Niklas Zennstrm and Janus Friis have been a golden pair in the Internet business. For a period during the early 2000s, their Kazaa peer-to-peer file

• Niklas Zennström and Janus Friis have been a golden pair in the Internet business. For a period during the early 2000s, their Kazaa peer-to-peer file sharing business was the world’s largest music sharing site. After selling that business to Sharman Networks, they moved quickly to establish Skype in 2003, which quickly became the dominant player in the world’s VoIP (Voice over Internet Protocol) telephone market.

  Skype’s free Internet-based VoIP service was an attractive alternative to the expensive traditional landline and mobile telephone services, gaining 60 million users by 2005. That same year, they sold Skype to eBay for $2.6bn (~a1.8bn) – an impressive figure for a business whose total revenues were just $60m and had still not turned a profit. The eBay deal, however, turned out not to be an unblemished success.

  Two entrepreneurs

  Zennström is the older of the two, aged 40 at the sale to eBay. He took a first degree in business and then an MSc in engineering and computer science from Uppsala University in Sweden. He then entered the telecommunications industry, spending nine years in Tele2, a fast-expanding European telecoms group. He met Friis in 1997, hiring him to manage a help-desk. Friis, a Dane, is 11 years younger and failed even to graduate from high school. But from the late 1990s the two worked closely together on a series of new ventures: as well as Kazaa and Skype, these included Altnet, claimed to be the world’s first secure peer-to-peer wholesale network, Joltid, a company in traffic optimization technologies, and the portal everyday.com. The pair were committed to disruptive innovation. Zennström told the Financial Times: ‘It’s everyone’s obligation to fight against monopolies and also companies that provide bad services.’ Of the traditional landline and mobile telephone companies, he declares: ‘They deserve to be challenged. They provide bad and expensive service.’

  The Skype business model

  Skype’s software allows people to use the Internet to make free calls to other Skype users all over the world. Given the cost of traditional international calls, this was an exciting idea. Initial funding, however, was not easy to find as the music industry was still pursuing a lawsuit against the two founders regarding the illegal filesharing their earlier Kazaa venture appeared to facilitate.

  For fear of legal action, Zennström and Friis dared not even enter the USA. Most traditional venture capitalists gave the new venture a wide berth. Moreover, it was not easy to see how to make money out of free calls. The business model is more complicated than that, of course. Most users have free calls, certainly. However, Skype has very low costs, as customers download the software off the Internet and it is the customers’ computers and Internet connections that make the network. It costs nothing to keep connections open continuously.

  Marketing is cheap, because customers naturally invite others to join. Skype has no telephone help-desk, citing the overwhelming number of customers and the effectiveness of its standard Internet queries services. Skype makes its money from its ancillary services, such as SkypeOut, which allows customers to call traditional landline or mobile numbers for a fee, often very small.

  Zennström explains the model: ‘We want to make as little money as possible per user. We don’t have any cost per user, but we want a lot of them.’ This overturns the traditional landline and mobile phone business model. Traditional telephone companies of both types face high costs of both marketing and capacity building. Customers are typically charged according to distance and by the minute. The traditional principle is to maximize revenues per customer, completely the opposite to Skype. Zennström summarized to Business Week: When you’re a phone company, you have marketing and customer-acquisition costs. When you have a customer, you have an operational cost of running the network. Then you have a cost for billing systems. That’s an operator business model.

  The business model of Skype is completely different. Skype has a software business model. We don’t have any distribution or marketing costs for each user – our software is spread virally. And when we have a new user, we have zero cost for serving that user because they’re using P2P (peer-to-peer) software and their own bandwidth. So we have zero costs of getting new users and zero costs of running traffic. Our costs are only business development and software development. Comparing the positions of the two types of companies, he added: ‘Something that is a great business model for us is probably a terrible model for them.’

  As shown in the figure, Skype’s service has been attracting snowballing usage. The tipping point came towards the end of 2004, and by March 2010 Skype was achieving more than 23 million users in a single day. Of course, this success raised an awkward paradox. If Skype became near universal, who would be left for people to call using the paid service of SkypeOut to access traditional phones?

  eBay’s move

  Skype was always likely to be for sale. Zennström and Friis had sold Kazaa quickly and their initial funders would want a profitable early exit too. It was not surprising that rumors started during 2005 of possible acquisition from technology giants such as Google, Microsoft and Yahoo!. In the end, however, it was online auctioneer eBay who did the deal, slightly surprisingly as it was not seen as a communications company.

  There are similarities in the underlying business models of the two companies. Both benefit from ‘network effects’, where value rises disproportionately fast with increasing members of the network. One more precise rationale from eBay’s point of view was that Source: Phil Wolff, Skype Journal, 8 March 2010; reproduced with permission.

  Skype Dialtone – Peak Number of Accounts Logged in during One Day Skype connections could be placed directly on the eBay site, allowing customers potentially to phone sellers with a single click of the button. Also, sellers could place voice links directly on their eBay sites, so that customers could click directly to a message, paying eBay a fee every time they did. On the other hand, Skype would strengthen its links with eBay’s subsidiary PayPal, which Skype already used for managing payments for its SkypeOut service. For Zennström, however, one major attraction of eBay was that it looked likely to leave Skype more alone.

  Companies like Yahoo! and Microsoft tend to integrate their acquisitions closely into their existing operations, extinguishing autonomy. Zennström and Friis might be working with eBay for some time. The deal included an 'earn-out' arrangement which would push Skype’s final sale price to over $4bn if they managed to meet revenue and profit targets over the coming years. Anyway, the two had an exciting vision for the future: to become the world’s biggest and best platform for all communication–text, voice or video – from any Internet-connected device, whether a computer or a mobile phone.

  eBay’s role

  eBay had a lot to offer an ambitious company like Skype. Founded only in 1995, it had reached revenues of $4.55bn and 11,600 employees in the space of 10 years. Zennström commented of Meg Whitman, eBay’s Chief Executive since 1998: ‘I think I can learn a lot of things from Meg. We want to see things through, but we also have some other ideas.’ Skype would still have its own strategy, budgets, culture and brands. Zennström insisted to the Financial Times: One of the important things for us, but also one of the great things with eBay, is that we wanted to make sure that we could merge with a bigger company, but that Skype stays as one company. Meg said: ‘Take advantage of the resources we have, but we are not going to tell you what to do because you’re the best in the world to run your own business.’

  The managerial demands of rapid growth were considerable. Staff quadrupled to 300 between 2005 and 2006, and included 30 nationalities scattered all over the world. eBay introduced five of its own senior managers to help, including a new president responsible for day-to-day operations, a chief financial officer and a new human resource director. But Skype was keen to preserve its own culture. According to Zennström, still the CEO, Skype’s passionate, pioneering culture had to be both protected and nurtured: ‘It’s how you operate, how you behave. It starts when we are hiring people. They need to be really thrilled about Skype as a movement, rather than a place to work.’

  eBay’s exit

  While Skype protected its culture, synergies were hard to find. Skype’s sales in 2007 had reached $383m, but eBay users were not making the hoped-for use of Skype connections. Targets were missed. In October 2007, Zennström was obliged to step down as CEO and eBay wrote down the value of its investment by $1.4bn. In March 2008, after a 30 per cent slide in share price, Meg Whitman resigned as CEO of eBay. The new CEO, John Donahue, commented on Skype: ‘If the synergies are strong, we’ll keep it in our portfolio. If not, we’ll reassess it.’ In September 2009, eBay announced that it was selling 65 per cent of its interest to the Silver Lake group of investors for $2bn. However, it transpired that eBay had neglected to acquire the source-code for Skype software back in 2005. To buy off the threat of legal action and close the deal with Silver Lake, eBay was obliged to give Zennström and Friis 14 per cent of their company back.

  • Sources:

  ‘Phone Service the “Zero Cost” Way’, Business Week online, January 2004; www.wikipedia.org; The Economist, 15 September 2005; Financial Times, 17 and 19 April 2006; Financial Times, 17 September 2009.

  
  

  Questions

  1. What are the advantages, and what are the possible limits, of Skype’s business model?

  2. What went wrong with eBay’s acquisition of Skype?

  
  

  Please provide descriptive and lengthy answers with explanations.