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Sep 15th 2005 | LONDON AND SAN FRANCISCO
From The Economist print edition
The acquisition by eBay of Skype is a helpful reminder to the world's
trillion-dollar telecoms industry that all phone calls will eventually
be free
NIKLAS Zennstrom and Janus Friis, the founders of Skype, which
distributes software that lets people make free calls from their
computers to other Skype users anywhere in the world, don't usually
travel to America. Legally, they probably could. But they prefer to
avoid that jurisdiction, since they also founded (and subsequently
sold) KaZaA, a peer-to-peer software company whose product many people
use to share copyrighted songs. So setting foot in America could
invite some legal trouble. This does not mean, however, that they
cannot appear at conferences in Silicon Valley, where Skype which uses
the same basic idea of KaZaA, but applies it mainly to voice
communication=97is considered the next big thing.
Thus, in July, Mr Zennstrom appeared, via a Skype video call, on the
screen of a packed auditorium at Stanford University, while sitting in
Estonia next to Tim Draper, a venture capitalist who invested $10m in
Skype. Mr Draper is the ultimate loud American, whereas Mr Zennstrom
is a sombre Swede. He's already taken down one industry and he's on to
the next one, hollered Mr Draper referring to recording studios and
telecoms companies. Mr Zennstrom started shifting uncomfortably. I
never wanna sell my stock until it's a hundred billion, Mr Draper
yelled, then started singing and dancing. The blushing Mr Zennstrom
was speechless.
Of course, Mr Draper was posturing. That became clear on September
12th, when Skype announced that it had agreed to be taken over by
eBay, based in Silicon Valley and the world's largest online
marketplace. Mr Draper and Skype's other investors will get nothing
like $100 billion, but eBay is paying a hefty sum $2.6 billion in cash
and shares and perhaps more if certain criteria are met nonetheless.
This pairing took many people by surprise. There have been rumours that
Yahoo!, Google, Microsoft and other technology companies were also
interested in buying Skype. Any of these might have made a more obvious
fit, since each also has instant-messaging software that can be used for
free phone calls (or 'voice chats', as opposed to text chats) between
computers. Google, the world's most popular internet search engine,
launched its own voice-chat software in August. A week later, Microsoft
bought Teleo, a San Francisco company that lets people call conventional
telephones from their computers (as Skype also does, for $0.02 a minute).
Yahoo! had already bought Dialpad, another Skype-like firm, in June. AOL,
Apple and others have similar products.
As Meg Whitman, eBay's boss, and Mr Zennstrom explain it, a
combination of eBay and Skype is not all that far-fetched. From eBay's
point of view, placing cute Skype buttons on the web pages where
people trade used cars, houses and other items that usually require
voice bargaining =93reduces friction=94, says Ms Whitman. Buyers can
simply click on the button and talk to sellers. Another idea is to
make money from 'pay-per-call' advertising, where advertisers would
place voice links (ie, Skype buttons) on certain pages just as they
now place text links on, say, the search-results pages of
Google. Whenever a web surfer clicks on one of these links and talks
to a salesperson, the advertiser would pay eBay and Skype a
fee. Google got rich by doing this in the text world; there is no
reason why eBay might not be able to do it in the voice world.
From Skype's point of view, the deal strengthens its existing link
with PayPal, eBay's online bank, which it uses to charge for services
such as calls from computers to conventional telephones (called
SkypeOut) or from conventional phones into Skype (called
SkypeIn). This involves prepaid accounts, which Skype users can top up
via PayPal with their credit cards.
For Skype, however, the main attraction may be that eBay, unlike the
other potential suitors, plans to leave it largely alone, both as a
brand and as a business. When Yahoo! and Microsoft buy companies,
they typically disintegrate them, says Mr Zennstrom. His vision for
Skype, by contrast, is to become the world's biggest and best platform
for all communications 'text, voice or video' from any
internet-connected device, whether a computer or a mobile phone.
This is every bit as audacious as it sounds. Mr Zennstrom, in general,
is a modest man. But his company is only three years old, will
probably make only $60m in revenues this year, and will certainly not
turn a profit. So it is the fact that his ambition is not nearly as
ridiculous as it sounds that should make incumbent telecoms firms
everywhere break out in a cold sweat.
That is because Skype can add 150,000 users a day (its current rate)
without spending anything on new equipment (users 'bring' their own
computers and internet connections) or marketing (users invite each other).
With no marginal cost, Skype can thus afford to maximise the number of its
users, knowing that if only some of them start buying its fee-based
services such as SkypeOut, SkypeIn and voicemail, Skype will make money.
This adds up to a very unusual business plan.
"We want to make as little money as possible per user," says Mr
Zennstrom, because we don't have any cost per user, but we want a lot
of them. This is the exact opposite of the traditional business model
in the telecoms industry, which is based on maximising the average
revenue per user, or ARPU. And that has only one logical
consequence. According to Rich Tehrani, the founder of Internet
Telephony, a magazine devoted to the subject, Skype and services like
it are leading inexorably to a future in which all voice
communication, near or far, will be free.
End of the line
The technical term that encompasses all forms of voice communication
using the internet is voice-over-internet-protocol, or VOIP. This
includes pure computer-to-computer calling as well as the various
hybrid states, such as a Skype user connecting to the traditional
telephone network, or even two people talking on seemingly
conventional phones that are linked, behind the scenes, via the
internet. It also includes residential VOIP providers such as Vonage,
based in New Jersey and the market leader in America with over 1m
subscribers, that supply their customers with adapters so they can
plug ordinary telephones into their broadband connections without
using a= computer.
Sandvine, a telecoms-equipment firm, estimates that there are 1,100
VOIP providers in America alone. But the trend is worldwide. IDC, a
market-research firm, predicts that the number of residential VOIP
subscribers in America will grow from 3m at the end of 2005 to 27m by
the end of 2009; Japan already has over 8m subscribers
today. Worldwide, according to iSuppli, a market-research firm, the
number of residential VOIP subscribers will reach 197m by 2010. Even
these numbers, however, do not include people using VOIP without
subscribing to a service (ie, by downloading free software from
Google, Skype or others). Skype alone has 54m users.
Even before VOIP makes 100% of telephone calls in the world completely
free (which may take many years), it utterly ruins the pricing models
of the telecoms industry. Factors such as the distance between the
callers or the duration of a call, the key determinants of cost today,
are simply irrelevant with VOIP. Vonage already lets its customers
choose telephone numbers in San Francisco, New York or London, no
matter where they live. A Londoner calling the London number is making
a 'local' call, even if the Vonage subscriber is picking up the phone
in Shanghai. As when checking e-mail on, say, Hotmail, the only thing
needed is a broadband-internet connection, but it can be anywhere in
the world. Sooner or later, people will discard their unwieldy phone
numbers altogether and use names, just as they do with their e-mail
addresses, predicts Mr Zennstrom.
Call duration is also becoming irrelevant. A lot of people open a
Skype audio channel and keep it open, says Mr Zennstrom. After all, it
costs nothing. Many people with Apple computers are already accustomed
to this. They open an application called iChat, which is a video and
voice link, and stay connected to their loved ones far
away. Increasingly, members of a family or a business team can stay
online throughout the day, escalating from unobtrusive instant-
messaging (Can you talk?) to a conference call, a video call and back
to a little icon on their screen.
It is thus altogether wrong to call this phenomenon the end, or death, of
telephony. "Calling it the death of telephony suggests people aren't going
to make calls, but they are," says Sam Paltridge, a telecoms guru at the
OECD. "It's just the death of the traditional pricing models. In short,
all this is great news for consumers and awful news for telecoms operators.
"VOIP will destroy voice revenues faster than most analysts' models
predict," says Cyrus Mewawalla, an analyst at Westhall Capital. Voice will
very rapidly cease to become a major revenue generator for all telecoms
operators, fixed and mobile.
That said, some telecoms carriers are much more vulnerable to VOIP than
others, says Mr Mewawalla. Telecoms operators offer and charge for a number
of services besides pure voice calls. Because VOIP will cause only the
revenues from voice calls to shrink, it will hit those operators hardest
that are most dependent on their revenues from voice (see chart 2).
For pure mobile operators, such as Vodafone or Taiwan Mobile as it
happens, Taiwan is the country with the highest ratio of Skype users
'VOIP could be an enormous problem', says Mr Mewawalla, because voice
accounts for over 80% of their revenues. By contrast, VOIP is less
threatening to integrated operators (ie, those offering both fixed
and mobile services) such as Deutsche Telekom or Japan's NTT. And
those carriers such as BT, France Telecom or KPN that are currently
building next-generation networks based on internet technologies will
be able to offer VOIP services themselves, bundled with other
offerings, and might emerge relatively unscathed.
Some operators are taking an unenlightened view by trying to delay the
advance of VOIP. China Telecom has been blocking access to Skype from
Shenzen, according to local newspaper reports. Vodafone has introduced
wording into new contracts for some German subscribers reserving the right
to block VOIP in future, though a spokesman for the company says it is not
doing so at the moment. Clearwire, an American wireless-broadband provider,
also reserves the right to block VOIP traffic. In February, Madison River
Communications, a rural phone company in North Carolina, was fined $15,000
by regulators for blocking access to Vonage's VOIP service. Occasionally,
operators have even blocked access to Skype's website, thus preventing
people from downloading the software or topping up their calling credit.
The more enlightened approach which most operators in rich countries,
to varying degrees, accept is to compete with VOIP openly or even to
embrace it. Already, says Mr Paltridge, pricing of traditional phone
services is changing quite radically as operators try to adjust and to
compete with the Skypes of this world. Operators are moving towards
flat-rate pricing plans for traditional telephone service, so that the
marginal price of making calls falls to zero. Many American regional
operators offer unlimited local and national calling for a fixed
monthly fee, and such schemes are also becoming popular in other
countries.
Several incumbent operators have also launched their own VOIP
services, such as Verizon's VoiceWing and BT's Broadband Voice. These
offer lower prices than traditional telephone service but are
generally not as cheap as a call between Skype and a regular
phone. "If you can't beat 'em, join 'em," says John Delaney of Ovum, a
consultancy. Such services are an admission that a less lucrative VOIP
customer is better than no customer at all. Switching to VOIP also
helps operators by lowering their own costs dramatically. BT and
others are building new, internet-based networks behind the scenes,
which will carry all voice traffic as VOIP even if the calls start or
end in the traditional way.
The other argument for embracing VOIP is that the incumbents can then start
offering the fun new services that VOIP makes possible and charging for
them. This goes far beyond traditional voicemail. Video-conferencing and
unified messaging whereby all forms of communication, from voicemail and
video messages to e-mails or entire electronic documents go into one
virtual inbox will become common, says Wendy McMillan-Turner, head of
voice services at BT. Since all of these features are essentially software
programmes, they can all be integrated with applications that people today
use on their computers, such as Outlook calendars and contacts files.
The service that many telecoms operators are most excited about,
however, is IPTV, which refers to television (and entertainment in
general) being delivered over new and super-fast broadband-internet
connections into homes. This would allow them to charge for a bundle
of services, including broadband access, entertainment and voice. The
voice component could then atrophy gracefully and eventually be thrown
in for nothing. Ultimately -- perhaps by 2010 -- voice may become a
free internet application, with operators making money from related
internet applications like IPTV, says Mr Mewawalla.
Cable operators are coming at VOIP from exactly the opposite
direction. They already offer television and entertainment, as well
as broadband access, so they might as well offer cheap telephony as
well. This puts the cable companies in a good position. Unlike the
telecoms operators, they do not depend on voice for their revenues
today, so they can use cheap VOIP service as a competitive weapon to
make life difficult for the telecoms operators, who are increasingly
their only competition. In California, for example, most people have a
choice between one cable company, Comcast, and one traditional
telecoms carrier, SBC. Since voice uses very little bandwidth compared
with television, the cable companies need not even add a lot in the
way of bandwidth.
The result, says Mr Mewawalla, is that voice service is fast becoming
a marketing freebie to make customers 'sticky' to keep them loyal. "I
would expect people to advertise free calls with VOIP, subsidised by
other elements of the package,' says Ms McMillan-Turner. Thus, BT will
consider value-added services sold around VOIP as voice revenues in
future, she says. BT hopes that selling such services will offset the
inevitable decline in traditional voice revenue. Evalueserve, a
consultancy, predicts that American and European fixed operators'
long-distance voice revenue will decline by around 40% by 2008, and
that in Europe 50% of broadband users will give up their voice lines
by 2008.
Mobile operators face a far greater challenge than fixed-line
carriers. Voice accounts for the bulk of their business and they
cannot (at least today) offer broadband access as easily as the cable
and fixed-line companies. New =93third-generation=94 (3G) networks
were supposed to make possible whizzy new data services to compensate
for flat and even declining revenues from voice calls, but consumer
adoption has been slow.
Worse, those very 3G networks that are supposed to provide future
growth for the industry could now undermine it, since they make
possible VOIP calling over mobile networks. Already, one mobile
operator, E-Plus in Germany, has announced a deal that will allow
subscribers to use Skype on its 3G network. Users would thus pay only
for the internet connection, while making free calls to other Skype
users and to other telephones for very little. E-Plus hopes to win
valuable business customers and to put pressure on much bigger but
less agile rivals such as Vodafone.
Today, VOIP calling over 3G networks is still very much a minority
sport, but as 3G coverage and transmission speeds improve something
the industry is racing to achieve, it will become common. This
represents a mortal danger for mobile operators. VOIP on mobile is the
first real threat they are going to face, and they are in a state of
shock, says Mr Mewawalla. Mobile operators generally charge three to
five times as much as fixed operators for each minute on the phone, so
they have far more to lose from falling voice prices. International
travellers will use VOIP over hotel-room broadband links or Wi-Fi
hotspots in airports to save on the roaming charges by their
mobile-phone company.
Vodafone counters that, like BT, it is moving towards internet-based
networks that will reduce its own cost of carrying calls and make
possible new value-added services. But this sounds unconvincing. Much
more so than fixed-line operators, mobile operators would have to
cannibalise their current business in order to generate new revenues
from VOIP. Ironically, this means that BT, once regarded as a
dinosaur-like incumbent, is now being held up as a shining example of
an operator that is embracing the future, while Vodafone, whose
pure-mobile strategy once seemed visionary, now stands accused of
being on the wrong side of history. At the end of the day, there is no
getting around the reality, as Skype's Mr Zennstrom says, that
"something that is a great business model for us is probably a
terrible business model for them."
Copyright 2005 The Economist Newspaper and The Economist Group. All
rights reserved.
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