Companies that provide voice-over-Internet Protocol (VoIP) telephony services are going to come under significant margin pressure after March and this could lead to a wave of consolidation in the sector, with some smaller players being driven out of business.

This is the bleak view of Ryan Miles, chief operating officer at office automation company Itec, who says the explosion in the number of new players in recent years in the VoIP market is not sustainable as call termination rates come down.

Miles says the reduction in the rates — they’re being brought down by the regulator, the Independent Communications Authority of SA (Icasa), over a three-year glide path between 2011 and 2013 — will hit smaller players the hardest.

On 1 March, the peak-time mobile call termination rate — what the mobile operators charge to carry calls onto their networks — will be cut from 73c/minute to 56c/minute. Next year, they’ll fall again, to 40c/minute. It’s possible Icasa will force further reductions in 2014 and beyond.

The reductions have already hammered least-cost routing companies — those that operate banks of Sim cards, steering calls along the cheapest routes — because the arbitrage opportunities they took advantage of when the rates were higher have largely gone away. The pressure is now also being felt by VoIP players, Miles says, with revenues and profit margins both falling.

He believes this year’s cut in termination rates will tip a lot of the smaller VoIP operators over the edge, forcing them to merge, be acquired, or risk going out of business. Miles says Itec is also one of the smaller players in the game and is considering its strategic options. “We are doing volumes significant enough that it does make sense but are cautiously monitoring our investment in this space.”

Because the VoIP market is highly competitive, companies have been forced to match the reductions in termination rates. “It’s become cut-throat,” he says.

Gross margins could soon fall into single digits. He adds that companies not selling at least 15m minutes a month of voice traffic won’t be able to keep their heads above water after 1 March. “That’s not easy to attain for any start-up business.”

Barriers to entry have risen enormously, whereas a few years ago they were “relatively low”.

“A lot of the tier two and tier three [VoIP] operators are now battling to break even. These guys will have to consolidate,” Miles says. “Either that, or they have to expand into another product set, like data services. But the same thing is happening with data charges.”

In addition, changing focus and reinventing their businesses is not something many companies are capable of.

He warns companies that use VoIP providers should not lock themselves into long-term agreements — including with Itec — given the turmoil that he expects in the next few years. Many companies buy their voice and data services from a single supplier but this is risky, he says. “Your business could come to a standstill if those things become dysfunctional in any way.” — Duncan McLeod, TechCentral