By Joanne Kelley

The latest idea to shake the world of telecommunications was, quite literally, born in a barn. Tel-Save Holdings, which operates from a converted barn in a small Pennsylvania town, saw that there was a huge opportunity to attract phone customers and simplify billing by using the Internet. Tel-Save grabbed the opportunity—and a million new customers. It did so at so little cost that it undercut the prices of its big competitors and threw the industry into a tizzy.

While the behemoths of the telecommunications world slash, trash, and generally devour each other, Tel-Save should have been just a gnat buzzing around the field of battle. After all, in a business that can require billions of dollars of annual capital investment, Tel-Save began with $150,000 of financing. The company was founded by a cable-TV installer with no background in the business. And Tel-Save is still so devotedly no-frills that it's hard sometimes to even see how it can operate.

But Tel-Save not only saw the right market, it acted fast and got some key details right. As a result, it blindsided its giant competitors in a way that will be hard for them to counteract for years.

"We really think we stole one from the big three" telephone companies, says Tel-Save President Gary McCulla. "We're out there taking everybody's top consumer customers."

Even in a regulated, expensive business such as telecommunications, it seems that information technology is letting competitors appear quickly, almost out of thin air.

Robert Rosenberg, president of Insight Research, a telecommunications market research firm, says: "Anyone with a fresh idea really can put a lot of wind in the sails of a company. It doesn't take a lot."

Daniel Borislow, then 29 years old, founded Tel-Save in 1989 after spending a few years running his own cable-TV-installation business in the Philadelphia area. He moved into the phone industry on little more than the advice of his roommate at the time, an AT&T employee who told him there was money to be made by reselling AT&T services. With a $150,000 loan from a silent partner, Mr. Borislow began peddling long-distance phone service to small and medium-size businesses. He became one of AT&T's bigger wholesalers, but buying bulk long-distance capacity and reselling it is a low-margin business with limited prospects for growth, as hundreds and hundreds of such companies know well.

With margins so precious, frugality was a point of pride. Tel-Save set up shop in New Hope, Pa. (population: 1,400), an artsy community among the trees along the Delaware River. For offices, the company found a red barn that had been used to manufacture keyboards for cash registers in fast food restaurants. The barn is next to a lawn and garden center and across the street from a ministorage building. Tel-Save has no formal reception area. Visitors find themselves wandering down hallways to the receptionist. One recent day, the only place to sit was a chair covered with papers outside a row of cubicles, where casually dressed employees in Birkenstocks toiled at computer screens.

Mr. Borislow shares an office, "the War Room," with eight others. There is no press officer or investor relations representative. Mr. Borislow writes his own press releases, sometimes rambling on or openly discussing how much he'd like a potential suitor to pay for Tel-Save. (The home-brewed approach to investor relations may have caused some problems: A group of Tel-Save shareholders launched a class-action suit in June, arguing that Tel-Save overstated its earnings.)

The company grew in fits and starts, becoming just profitable enough that Mr. Borislow could consider expanding. He wanted to get into the consumer long-distance market. He also saw longingly that long-distance companies were moving to give consumers a single bill covering all their telecommunications needs. The question in early 1997 was: How could he keep up with the big boys while operating on a shoestring budget?

His answer: the Internet.

Mr. Borislow decided that telecommunications lends itself to selling on-line. Service is widely seen as a commodity. Customers have been conditioned to switch carriers to find a better price. And there's nothing about long-distance service that makes consumers want to touch it, the way they might want to feel clothes.

Mr. Borislow also saw that he could use the Internet to send customers their bills, putting him ahead of competitors. He could even receive payments on-line, via credit card. And the number of users of the Internet was growing daily.

He then realized he didn't have to limit himself to monthly bills. He could provide information on the cost of calls as soon as the customer finished them. There would be no nasty surprises at the end of the month. And because the bills are on-line, the data could be manipulated. A customer could, for instance, find out how much he spent talking to Aunt Mabel each week.

The idea of using the Internet wouldn't even require heavy investment in some advanced piece of technology—the game that telecommunications companies generally have to play to stay competitive. Instead, Tel-Save just had to write a manageable piece of software.

And the investment would save tons of money in operating expenses. Finding customers on-line would let Tel-Save avoid traditional marketing costs, which can total as much as a third of revenue at some companies. Tel-Save, whose revenue totaled $305 million in 1997, also would avoid the enormous cost of sending out paper bills. Customers could even be made to do the time-consuming work of signing up for and allocating phone lines—an on-line subscriber simply fills in a few lines in a pop-up box and clicks 'yes' to be activated.

Mr. Borislow realized that he needed a partner to give his idea the greatest chance of success. He simply didn't have access on his own to enough on-line consumers. He also worried he would frighten away prospective customers as soon as he asked them for their credit-card information on-line.

But the decision to find a partner wasn't easy. Mr. Borislow faced what has become a big problem for companies—especially smaller ones—that want to take advantage of the Internet. They can piggyback on someone else's brand and make a quick splash, but they'll give up their chance to develop a brand of their own. And early experience with the Internet suggests that brand is even more important in that world of nearly infinite choices than it is in the traditional, physical world of business, because brands help consumers make quick, reliable choices. Alternatively, companies can eschew partnerships, but they run the risk that someone else may be able to develop a brand faster and that they'll never get anyone's attention.

Mr. Borislow decided it was more important to break out of the pack quickly. He'd worry about branding later.

He decided to start at the top and go after a relationship with AOL. AOL's customers generally come from high-income households with two to three times the phone usage of average customers. And it already had credit-card data on file for its members.

"AOL has done all the hard work in terms of establishing a credit-card relationship with users of AOL," says Mr. McCulla, Tel-Save's president. "You can imagine what it would be like trying to telemarket long-distance services and then at the end of the sale asking for a credit-card number. You'd just get, 'NO, NO, NO!'"

Mr. Borislow flew off to Washington in early 1997 to woo AOL. He carried a $50 million check in his pocket, hoping to get AOL to close a deal on the spot. In fact, Tel-Save was the right company at the right time. AOL wasn't exactly riding high, and it desperately needed someone to endorse it as a source of business. AOL also needed cash to help finance extensive expansion plans.

Still, AOL's chief executive, Steve Case, has always had an aggressive view of what AOL would become, so he held out for more money. Eventually, Tel-Save paid $100 million for the exclusive right to sign up consumers on the AOL system for telecommunications services. The exclusivity lasts until 2001.

"We basically bet the ranch here we could make it work on AOL," Mr. McCulla says.

With AOL's access to its 12 million members lined up, Tel-Save became aggressive. Its low operating costs let it do away with monthly fees for consumers and charge just nine cents a minute for calls anywhere. That was a penny less than the rock-bottom price of larger competitors.

Traffic exploded. With nearly a million new customers, on top of the 300,000 that Tel-Save already had, revenues are expected to double to more than $600 million in 1998 from 1997. Analysts expect revenue to reach $1 billion in 1999.

Tel-Save's success didn't go unnoticed. AT&T and MCI Communications moved quickly to duplicate the deal. They forged marketing alliances with Internet search companies to find new customers. Smaller players such as LCI International established on-line marketing links of their own. But none of those other on-line companies can currently come close to AOL's audience.

Competitors slashed long-distance rates to match Tel-Save. Some even tried to beat its prices. But the "me-too" responses fell short. They continued to carry monthly fees, or charged a penny extra per minute. And they couldn't deliver real-time billing.

To survive over the long haul, Tel-Save needs to do still more. Among other things, it will probably have to offer local and wireless service and all the other things that customers want as the industry moves closer to the holy grail of one-stop shopping. "Long distance is going to go away as a stand-alone product," predicts Timothy Horan, a telecommunications analyst at BancAmerica Robertson Stephens. "Tel-Save needs to start selling other services."

In that sense, Tel-Save is again running at a disadvantage to its larger rivals because of its decision to sacrifice its brand. Consumers who sign up for its service on-line are using "AOL Long Distance" and may never have even heard of Tel-Save.

The company hopes to become a reseller of local service, and has been acquiring its own switches to lower payments to AT&T. But even company officials acknowledge that Tel-Save needs to get bigger by being bought or by acquiring another company.

"When you compare the resources of a Tel-Save vs. the resources of an AT&T, it's got to only make sense that these big guys are going to prevail," Tel-Save's Mr. McCulla says. "As much as we can be aggressive and entrepreneurial, sooner or later critical mass does have its impact."

A sale might well be announced any day. As this article goes to press (in late July), Mr. Borislow is expected to say soon whether he intends to stay independent or will try to sell Tel-Save.

Whatever happens to this upstart, the message is the same. As technology causes upheaval in the business world, more and more Tel-Saves will appear in more and more industries.

These companies may be born in a barn. They may not have the pedigrees of traditional competitors. They may not even survive for long as independent entities. But they're going to change a lot of the rules of competition.

DOUBLE, DOUBLE, TOIL, AND TROUBLE

Coupled with Tel-Save's rise to prominence, the audacity of Worldcom, based in the metropolis of Jackson, Miss., suggests that the teleCommunications world is especially ripe for assaults by young companies in remote places. But the Internet's exponential growth is causing trouble for established companies across the board:

—Everybody's favorite example, Amazon.com, now has a market value greater than that of Barnes & Noble and Borders combined because of its decision to sell books only on-line.

—Reel.com has taken a shot at Blockbuster by making it easy to buy videos on-line. You can even rent them that way, which may attract movie buffs who would rather see a hard-to-find classic than settle for one of the 100 or so copies of the latest blockbuster gobbling up all the space at the neighborhood video store.

—Firefly has gone after the huge music-store chains with a service they can't offer. It helps shoppers find new groups and types of music by telling them about the purchasing habits of people whose tastes resemble theirs.

—In financial services, E*Trade and others are attacking brokerage firms by offering inexpensive, on-line stock trading. They're now talking of expanding onto the turf of banks, offering mortgages and other financial services. Wit Capital and others are even going after the investment banks, doing stock offerings on-line. A Microsoft/FDC alliance, among others, will soon present and collect bills electronically, threatening to cut banks out of the loop unless their counter-alliance can save the day.