable software, etc.
“Third, if you combine these first two trends with new technologies like SIP, and the cost momentum from China, you could transform small business and consumer telecom.
”...if you combine [these] trends with new technologies like SIP, and the cost momentum from China, you could transform small business and consumer telecom…”
“The business case was simply this: a new category of easy to use, open, programmable phones would replace proprietary ones, they would work with any number of broadband carriers, and have all the features you need without the carrier’s network providing voicemail, call waiting, etc., or without a centralized PBX as in the case of small businesses or teleworkers. These new devices and some ancillary services would best be distributed in a lean, ‘Amazon-style’ distribution model, but with considerably higher margins than the vast proportion of the SKUs you would find there.
Moderator: “So why not just make telecom another product category or ‘store’ within Amazon?”
Diego Piacentini: “Of course, this was my reaction as well. I think they got a little scared and said ‘no, no, this is not why we are talking to you!’ (laughter) In their view, this new product category fit between a mass, e-commerce solution like Amazon, and high-cost, usually low-service, consumer electronics retailer like a Best Buy (NYSE: BBY).
“The company founders believed the new peer-to-peer new telecom products were powerful, simple, upgradeable, and self-installable. But… okay, maybe, just a little service was required to set it up. (laughter) If so, almost all of that assistance can be web-delivered. The margins of the product itself, as well as add-on assistance service revenue would allow this to be done profitably. To put it in simple terms, imagine going to a website, ordering a small PBX, it arrives in the mail two days later, you plug it in, talk to a vendor representative for ten minutes, and that’s it. Almost all the distribution, set-up, and support costs would be driven out.
“Perhaps needless to say, I was more than a little skeptical. When technologists talk about ease of use, my experience is to make sure you know where your wallet is at all times. (laughter) But as to the vision, I remained open-minded. I went away and did some research and became more interested in a somewhat more pragmatic version of their vision.
Moderator: “So what does Phones.com do? It still sounds like it follows the original vision.”
Diego Piacentini: “Yes, it very much does. We are the premier e-commerce source for the new generation of household and small business phone systems. The original vision, while needing quite a bit of implementation work, was basically correct. So, at Phones.com we do six things:
“First, we do sell the phone systems in an array of configurations and from a family of different vendors, especially NetGear (laughter).
“Second, before we sell you anything, we have a free online consultation process that recommends and configures a system based on a pretty extensive web-administered questionnaire. This is the first element that an Amazon is not going to do well.
“Third, we pre-populate it with things like your phone numbers, contact information and carrier service plans before we even ship it to you, and then using web-based software configuration, fine tune it online once you’ve plugged it in. Again, not an Amazon thing.
“Fourth, We are a marketplace where you can obtain other elements of the ‘infrastructure’. You still need phone numbers for VoIP, now there are so-called ‘ENUM’ services which issue numbers and clear voice traffic, even if you didn’t sign up for broadband phone service from, say, a Vonage. You will need an ISP to transport your packets, if you don’t have one already, we can set up accounts for you, etc. Basically, without your having to worry about it, we make sure you have the kind and quantity of ‘dial tone’ you need if you don’t already. Did I mention this wouldn’t be a great thing for Amazon either? (laughter)
“Fifth, we provide extra support. Not surprisingly, it turns out that despite the founders vision of total simplicity, total self-installation, etc. there are times and kinds of customers for whom this is not a good choice. Many fewer than I would have thought, by the way. Our web-based tools, for example, may be insufficient, or the customer simply isn’t comfortable or able to use them.
“Sixth, we are also increasingly a marketplace of new software-based features that small innovative companies sell to our customers for nominal fees. So if you want integration with Microsoft Outlook, for example, you might buy that separate feature there. Of course, we’ve already pre-tested and pre-certified anything that goes into the feature marketplace.
Moderator: “The extra support – it’s either expensive or eats away your margins?”
Diego Piacentini: “No. Over time we’ve found most of our customers are buying their systems ‘as is’, that is without even a nominal support contract for consultation with an expert, etc. This speaks very highly of these products and their ease of use.
”What we’ve found is that customers actually want to go well beyond what many of these systems provide initially. This includes forms of integration with their other office systems and communications activities, like setting up a web video conference with a client, for example.
“I’m very proud of how we help our customers. Because the products are highly reliable and simple, the extra support is almost always about doing more, not about fixing something that’s broken. Each of these ‘more’ projects tends to cost our customers somewhere on the order of $300 to $1,000.
“At Phones.com we noticed a company called LogoWorks during our strategic planning process. They serve small businesses by routinizing and packaging corporate identity services – getting a logo designed, a website, letterhead, etc. They have a web-based questionnaire and client interaction process that standardizes a good deal of a very creative process. Behind the scenes they have a network of independent graphic designers to whom they bid out the work. Quite amazing really and we chose to emulate some of this model. What was clear to me was that the cottage industry of former PBX technicians, Centrex resellers, etc. could be recruited, certified and do mini-projects of the kind we’ve been talking about. The model works extremely well for us and our contractors. I’m sure Bob will talk about these kinds of ideas in more detail.”
Moderator: “Perfect timing. Thanks Diego. Bob, we’re really pleased you were able to join us today. It seems like ever since you took over as CEO of Home Depot you’ve been continuously transforming the organization. I think about the last thing anyone would have predicted is that Home Depot has become a very influential retailer in all manner of technology-related infrastructure. Can you tell us about the strategy and how it’s going?”
Bob Nardelli: “I’m very happy to join you, and I have orange aprons and tool belts for my co-panelists right here. (laughter)
“I’m glad you phrased it as ‘technology-related infrastructure’ by the way, because as dry as that sounds, that’s an area where homes really are in need of major improvements, often as much as plumbing or electrical systems, or adding another room. Let’s just quickly backtrack to what caused The Home Depot to get into more technology-related consumer and small business markets, and then I’ll describe a bit more of what we’ve been doing.
”...consumer demand for home technologies began to create a real problem in the home itself…”
“Somewhere in the last five to ten years, consumer demand for home technologies began to create a real problem in the home itself. The basic issue was that there were an increasing number of devices, in many cases they would be spread over several rooms in a home or building, and they needed to be interconnected. An early example of this was networking home computers. People subscribed to broadband and then wanted to be able to use it in other rooms at other computers, not just where the DSL or cable modem was. So as you know, WiFi became popular at home.
“As you also know, there really wasn’t a satisfactory answer to the interconnection problem. WiFi is a bit temperamental as far as how the signal propagates around rooms. You could never be sure that WiFi would work in certain spots until you bought it and tried it out, there was really no way to set up multiple mini hotspots in a home without dragging wires to multiple transmitters, although you could wirelessly relay the signal, etc. So a new version of WiFi came out, solved some of the problems, but, in general, it was still too complicated or unsatisfactory for many people.
“At the same time, the interconnection needs increased significantly from entertainment-driven applications. About the same time as WiFi began proliferating in the home, early versions of what were called ‘home media centers’ came on the market. They did wonderful things like take music off the internet and play it on your big stereo in the living room, or display digital photographs on your wide-screen TV in the family room. Except nobody could figure out how to wire up these devices, and weren’t about to pound holes in the wall and fish cables around, and so on, and I’ve already described the WiFi problem.
“On top of this, the quality of interconnection required kept increasing and getting more complicated. What wiring medium should you use? If you had high-definition TV, or broadband IP TV, all of a sudden re-using old phone or coax wires in the wall, even if you already had them where you wanted them, often wouldn’t work.
“These wires weren’t meant for this. Perhaps they had corroded, or were split too many times, or used poor quality connectors, or weren’t properly shielded, or whatever. So signal degradation, voltage leakage, outside RF interference, etc., often prevented it from working. I remember a cable overbuilder in California, an early mover in the deployment of ADSL2 for video, said home installations were often taking five hours to do – and this was by their own technicians, so you can imagine that DIY wasn’t going to work.
“I have to confess, a few years ago, I was entirely unaware of any of this. I started noticing it in my occasional conversations with cable, satellite, computer company executives, and so on. They kept complaining and complaining about how something as mundane as inside wiring was a barrier to further growth. Out of curiosity, I had some of our people look into it.
“They found the story that I just outlined and a total absence of systems products in the DIY market for these needs. They discovered that cable or satellite installers, usually independent contractors, electricians, and so on really didn’t do much about any of this. Certainly, that wasn’t true at the high end. If you were building a home theatre for six figures, well, this wasn’t going to be an issue. But right below that custom tier, nothing.
“So we discovered three things: inside wiring was a big problem, there were no products, certainly not at the DIY level to solve it, and the cottage industry of everything from handymen to licensed electricians and everything in-between wasn’t servicing this market and had no idea what to do.
“I went back to a few friends in the cable, satellite, phone, computer industries and asked how they thought The Home Depot might be able to help them. They certainly unburdened themselves, to put it mildly. It turns out they had been trying to solve this problem on their own without much success. They had asked stores like Best Buy to come up with something, but they have no process for product development. They’d asked industry suppliers to do something, but they have a tradition of making components and subsystems for technicians, not prepackaged solutions for DIY.
“The whole problem seemed to fall in the ‘messy middle’ – no one’s problem, and everyone’s problem, a product solution, and a labor-based solution.”
“So nothing was happening. The whole problem seemed to fall in the ‘messy middle’ – no one’s problem, and everyone’s problem, a product solution, and a labor-based solution.”
Moderator: “Bob, roughly around that time as I recall, Home Depot started a significant growth initiative in home-related services – did this inside wiring problem play into that?”
Bob Nardelli: “The timing was very fortunate. I think a lot of our executives thought ‘why on earth is Bob wasting his time on wires and connectors? We have people three levels down that worry about merchandising, etc.’ But we were already formulating a new growth strategy in which one of the cornerstones, as you point out, was home-related services.
“One of my favorite quotes from [former HBS marketing professor] Ted Levitt , and I love the example he picked, is ‘Customers don’t want to buy a quarter-inch drill. They want a quarter-inch hole.’
“When I came to The Home Depot from GE (NYSE: GE), we already had some ‘solution selling’ going on. Bathroom, kitchen cabinet, exterior door, lighting, flooring installations, and so on. We also had our Expo Design Centers which offered a higher-end experience geared around major remodeling projects – more consultation and installation services. These were all good things, but I wasn’t satisfied with what I saw. It occurred to me as well, that it’s not often that an entire new product category of building products comes along, and that home technology was creating just such a new opportunity for us.
“So to make a long story a bit shorter, our home services strategy and emerging home technology opportunities converged to make an early test case for what I wanted to do more broadly: create a service offer somewhere between pure DIY and larger-scale, custom services along the lines of our Expo centers that didn’t scale up very well.
“We rounded up a bunch of vendors such as Belkin, for example and explained what we wanted. Obviously, given our size and distribution power we got a considerable amount of attention. Now, we have an exciting product line-up such as very thin optical fiber kits which can be run along walls, baseboards, etc. and are practically invisible, enabling very high quality, high-bandwidth connections at low labor costs, no punching holes in walls, etc.
“Also, relating to Diego’s point about quality certification of independent providers of support and installation, we instituted a program to train and manage contractors, enabling us to professionalize and standardize a uniform installation and service offer.
“It’s not really a big business, yet. But it jump-started our progress towards the larger goal of building a reliable, large-scale network of low-cost, value-added services providers. It’s something we’re re-engineering into our core building product lines – the kitchen cabinet installations, and so on. Think of it as six-sigma philosophy brought to product installation.”
Moderator: “Bob, thank you, I know many in our audience will be thinking about all the possibilities in their homes that they hadn’t considered before.
“And thanks to Patrick and Diego for sharing their views as well. (applause) Let’s turn to the floor for some Q&A …”
* * * * *Disclaimer: This “transcript” is entirely fictitious, created to illustrate simulated strategic outcomes in telecom and other industries. We use the names of actual companies and publicly-known individuals in order to add a measure of realism, detail, and interest to discussions of industry strategy. We are entirely responsible for the views expressed in these simulated scenarios; they are not endorsed, sponsored, or in any way the responsibility of the entities or individuals named herein.
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11 October 05
