This week, Microsoft announced a blockbuster $8.5 billion deal to purchase Internet communications firm Skype. Judging from the commentary and feedback I've seen online, the deal is somewhat controversial, and most analysts I've seen quoted publicly have predicted little in the way of positive results. My own reaction is simple. I feel that Microsoft purchased Skype for two simple reasons: One, as a defensive measure to keep the company and its technology out of the hands of competitors like Facebook (and perhaps Google, though there is evidence now that Google wasn't interested).
Two, Skype is a great brand, and as both companies noted during a post-announcement press conference, it's one of the few tech brands that can be used as a verb. Good brands do matter, and they're hard to create, as Microsoft has discovered to its dismay with such expensive duds as Zune.
Both of these reasons are perfectly valid from a competitive or business strategy standpoint, and I think this is something many forget as they provide their knee-jerk reactions to the deal. My big question, however, is a bit more nuanced, and it goes something like this: Since Microsoft already has successful products in place that duplicate all of Skype's capabilities, why even bother with Skype?
To understand what I mean by this, you first need to understand these products and technologies. And my guess is that you haven't heard of, or at least don't know all that much about, at least one of them. The two main products of concern are Windows Live Messenger, which is aimed at consumers, and Lync, a business platform for communications that's available in both on-premise and cloud-hosted (Office 365) forms.
Windows Live Messenger is broadly known as Microsoft's instant messaging client for Windows, but the truth is, it's more than that, a lot more. First of all, it's not available only for Windows; there are clients for the Xbox 360, Zune HD, Windows Phone 7 (sort of, a more integrated solution is coming in Windows Phone 7.5), on the web, on the Mac, on iOS (iPhone, iPod touch, iPad), and on various mobile platforms. Secondly, this application isn't just about chat: From just a communications perspective, Windows Live Messenger also supports HD video chat, audio chat, video messaging (video voicemail), and more.
Lync is less well known, but that's only because Microsoft has been rebranding its business communications tools of late. Lync is in fact the latest version of a product called Office Communicator that debuted, surprise, surprise, over 6 years ago. It provides communications features similar to Messenger, but aimed at corporate users, and also adds video conferencing, desktop and application sharing, live collaboration on whiteboards and PowerPoint presentations, and other business-friendly features.
From a technical perspective, Messenger and Lync are client-server systems in the sense that clients don't connect directly to one another but instead go through an Internet-facing server of some kind. Skype, however, utilizes a peer-to-peer system which requires more resources on each PC and, as it turns out, more bandwidth. (Skype's name comes from "Sky peer to peer".) For this reason, many networks actually try to ban Skype, and as users have moved more and more to highly mobile devices like smart phones, mobile operators have also tried to prevent Skype from sucking up their limited 3G bandwidth.
With this in mind, I ask again in slightly expanded form: Since Microsoft already has products that offer the same features as Skype, but in a less resource and bandwidth hungry form, why would it want to purchase Skype? (Outside of the two reasons I list at the top of this article.)
To find out, I watched, and rewatched, the Microsoft/Skype press conference, listened closely to what the various parties said, took notes, and tried to summarize this in a way that's more easily digesible. Here's what I found out.
The vision
"Communications is perhaps the most fundamental area in which technology can be transformative," Microsoft CEO Steve Ballmer said at the start of the press conference. "At Microsoft, we see enormous opportunity that brings together what people want--data, voice, video, IM, all on a single screen--whether it's a smart phone, a PC, a slate, or the TV. Microsoft and Skype together will define this future and what it really, really looks like."
There's not much I can add to a statement that nebulous. That's by design, of course: It's just an overly broad way of defining what a combined Microsoft/Skype will set out to accomplish.
Skype CEO Tony Bates offered a more detailed vision of the future later in the conference, noting that there were three key opportunities going forward: the core communications service (i.e. what Skype does today), new premium subscription packages (i.e. monetization, something we all knew/feared Microsoft would do here), and (in-app) advertising. He later mentioned the mobile space separately, but I'd argue that's a core area as well, and separate in many ways from the traditional (PC-based) Skype service because of the different expectations people have of mobile devices.
Why Skype?
"Anytime people around the planet talk about communications, they talk about Skype," Ballmer said. "The Skype brand has become a verb, nearly synonymous with video and voice communications. Clearly, Skype has built an innovative product with global scale, and the number of Skype users is rapidly accelerating, which really was exciting to me. There are 170 million connected Skype users, growth of 40 percent year over year. That number is growing by 600,000 new registrations every day."
This is true, of course. But it's also true that Microsoft's consumer-oriented communications solution, Messenger, has a much larger user base, though growth figures are hard to come by. In 2010, the last time for which any figure is available, Messenger had over 300 million active users.
"Video chat capability [is] exploding," Ballmer continued. "It now represents more than 40 percent of all Skype use."
This, of course, is the big deal, not just now, but even more so going forward. Communications, of course, are evolving, and while text-based chatting and email will make sense for millions of people for years to come, more immersive forms of communication--like video chat and video conferencing--is the future.
Skype delivers this today, yes. But again, so does Messenger and Lync.
Show me the money
One of the biggest and easiest criticisms of the Skype deal is that Microsoft is spending a pretty lofty sum--at $8.5 billion, it's Microsoft's biggest-ever acquisition by far--for a company that has never really made any money. Worse, its previous owner, eBay, was so eager to get rid of this dog that it jettisoned the company after less than two years, taking a loss. (Less so now that Microsoft has purchased Skype, as it turns out.)
So why was Skype worth this lofty sum? And does Microsoft have any chance at all of earning back the price it paid?
According to Ballmer, Skype has "multiple revenue streams," though I'd describe it more as "multiple possible revenue streams." "Overall revenue has grown 20 percent year-over-year," he said, while not noting that profits were non-existent to tiny during this time period. He also mentioned advertising, though in a later Q & A, this possibility (which essentially amounts to pushing huge ads in-app at Skype users) was downplayed.
Normally, I'd argue that Microsoft will never have to--or be able to--justify or explain the expense of Skype because the technologies would obviously just be spread around the company, popping up in such products as Xbox 360, Office, Messenger, and so on, all of which are contained in different business units, each with its own financial reporting. But Ballmer actually claimed that Skype would be a new business unit at Microsoft--the Microsoft Skype division, literally--and this suggests that we will be able to see exactly how well it does. That's amazing. And I bet it's going to be consistently bad news.
Microsoft carted out CFO Peter Klein to prove the doubters wrong. He argued that Skype was "a strong growing business with an engaged user base, and great technology." (The company did recently post a tiny profit after losing money last year. I'll address the "great technology" aspect of this towards the end of this article.)
Why buy Skype? Why not just partner with Skype, as you did with Nokia?
I was interested to see Ballmer address this issue right up front, rather than have to be asked about it.
"We've been talking for a while about ... partnership opportunities, including partnering in the advertising area," he said. "Based on Skype's great market position and innovative technology though, it became clear to us that we had the opportunity to do even more together as a single company in a way that would be innovative and beneficial to customers, as well as both companies. So, we made an unsolicited offer to acquire Skype."
The message here, as I see it, is that every deal is different. Nokia, for example, was probably too big for an acquisition, and let's face it, the company (Nokia) hasn't fallen far enough to be able to handle such a sale. (Wait for it, though, it could still happen.) All you have to do is look at Microsoft's failed bid for Yahoo! to understand how much Microsoft (i.e. Ballmer) is willing to spend to get ahead ($45 billion). At $8.5 billion, Skype is arguably a bargain, and not to be a jerk about it, but Skype's business is at least forward-leaning. Yahoo! was (and still is) declining rapidly.
What about existing Skype users? What about existing Skype users with non-Microsoft PCs and devices?
Most Skype users don't pay the company a dime and many use Macs or non-Microsoft mobile devices. Surely these cheap cling-ons will be jettisoned as Microsoft subsumes Skype and starts improving the Skype clients, first with the Windows version and then maybe eventually it just gives up on the non-Microsoft clients. Right?
Not according to Ballmer. "We will continue to support non-Microsoft platforms, because it's fundamental to the value proposition of communications," Ballmer said. (Notably, he didn't bring this topic up on his own, but had to be asked about it in the Q & A.) "We're one of the few companies actually who has a track record of doing this. You take a look at the work we've done over the years with Office, for example, on the Mac. If you even take a look at some of the great work we've done with applications, on top of Apple, other Apple devices. I think we have a track record of understanding our customers and the need to support our customers, as they want to travel in various places."
"Fundamental to the value proposition of communications is being able to reach everybody, whether they happen to be on your device or not," he continued. "And I think that, in fact, will be one of our competitive advantages, both for the Skype communications services, and in fact, for the devices as we move forward."
How will Microsoft integrate Skype into its own products?
While Microsoft intends to keep shipping free, standalone versions of the Skype client, it obviously needs to maximize its usage of Skype technology to justify the expense of this purchase. And sure enough, Ballmer said that Microsoft would integrate Skype throughout its product portfolio. "We're committed to optimizing Skype for the TV, with Xbox and Kinect, for the Windows Phone, and the Windows PC," he said. "We [also] want to extend the reach of Skype by connecting Skype users with users of our Outlook products, our Lync enterprise unified communications product, Xbox LIVE, and other opportunities like Messenger and Hotmail."
Because Skype is perceived as a purely consumer technology, he explicitly called out his desire to "connect Lync to the rest of the Skype customer base," which he said customers would see as a huge value. I suppose so. Currently, you can manually add contacts from Messenger to Lync (assuming your business allows this federation capability), so I assume it would work somewhat like that.
Ballmer also hinted at Microsoft's plans to get Skype pushed out to more wireless carriers. "There will be a number of other new ways to work proactively and positively on the partnerships that we put in place with mobile operators around our Windows Phone," he said. "And that will be an area of focus as we get through the regulatory process." This suggests native Skype capabilities--i.e. IP-based text chats, phone-style audio conversations, and video chat on Windows Phone.
Ballmer also made an interesting comparison between Outlook and Skype, noting that this new product would fit into Microsoft's broader product portfolio in a way that is similar to Outlook. That is, it will sit neatly between both business and consumer usage scenarios. "You can manage all of your electronic mail communications, and calendar, your work life, personal life in Outlook," he said. "In a sense, what you could say here is that Skype joins in really quite naturally. It connects both work and home. And it fits into the context of the way that people live. It enables communication across all of people's lives, and all of their devices."
Fair enough. Certainly, if Skype is integrated across all of Microsoft's products that make sense, it would be pervasive and adoption (and use) could certain rise.
On the other hand, I again have to wonder: Why not just do this with the technologies that Microsoft already owned?
Boil this all down and a few facts emerge. First, as I noted at the top, this deal was clearly made, in part, to prevent Microsoft's competitors from getting Skype. The irony here, of course, is that Microsoft can now go back to these competitors--like Facebook, most obviously--and actually strike licensing deals whereby these companies pay Microsoft to use Skype technology in their own products and services. It's easy to imagine live audio and video chats on Facebook. It's equally easy to imagine them accompanied by a little blue Skype logo.
Second, also as noted above, Skype really is a great brand, with great recognition around the world. So while Microsoft may have its own communications solutions--Messenger and Lync--maybe they're not as well known or beloved as Skype. Maybe this puts the consolidated Microsoft communications portfolio over the top.
Third, and yes, I did mention this too, Skype and Messenger/Lync use different technologies. That is, Skype is peer-to-peer and Messenger/Lync is client-server. But this leads me to my final question: If Microsoft already had its own communications technologies, and those communications technologies were known to be in some ways superior to Skype's offerings--i.e., yes, they require a server somewhere, but they also consume less bandwidth and require less horsepower on each client devices--then why the heck did Microsoft buy Skype??
Interestingly, Google was once interested in buying Skype too. And the reason it didn't is because Skype's peer-to-peer communications technologies were too inefficient and Google figured it would lose two years rearchitecting it so it was simply easier (and better) to just start over from scratch. This episode is nicely told in Steven Levy's book "Into the Plex", but you can read a condensed version of this story in Wired:
"The worst thing about peer-to-peer is that it doesn't work well with Google,” product manager Wesley Chan told Levy during an amazing interview for In the Plex in February 2010. "Peer-to-peer just eats up your bandwidth, right, it's like the old technology." So if Google bought Skype, Chan concluded, it would have to rewrite the entire Skype platform. "It would've been disastrous," he said.
So here's Microsoft with its own client-server communications architecture(s). And what it says it's going to do is integrate Skype--which is based on peer-to-peer--with those existing products. Just like Google would have had to do. But Google walked away from this deal years ago.
So ... why did Microsoft buy Skype?