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Wednesday, May 11, 2011

Why Skype matters to Microsoft

I'm near the end of a two-week business trip to Europe, and I've been using Skype a lot. Actually, even when I'm home I use Skype to stay in touch with overseas colleagues, to call Eric in Ireland, and to make long-distance personal telephone calls inside the U.S. from my office.

Many of us at Nortel perceived Skype as a competitive threat to Nortel's VoIP products when Skype was released in 2003. I began using it then, so I've got a long-standing familiarity with what it does and its significance in the market.

eBay acquired Skype in 2005 without having a good rationale for the deal. eBay also overpaid badly -- a testament, some would argue, to the investment bankers hired by Skype's founders. (Never trust Wall Street when they're trying to sell you something.) eBay realized its mistake and bailed out shortly thereafter.

Now comes news that Microsoft has acquired Skype for over $8 billion, a higher price than eBay paid. (Yes, the interim owners of Skype made out like bandits.) Why would Microsoft pay such a ridiculously high multiple of Skype's earnings? Simple: Microsoft is floundering and needs something -- anything -- to rescue Windows Phone 7 from market failure.

The PC business and the Office franchise have gone flat; consumers now value tablets and smartphones more than PCs. However, Microsoft's Windows Phone 7 operating system for tablets and smartphones has a very low market share compared to Apple's iOS and Google's Android. If Microsoft doesn't do something drastic and soon, they will become irrelevant to the endpoint market. Give credit to Steve Ballmer, the CEO of Microsoft; he's willing to make bold moves to stay in the game.

First he cut a deal with Nokia that makes Windows Phone 7 the basis for all future Nokia smartphone products. (That's a death knell for Symbian, the OS that Nokia has used for 10 years.) Microsoft threw some cash at Nokia in the process. Nokia gives Microsoft a captive outlet for Windows Phone 7.

Now Ballmer has acquired Skype, so that he can embed its functionality inside Windows Phone 7. This gives Microsoft instant credibility in user-to-user comms as well as a critical mass of "on-net" users. Is it worth $8 billion? Probably, in the context of Windows Phone 7. Microsoft has so much cash that they will hardly notice the cash hit.

And Microsoft has a long history of acquisitions. I met the inventor of PowerPoint, who had worked for Nortel in the 1980s when he conceived of a software product to put presentations in the hands of the content developer instead of an outsourced graphic artist. He left Nortel, formed a copy in Silicon Valley to develop PowerPoint, brought it to market, and then sold it to Microsoft. Many elements of Microsoft products have a history like that.

One more thing: the Microsoft-Skype deal is also the beginning of the end for "minutes-based" pricing from AT&T, Verizon Wireless, and Sprint. Voice is merely a slow form of data. Why is voice priced at such a high premium, relative to other forms of bits, when it moves across a wireless network? Only because that's how the wireless business developed. But the day is coming when you will buy a data package from your wireless provider without any "minutes". Because of the large sums of money involved, the transition will be slow -- another 10 years, perhaps -- but it's inevitable.