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Weekly Column

Skyped: The Likely Sale of Skype Will Be Another Kick in the Head to Old-Line Phone Companies Worldwide

Status: [CLOSED]
By Robert X. Cringely

In high tech, the theory goes, advantage lies with the pioneers -- the first company to introduce a product in a new category. And that's true except when it is not, which is typically when the pioneers were too early, too expensive, or too difficult to use. In those cases, a second model generally holds, and in that one, the dominant company is a later entrant who simply does the task far better than it had been done before. For Internet searching, Google is a perfect example of this latter effect, entering the market years after Alta Vista and Excite. And the Google of VoIP looks like it might be Skype, which was almost sold last week to Rupert Murdoch's News Corp. for $3 billion.

It may seem odd for me to be writing a story about a company ALMOST being sold, but there is still plenty to be learned from this story that never really happened, especially if Skype ends up being sold next week or the week after, which is a very real possibility.

Skype, for those who've never heard of or used the service, is a Voice-over-Internet Protocol (VoIP) company based in Luxembourg. Remember when all the hot Internet startups were in the U.S.? No more. That started to change years ago when Mirabilis, an Israeli company, invented the ICQ messaging system, later sold to AOL.

Since the Internet is a global network, good ideas can originate from anywhere.

Skype comes from the people who did the Kazaa peer-to-peer network application that drives record company executives mad while simultaneously loading spyware on your PC. But where Kazaa at one point annoys everyone, Skype just offers peer-to-peer voice communication, sans spyware, for the best of all prices: free. If I have Skype on my computer and you have Skype on yours, we can talk for nothing and the audio quality is surprisingly good -- good enough that 142 million people have so far downloaded Skype, with probably 20 million using the service on a daily basis.

The big question for any of these software-only Internet services is always how they make their money? Having millions of users is nice, but if none of them are paying, well what's the point? One alternative is to run ads on the phone client, but Skype sees its payday coming primarily by linking its system to regular old telephones. SkypeOut lets you buy time that can be used for calling any phone anywhere, generally for less than two cents per minute. SkypeIn gives you a regular phone number your Skypeless friends can call. Numbers are available in many cities and the price is around $37 per year. SkypeZones allow users to make Skype calls at 17,000 WiFi hotspots around the world for $7.95 per month. And SkypeVoicemail, which is free with SkypeIn, is available separately for otherwise non-paying Skype users so they can send or receive voice messages.

If Skype has 20 million regular users (there are 2.6 million signed-in right now as I am writing this) and 10 percent of those can be converted to SkypeIn, that's $74 million in revenue with some inevitable SkypeOut volume, too. In short, it is a business. But is it a business worth $3 billion?

Remember in the heady days of the Internet boom when Microsoft paid $400 million for Hotmail and AOL paid $178 million for ICQ, neither of which had revenue or even a HOPE of revenue?

Yeah, but that was then and this is now, and $3 billion is a LOT of money. What makes Skype worth so much?

The big difference between Skype and Hotmail or ICQ is that Skype threatens existing, highly profitable franchises. As free e-mail, Hotmail may have threatened paid e-mail services, but there were no hugely profitable paid e-mail services. And ICQ threatened nobody. But Skype absolutely takes money out of the pockets of existing telephone companies. And since the value of a telephone subscriber is generally a known quantity, the value of an active Skype customer can be at least guesstimated.

If Skype really has 20 million active users and the company is worth something near $3 billion, then the market value of a Skype customer is $150.

While that may seem like a lot of money, it is around 10 percent of the imputed value of a traditional telephone, mobile telephone, or cable television customer. This lower value evidently factors in the ephemeral nature of a Skype customer who might disappear forever at any moment, or go for months without using the service.

Yeah, but who would want to buy Skype, especially for that kind of money?

Frankly, News Corp. surprises me, though the company did recently buy Intermix (MySpaces) for $580 million. It surprises me so much, in fact, that my guess is Rupert Murdoch wasn't really serious and mainly looked at Skype to see the company's books and to learn more about the VoIP business without having to pay for the lesson. So what's most interesting about News Corp. and Skype isn't that the deal fell through, but that News Corp. even knew Skype was available. That means the company is probably being broadly flogged by an investment bank. It also means that whether News Corp. is the purchaser or not, Skype WILL be sold sometime in the near future.

The sale of Skype was pretty much inevitable. Startups only have so many exit possibilities, and Skype was sure a lot more likely to be sold than to go through an IPO. And there just aren't that many Swiss companies going public on NASDAQ these days.

So if Skype is on the block, who is likely to be the eventual buyer and with what effect?

Skype takes customers away from traditional wired telephone companies, so while an SBC or Verizon might buy the company, I just don't see that. If they bought Skype just to kill it, well then another Skype will appear overnight to take its place, so that isn't going to happen. If they buy Skype to make money from it without killing their own customer relationships, then these are smarter phone companies than the ones I know.

A big broadband provider like Comcast could buy Skype. There is actually a lot of synergy between Comcast (or most any other big cable company that also offers broadband) and Skype. Using Comcast just as an example, the company is trying to enter the local phone service business, so it wants phone customers. Since Comcast's own phone offering is VoIP, there are probably some technical synergies. And buying Skype would give Comcast a global reach and global customer relationships for any future broadband content business. If Comcast started offering movies for download, for example, owning Skype would give it 20-plus million extra customers on top of the seven-plus million U.S. broadband customers it has already.

So a Comcast might well be interested in Skype and $3 billion would probably not be too much to pay.

But I think the most likely purchaser of Skype would be a mobile telephone company. Since Skype service requires broadband, and broadband so far is inherently fixed, Skype threatens only incumbent FIXED phone service, not mobile service. Skype causes headaches for Verizon, but not for Verizon Wireless. So Skype would appeal most to mobile phone carriers who have no fixed telephone assets. That means no offers from SBC, BellSouth, Sprint, or Verizon, just to speak of U.S. carriers, but Skype might be supremely attractive to a Vodaphone or an NTT DoCoMo, both of which have the ability to finance such a deal effortlessly.

Expect Skype to be sold, another viral marketing success sucked up by big business. Expect it to go to either a major broadband provider or, more likely, to a big mobile carrier with no fixed telephone assets. And whoever buys Skype, expect them to throw money into making the company into even more of a multinational telecom headache than it currently is.

Of course, the rest of the VoIP industry loves this. If Skype is worth $3 billion, then so is Vonage and maybe Packet8. This purchase will validate the VoIP industry, give it a per-subscriber value number that can be used to justify more debt, raising more money that can be used to further undermine those creaky old phone companies.

And that may be the greatest reason why Murdoch was interested in the first place. By putting Skype in play, he distracts for no money at all most of the major media companies. And while they try to figure out how to respond to VoIP, old Rupert will be attacking them on some completely other front. He'll be stealing their shoes.

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