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To understand what's going to happen to the telephone companies this year thanks to WiFi (otherwise known as 802.11b) and Voice over IP (VoIP) you only need to know one story: ZapMail.

The story goes like this. In 1984, flush from the success of their overnight delivery business, Federal Express announced a new service called ZapMail, which guaranteed document delivery in 2 hours. They built this service not by replacing their planes with rockets, but with fax machines.

 

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This was CEO Fred Smith's next big idea after the original delivery business. Putting a fax machine in every FedEx office would radically reconfigure the center of their network, thus slashing costs: toner would replace jet fuel, bike messenger's hourly rates would replace pilot's salaries, and so on. With a much less expensive network, FedEx could attract customers with a discount on regular delivery rates, but with the dramatically lower costs, profit margins would be huge compared to actually moving packages point to point. Lower prices, higher margins, and to top it all off, the customer would get their documents in 2 hours instead of 24. What's not to love?

Abject failure was not to love, as it turned out. Two years and hundreds of millions of dollars later, FedEx pulled the plug on ZapMail, allowing it to vanish without a trace. And the story of ZapMail's collapse holds a crucial lesson for the telephone companies today.

The Customer is the Competitor

ZapMail had three fatal weaknesses.

First of all, Federal Express didn't get that faxing was a product, not a service. FedEx understood that faxing would be cheaper than physical delivery. What they missed, however, was that their customers understood this too. The important business decision wasn't when to pay for individual faxes, as the ZapMail model assumed, but rather when to buy a fax machine. The service was enabled by the device, and the business opportunity was in selling the devices.

Finally, because it misunderstood how the fax network would be built, FedEx misunderstood who its competition was. Seeing itself in the delivery business, it thought it had only UPS and DHL to worry about. What FedEx didn't see was that its customers were its competition. ZapMail offered two hour delivery for slightly reduced prices, charged each time a message was sent. A business with a fax machine, on the other hand, could send and receive an unlimited number of messages almost instantaneously and at little cost, for a one-time hardware fee of a few hundred dollars.

There was simply no competition. ZapMail looked good next to FedEx's physical delivery option, but compared to the advantages enjoyed by the owners of fax machines, it was laughable. If the phone network offered cheap service, it was better to buy a device to tap directly into that than to allow FedEx to overcharge for an interface to that network that created no additional value. The competitive force that killed ZapMail was the common sense of its putative users.

ZapPhone

The business Fred Smith imagined being in -- build a network that's cheap to run but charge customers as it if were expensive -- is the business the telephone companies are in today. They are selling us a kind of ZapPhone service, where they've digitized their entire network up to the last mile, but are still charging the high and confusing rates established when the network was analog.

The original design of the circuit-switched telephone network required the customers to lease a real circuit of copper wire for the duration of their call. Those days are long over, as copper wires have been largely replaced by fiber optic cable. Every long distance phone call and virtually every local call is now digitized for at least some part of its journey.