IP PBX AND IP CENTREX GROWTH OF VOIP IN THE ENTERPRISE

2004-2009

The contents of this study represent our analysis of the information generally available to the public or released by responsible individuals in the companies mentioned. It does not contain information provided in confidence by our clients. Since much of the information in the study is based on a variety of sources that we deem to be reliable, including subjective estimates and analyst opinion, The INSIGHT Research Corporation does not guarantee the accuracy of the contents and assumes no liability for inaccurate source materials. We are indebted to The Eastern Management Group, Inc., Bridgewater, NJ, for providing historical line shipment data. Eastern’s Monitor product has been an authoritative industry source for PBX and Centrex line shipment data for more than 20 years; any inaccuracies in interpretation of the data are wholly our own. Copyright © 2004 by The INSIGHT Research Corporation. All Rights Reserved. Printed in the United States of America. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, prior to written permission of the publisher.

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IP PBX and IP Centrex: Growth of VoIP in the Enterprise 2004-2009

TABLE OF CONTENTS

Chapter I

EXECUTIVE SUMMARY......................................................... 1

1.1 VoIP in the Enterprise Market ...........................................................................................................1 1.2 Market Segments & Definitions ........................................................................................................2 1.3 Market Forecast and Market Analysis ...............................................................................................3

Chapter II

BACKGROUND ...................................................................... 8

2.1 Market Segments and Definitions......................................................................................................8 2.1.1 PBXes and KTSes ....................................................................................................................11 2.1.2 Hybrids .....................................................................................................................................12 2.1.3 The Uniqueness of the PBX .....................................................................................................12

2.2 Network Switching: Centrex.............................................................................................................13 2.2.1 Centrex vs. PBX.......................................................................................................................14 2.2.2 Two Forms of IP Centrex .........................................................................................................15 2.2.3 Softswitch................................................................................................................................16

2.3 VoIP Technology in the Premise .......................................................................................................18 2.3.1 Understanding Internet Protocols .............................................................................................19 2.3.2 Voice over IP: Standards, Protocols, and Architectures ..........................................................20

2.3.2.1 VoIP Media Protocols .......................................................................................................22 2.3.2.2 VoIP Signaling Protocols ..................................................................................................23 2.3.2.3 VoIP Gateways & Protocols..............................................................................................24 2.3.2.4 The H.323 Standard...........................................................................................................25

2.3.3 An IP-Enabled Phone System...................................................................................................28

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Chapter III

THE ENTERPRISE VOICE MARKET TODAY.......................... 30

3.1 Enterprise Voice Market Installed Base.............................................................................................30 3.2 Premises Voice Total Addressable Market ........................................................................................32 3.3 Premises Voice Market Vectors: Base Year, End Year ....................................................................34 3.4 The Rise of VoIP in the Premises ......................................................................................................39

3.4.1 Premises Equipment Provider Market Shares ..........................................................................41 3.4.2 Key/Hybrid Market ..................................................................................................................48 3.4.3 TDM and IP Extension Shipments ...........................................................................................49

3.5 Centrex Market ..................................................................................................................................52 3.6 Next Generation IP Centrex Market ..................................................................................................57

Chapter IV

ENTERPRISE VOIP DRIVERS AND INHIBITORS................... 60

4.1 Premises VoIP Drivers.......................................................................................................................60 4.1.1 VoWLAN .................................................................................................................................60 4.1.2 Cost Savings .............................................................................................................................61 4.1.3 Remote Access .........................................................................................................................62 4.1.4 Inter-Site Networking..............................................................................................................63 4.1.5 Branch Offices..........................................................................................................................64 4.1.6 Moves, Adds, and Changes (MAC)..........................................................................................65 4.1.7 Productivity Enhancing Applications .......................................................................................67 4.1.8 Toll Savings..............................................................................................................................68 4.1.9 Call Centers ..............................................................................................................................69

4.2 Premises VoIP Inhibitors ...................................................................................................................70 4.2.1 Availability...............................................................................................................................70 4.2.2 LAN/WAN Engineering..........................................................................................................72 4.2.3 Training ....................................................................................................................................73 4.2.4 Remote Access Voice Quality..................................................................................................74 4.2.5 Security.....................................................................................................................................74

4.3 Service Providers ...............................................................................................................................75 4.3.1 Overview ..................................................................................................................................75 4.3.2 IP-enabled vs. Pure IP Centrex.................................................................................................75 4.3.3 Managed Premises-Based VoIP Services.................................................................................77

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4.3.4 IP Centrex and Managed Service Drivers ................................................................................78 4.3.4.1 VoWLAN..........................................................................................................................78 4.3.4.2 Cost ...................................................................................................................................79 4.3.4.3 Remote Access ..................................................................................................................80 4.3.4.4 Inter-Site Networking........................................................................................................80 4.3.4.5 MAC..................................................................................................................................81 4.3.4.6 Productivity Enhancing Applications................................................................................82 4.3.4.7 Toll Savings ......................................................................................................................84 4.3.4.8 Call Centers .......................................................................................................................84

4.3.5 VoIP Obstacles .........................................................................................................................85 4.3.5.1 Availability........................................................................................................................85 4.3.5.2 LAN/WAN Network Engineering.....................................................................................87 4.3.5.3 Training .............................................................................................................................89 4.3.5.4 Remote Access Voice Quality...........................................................................................91 4.3.5.5 Security .............................................................................................................................93

Chapter V

VENDORS .............................................................................. 95

5.1 Legacy Vendors .................................................................................................................................95 5.1.1 Avaya .......................................................................................................................................95 5.1.2 Nortel........................................................................................................................................98 5.1.3 NEC..........................................................................................................................................100 5.1.4 Siemens ....................................................................................................................................101 5.1.5 Mitel .........................................................................................................................................103 5.1.6 Inter-Tel....................................................................................................................................105

5.2 IP PBX Vendors.................................................................................................................................107 5.2.1 Vertical Networks.....................................................................................................................108 5.2.2 Alcatel ......................................................................................................................................108 5.2.3 3Com ........................................................................................................................................109 5.2.4 Cisco.........................................................................................................................................111

5.3 Service Provider Profiles ...................................................................................................................113 5.3.1 Verizon .....................................................................................................................................115 5.3.2 Qwest........................................................................................................................................116 5.3.3 AT&T.......................................................................................................................................117 5.3.4 Sprint ........................................................................................................................................118

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5.3.5 MCI ..........................................................................................................................................120 5.3.6 GoBeam....................................................................................................................................121

Chapter VI

MARKET FORECASTS ........................................................... 124

6.1 Market Summary ...............................................................................................................................124 6.2 Forecast Summary .............................................................................................................................127 6.3 Market Forecast .................................................................................................................................129

Appendix

GLOSSARY ............................................................................ 148

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TABLE OF FIGURES

Chapter I

I-1 Comparison of Total Premises vs. Centrex Installed Base 1995-2009 (Extensions Millions)...........4 I-2 Total Addressable Market: Premises Equipment Revenue ($Billions) .............................................5

Chapter II II-1 Centrex IP Enabled Variant ..............................................................................................................15 II-2 Softswitch Architecture in the Centrex Environment .......................................................................17 II-3 Protocols for Real-Time Communications........................................................................................22 II-4 Typical H.323 Network Architecture................................................................................................27 II-5 Integrated H.323 gateway/gatekeeper residing at a digital station port. ...........................................29

Chapter III III-1 Comparison of Premises vs. Centrex Installed Base 1995-2009 (Total Extensions Millions) .......30 III-2 Comparison of Premises vs. Centrex Installed Base: Detailed Contribution Comparison,

1995-2003 (Total Extensions Millions) .........................................................................................31 III-3 Total Addressable Market for Premises Equipment, 1995-2003 (Total Revenues Billions)..........32 III-4 Total Addressable Market for Premises Equipment: Relative Contributions,

1995-2003 (Total Revenues $Billions) ..........................................................................................33 III-5 Total Premises-Based Installed Extensions, 2003 and 2008 (Millions) .........................................35 III-6 Premises Extension Shipments by Category, 2003 and 2008 (Millions)........................................35 III-7 Total Premises Equipment Revenues, 2003 and 2008 ($Billions) .................................................36 III-8 Historical View of Legacy Premises Retirements and Shipments,

1995-2003 (Total Extensions Millions) ..........................................................................................37 III-9 Installed Base of Legacy vs. VoIP Extensions, 1995-2003 (Total Extensions Millions)...............39 III-10 Premises Vendor Line Shipments: TDM vs. VoIP, 2002 (Number of Extensions Million) ..........40 III-11 Premises Vendor VoIP Extension Shipments, 1999-2003 (Total Extensions Millions) ................42 III-12 Legacy Vendor Total VoIP Extensions Shipped, 2002 and 2003 (Millions) .................................43 III-13 Total Legacy Extensions Shipped by Vendor: TDM vs. VoIP, 2003 (Millions) ..........................44 III-14 IP PBX VoIP Extensions Shipped, 2002 and 2003 (Millions) .......................................................45 III-15 Vendor Comparison: Percentage of Total Premises VoIP Extension Market, 2002 and 2003 ......46 III-16 Relative VoIP Extension Shipments 2002 (Extensions Millions) ..................................................47

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III-17 Relative VoIP Extension Shipments, 2003 (Extensions Millions)................................................47 III-18 Legacy PBX Vendor TDM Extension Shipments, 2002 and 2003 ...............................................49 III-19 Legacy PBX Vendor VoIP Extension Shipments, 2002 and 2003................................................50 III-20 IP PBX Vendor Market Shares, 2002 and 2003 ............................................................................51 III-21 Legacy Centrex Installed Base, 1995-2003 (Extensions Millions) ...............................................52 III-22 Legacy Centrex Line Segment Details, 2002 (Extension Millions) ..............................................53

Chapter V V-1 Legacy Centrex Installed Base, 1995-2003 (Extensions Millions) ....................................................114 V-2 Legacy Centrex Relative Shares ........................................................................................................114

Chapter VI VI-1 Total Enterprise Voice Extension Installed Base, Year End 2003 (Extensions Millions)..............129 VI-2 Total Enterprise Voice Extension Installed Base, 2009 (Extensions Millions)..............................130 VI-3 Total Enterprise Extension Shipments, 1999-2009 (Extensions Millions) .....................................131 VI-4 Comparison of Total Premises vs. Centrex Installed Base 1995-2009 (Extensions Millions) .......132 VI-5 Comparison of Total Premises vs. Centrex Installed Based-Detailed Contribution

(Extensions Millions).....................................................................................................................134 VI-6 Total Enterprise Extension Installed Base, 1999-2009 (Extensions Millions) ..............................136 VI-7 Relative Shipments of VoIP Extensions (Extensions Millions) ....................................................137 VI-8 VoIP Extension Shipments, 1999-2009 (Extensions Millions) .....................................................139 VI-9 Total VoIP Extension Installed Base, 1999-2009 (Extensions Millions) ......................................141 VI-10 Total Addressable Market: Premises Equipment Revenue ($Billions) ........................................142 VI-11 Total Addressable Market for Premises Equipment: Relative Contributions in terms of Revenue,

1995-2009 ($Billions)...................................................................................................................144 VI-12 Premises Extension Revenues, 1999-2009 ($Billions)..................................................................145 VI-13 Installed Base of Legacy vs. VoIP Extensions, 1995-2009 (Extensions Millions) .......................146

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TABLE OF TABLES Chapter I

I-1 Pure IP Centrex Service Provider Comparison..................................................................................7

Chapter III III-1 Comparison of Premises vs. Centrex Installed Base 1995-2009 (Total Extensions Millions) .......30 III-2 Comparison of Premises vs. Centrex Installed Base: Detailed Contribution Comparison,

1995-2003 (Total Extensions Millions) .........................................................................................31 III-3 Total Addressable Market for Premises Equipment, 1995-2003 (Total Revenues Billions).........32 III-4 Total Addressable Market for Premises Equipment: Relative Contributions,

1995-2003 (Total Revenues $Billions) .........................................................................................33 III-5 Historical View of Legacy Premises Retirements and Shipments,

1995-2003 (Total Extensions Millions) ........................................................................................38 III-6 Installed Base of Legacy vs. VoIP Extensions, 1995-2003 (Total Extensions Millions) ..............39 III-7 Premises Vendor VoIP Extension Shipments, 1999-2003 (Total Extensions Millions) ...............42 III-8 Legacy Centrex Line Segment Details, 2002 (Extension Millions) ..............................................53 III-9 Pure IP Centrex Service Provider Comparison .............................................................................58

Chapter VI VI-1 Total Enterprise Extension Shipments, 1999-2009 (Extensions Millions) ......................................131 VI-2 Comparison of Total Premises vs. Centrex Installed Base 1995-2009 (Extensions Millions).........133 VI-3 Comparison of Total Premises vs. Centrex Installed Based-Detailed Contribution Comparison

(Extensions Millions).......................................................................................................................135 VI-4 Total Enterprise Extension Installed Base, 1999-2009 (Extensions Millions).................................136 VI-5 Relative Shipments of VoIP Extensions (Extensions Millions).......................................................138 VI-6 VoIP Extension Shipments, 1999-2009 (Extensions Millions) .......................................................139 VI-7 Total VoIP Extension Installed Base, 1999-2009 (Extensions Millions) ........................................141 VI-8 Total Addressable Market: Premises Equipment Revenue ($Billions)...........................................142 VI-9 Total Addressable Market for Premises Equipment: Relative Contributions in terms of Revenue,

1995- 2009 ($Billions)...................................................................................................................144 VI-10 Premises Extension Revenues, 1999-2009 ($Billions)..................................................................145 VI-11 Base of Legacy vs. VoIP Extensions, 1995-2009 (Extensions Millions) ......................................146

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CHAPTER I EXECUTIVE SUMMARY

1.1 VoIP in the Enterprise Market Voice over Internet Protocol (VoIP) is finding its way into enterprises of all types and sizes; it is the technology bright spot in an otherwise hard-pressed telephony market. Enterprise-voice decision makers have cast their vote with their budgets: they are committed to VoIP within the enterprise and they are not backing off from this commitment—as the relative success of VoIP in the face of real economic hard times over the past few years suggests. VoIP is on the way to becoming the predominant form of enterprise voice technology at some point in the future, although questions remain as to the precise timing, the manner in which it will begin to dominate, and the vendors that will provide it. INSIGHT Research has taken a critical look at these key questions and their ramifications: When: VoIP will represent the predominant form of enterprise voice, sometime soon after 2009, probably 2011. How: VoIP extensions will be delivered primarily through the premises-based, VoIP-aware, voice platform. IP Centrex will play a role, but we do not foresee a major shift in the balance of power between premises-based and network-based solutions until some relief is granted to bypass current Centrex tariff structures. By whom: A classic struggle between two inherently different representations of an embedded base of equipment is already under way. Cisco and others will continue leveraging an embedded base of data networking gear into the premises PBX market, while leading legacy vendors, best represented by Avaya and Nortel, will counter with migration strategies applicable to their equally impressive installed base of voice platforms.

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1.2 Market Segments & Definitions In our study, we address the dynamics of the migration to the pure IP private branch exchange (PBX) in terms of four basic types of premises-based voice systems:

• Legacy PBX is the traditional time division multiplexing (TDM)-based PBX characterized by a completely proprietary platform.

• IP-enabled PBX is a legacy PBX with gateways to the local area network

(LAN) and wide area network (WAN) to support VoIP. They are like the converged PBX (see below) in their use of internal gateway cards, but the cards differ in one key respect. The voice stream from an IP phone or endpoint enters the PBX, where it is converted back to TDM, switched on the TDM bus to the appropriate port, and then sent back out over the LAN to the other IP phone. In other words, the PBX is still using its TDM bus to perform voice switching.

• Converged PBX switches voice calls through the TDM bus within the PBX

and uses the LAN to switch the voice stream between IP phones (so called peer-to-peer). Converged PBXs are almost always legacy PBXs with added signaling capabilities in their internal VoIP gateway devices.

• IP PBX is a purpose-built PBX that has dispensed with the TDM-bus

entirely, utilizing the company LAN for all voice connections and related switching. A combination of LAN switches, media gateways to access the PSTN’s trunk lines, and call control servers form the basic architecture of most pure IP PBXs

Similar to our PBX terminology, the network-based Centrex has its variants:

• Centrex is the original outsourced enterprise voice solution based on the Class 5 central office (CO) switch. Centrex derives all of its features from this switch, and all calls, whether internal or external, must be carried to the Class 45 switch at the carrier’s central office.

• IP-enabled Centrex is a legacy Centrex service now being delivered

through a specialized gateway to the Class 5 switch. The gateway converts

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the circuit-based Centrex lines into IP packets and vice-versa, so Centrex extensions appear in the form of IP phones.

• IP Centrex is a network-based enterprise voice service based upon

softswitches, application servers, and media gateways. Unlike IP-enabled Centrex, all calls do not have to exit the enterprise premises to be switched at a centralized location. Like a pure IP PBX, premises-based media gateways under the control of the softswitch perform the necessary call control functions for switching both internal and external enterprise calls. Other terms used to describe the same service are Network-based IP PBX and Virtual PBX.

1.3 Market Forecast and Market Analysis Our analysis suggests that the entire enterprise voice marketplace will experience only modest growth from an equipment standpoint throughout the forecast period. The total number of extensions will experience only modest growth and the total revenue derived from equipment sales will experience no growth. The premises-based enterprise voice marketplace is basically flat—it is not possible to grow the number of extensions substantially or to derive much greater equipment revenues for the foreseeable future because every business has a phone and new business formations are growing at a very modest pace. The so-called “growth” related to VoIP extensions and VoIP related revenue really takes place as part of a classic market-substitution scenario, wherein VoIP displaces TDM extensions and TDM related revenues. Figure I-1 shows how premises-based lines compare to network-based lines both historically and to the end of the forecast period.

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Figure I-1 Comparison of Total Premises vs. Centrex Installed Base 1995-2009 (Extensions Millions)

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1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

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VoIP technology adoption depends on the commitment of enterprises to truly migrate to converged voice and data networks. VoIP equipment never was and never will be the least expensive way to deliver a voice extension within the enterprise. While it is true that some VoIP phone systems, such as those offered by Altigen, are less expensive than comparable TDM units, this is more the exception than the rule. The typical cost of a VoIP extension from the legacy vendors (per-port platform costs plus IP-phone costs) is only marginally higher (around 25 percent) than that of a digital extension. Likewise, the pure play IP PBX vendors currently offer per-seat pricing (i.e., the cost of both the associated hardware and the phone) that is also very competitive—again, about 25 percent higher than digital TDM-based extension pricing. While some analysts predict that the VoIP extension costs will achieve cost parity with their TDM counterparts, INSIGHT does not. Because the TDM base is contracting, and there is little R&D money devoted to it, the price of a TDM-based extension is destined to drop faster than a VoIP extension. Lower-priced

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extensions will not stem the tide of VoIP adoption, but it will ensure a price differential for some time to come. Figure I-2 shows the enterprise premises equipment total addressable market over time. Figure I-2 Total Addressable Market: Premises Equipment Revenue ($Billions)

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1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Revenues peaked between 1998 and 1999—an event that will not repeat itself. Our assumptions about year-over-year per-line price declines play a part in the flatness of the projected market, with the decline in TDM extension prices being more pronounced than the decline in VoIP extension prices (a key assumption). Likewise, with the mix of extension types moving heavily towards VoIP, this chart is optimistic about total revenues. INSIGHT is optimistic because the VoIP extensions will be more expensive than the TDM extensions on either a Key/Hybrid or PBX system (one of the other key assumptions). Although it is the most expensive type of extension, VoIP will be purchased in increasing amounts on a year-by-year basis, offsetting the declining revenue from TDM extensions and leaving the overall market relatively flat from a total addressable market (TAM) perspective.

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The revenue potential of the enterprise-voice marketplace is predicated on the sales of software-based applications made possible by VoIP—not by equipment sales. Those equipment vendors that also manage to sell significant amounts of VoIP-related applications software (and keep most of the revenue for themselves) will be the true winners of the race. The legacy-Centrex market has maintained about a 15 percent share of the total number of enterprise extensions for a number of years. Although many analysts have pointed to the promise of IP Centrex as a way for the legacy Centrex service providers (SPs)—which effectively means the regional bell operating companies (RBOCs)—to increase this historical market share, IP Centrex only recently began shipping in any numbers, and the current tariff regime associated with traditional Centrex is likely to hamstring any potential for growth until the RBOCs gain relief. IP Centrex service is predicated on the use of softswitch technology, distinguishing it from IP-enabled Centrex, which is predicated on the use of a specialized gateway between the Class 5 switch and the IP network to reach the customer sites. The pure IP Centrex SPs are represented by a collection of very small competitive local exchange carriers (CLECs). To put things in their proper perspective, the largest identified pure IP Centrex SP—GoBeam Communications—has something just north of 10,000 lines. The grand total in the pure IP Centrex marketplace at a maximum is the vicinity of 100K lines—and is actually probably much less. This is clearly a small percentage of the total opportunity. Table I-1 identifies the so-called leading SPs in the pure IP Centrex category, identifying which softswitch they are using.

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Table I-1 Pure IP Centrex Service Provider Comparison

Company SoftswitchGoBeam SylantroCbeyond Communications

Cisco BTS 10200

DSL.net / TalkingNets

Sonus Softswitch with BroadSoft Application Server

Calltower Cisco CallManagerTelverse Sylantro While they continue in business, there is no indication that any of the current players are experiencing much growth in their softswitch-based, pure IP Centrex business. GoBeam was acquired by Covad for $48 million in stock. Covad has been in and out of Chapter 11 and is looking to GoBeam to expand upon its overall service offerings. Telverse was acquired by Level3 for $30 million in stock. Like Covad, Level3 has been in and out of bankruptcy court, and had something under 5,000 lines in service at the time they were acquired. Given the acquisitions of GoBeam and Telverse, Cbeyond Communications is now the leader in the IP Centrex CLEC market. Yet the combined total of lines in service represented by the collection of IP Centrex CLECs is still negligible compared to the number of legacy Centrex lines currently in service.

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