Look Out, Vonage. Here Comes magicJack

The magicJack itself is about the size of a matchbox.

Another upstart has crashed into the world of telephones, selling calls so cheaply it would seem no incumbent can compete. The magicJack website looks like a carnival, and inventor Dan Borislow can sound like a carnival barker. But his $40 device is selling fast with its promise of a year of unlimited calls anywhere in the United States. "We're now the largest telephone company out there," Borislow boasts with typical lack of restraint. He's referring to magicJack's availability in all 50 states, with phone numbers offered in about 80 percent of area codes—claims that even AT&T can't make.

The colorful and wealthy Borislow—who also raises, races, and wagers on racehorses—has launched magicJack fast out of the gate. The startup has sold more than 400,000 devices just six months after its official unveiling. It's selling about 7,000 a day, the company says, adding twice as many net new accounts over the period as Vonage, an Internet phoning pioneer. MagicJack's appeal is not only the price, which falls to just $20 for a second year of calls, but sound quality that's consistently good. And it's flat simple to install and use.

MagicJack's early success suggests a new threat to telephone companies, which are losing business to wireless phones and Internet calling. But it's still a pipsqueak in telecom, where cable companies are mounting the real threat with Internet phoning. The big guys are successfully bundling voice service with TV and broadband. Cablecos account for 80 percent of the 16.2 million Internet phone lines in U.S. homes, according to data from TeleGeography Research, which tracks the communications market.

Even Vonage has stumbled in trying to muscle in with Internet calling, often called VoIP (for "voice over Internet protocol"). Other Internet startups like SunRocket have simply disappeared, leaving customers scrambling to replace phone service. "VoIP has made and broken many companies along the way," says Jon Arnold, an independent analyst who follows the market.

Depending on an Internet startup for phone service can be dicey. But Borislow says magicJack is in the business for the long haul. He and Chief Executive Officer Don Burns funded much of the $25 million spent to build the company. Borislow made his money in the 1990s on cheap long distance through Tel-Save (later called Talk America). Burns made his fortune by creating "10-10" long-distance dialing.

After a few years as a young retiree, Borislow, now 46, dove back into telecom. He spent more than three years building a system of computers and switches that gives magicJack a private network for carrying calls. That amounts to unprecedented control over call quality for an Internet phone company, Borislow says. "It's a lot like a land line, but instead of connecting to AT&T, you connect to my network."

There have been stumbles. Some customers complained that tones from their phones wouldn't work on menu-driven services, such as those reached at an airline's 800 number. And the service had problems across wireless broadband connections sold by cellphone carriers. Borislow says those issues should be resolved in a software update sent automatically to all magicJack devices.

Customer service is available only through online chats, and has drawn poor reviews. Borislow says it's getting better and he plans to keep it online. For one thing, if a customer is able to reach customer service on the Web, that eliminates a poor Internet connection as the culprit behind any magicJack problems.

Here's how the whole thing works: The jack's magic is in an oversized thumb-drive that connects to the USB port of a computer. At magicJack's other end is a standard phone jack attached to a conventional handset. The device loads its own software, and in a couple of minutes users can be making and receiving calls with their old corded or cordless phone. MagicJack customers must keep their computer powered up to make and receive calls. But piggybacking on the PC (including Macs with Intel chips) helps keep costs down.

Skype, a popular Internet calling service, requires a software download and a PC's microphone and speakers to make calls. Or users can buy and install their own hardware. Vonage and other companies send a box that lets consumers plug a conventional phone directly into their broadband router. That can raise its own issues, and quality can vary. They also typically charge $20 a month for service.

Borislow plans to make money by selling advertising, which will be displayed as part of the software that runs while magicJack is plugged in. "It'll eventually become more of a portal," he says of the software interface.

The company also reserves the right to monitor the numbers dialed to tailor those ads, which some critics find creepy. Rob Beschizza at BoingBoing called it "systematic privacy invasion."

Borislow responds that targeting ads based on user information is no worse than what Google does in tailoring ads based on Web searches or the content of E-mails in its Gmail system. "We'll be doing what other people do in Web advertising," he says, promising to protect user privacy. His software robots won't monitor the content of phone calls themselves. "I'm not going to do anything to piss off my customers."

Borislow, meanwhile, doesn't rule out selling his new company if the right offer comes along. But he also talks as if magicJack could soon rank among the big telecom companies. Nobody has offered a consumer broadband device that operates across its own phone network, he says: "This is a disruptive technology."

Analysts are skeptical. There will be niches for startups, but the telcos and cablecos have too much advantage in owning the wires that deliver broadband to the home, says Paul Brodsky, an analyst at TeleGeography. He says the days have come and gone when independent VoIP companies could disrupt the telecom market.

Once in the home with an IP network, the incumbent companies can deliver phone service for little cost. "Once you have an IP network, it really doesn't cost anything to run voice over it," says Arnold, the independent analyst. "It's a race to zero."

With a multimillion wager on his latest tech horse, that's a race Borislow is willing to run.

Clarified on 6/6/08: An earlier version of this article included a quote from analyst Paul Brodsky that is now paraphrased.