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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—is 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 “reduces
friction”, 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 “third-generation” (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.”
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