New Skype seeks users who pay

Buyers' dilemma: Skype is wildly popular, but 90% of its traffic brings in no revenue.

EBay announced on Nov. 19 that it had finally completed the sale of a majority stake in Skype Technologies to a group of investors, including the Canada Pension Plan Investment Board. While the sale was a struggle — Skype’s founders launched a legal battle against eBay that put the deal in peril — the real work for the new owners is just beginning. The investor group, led by American private-equity firm Silver Lake, now has to figure out how to convince more Skype users to actually pay for the communications service, all the while fending off Google, which is becoming a major competitor.

Skype, which permits free video and voice calling over the Internet, launched in 2003. EBay snatched up the popular Luxembourg-based company in 2005 for a whopping US$2.5 billion, from founders Niklas Zennström and Janus Friis. EBay wanted to integrate Skype with its auction operations, allowing buyers and sellers to interact, but the desired results never materialized. Under shareholder pressure, eBay announced the sale to the Silver Lake-led group in September. Founders Zennström and Friis, who still owned the underlying technology, quickly filed a suit. Ultimately, the pair settled for a 14% stake in the company. (The investor group, including the CPPIB, owns 56%; eBay retains 30%.)

It’s easy to see why the founders wanted back in. Skype has added hundreds of millions of users since they sold it in 2005. In the third quarter alone, user accounts increased by 40.8%, compared to the same period last year, bringing the total to 521 million. Despite the huge boost in accounts, revenue during that time increased more slowly at 29%, to US$185 million. That’s because most people use Skype for free. The company doesn’t charge users to call another Skype account. It makes money only when customers call an outside mobile or a land line. Its chatty devotees tallied up more than 30 billion minutes on Skype during the third quarter, but only 10% of those minutes were paid. “It’s a challenge migrating these customers to paid subscribers,” says Amit Kaminer, a research analyst with the SeaBoard Group, a telecom consultancy in Montreal.

One Skype strategy: boost revenue by increasing its presence on mobile devices. The more Skype integrates itself into every aspect of communications, the more comfortable users will feel buying cheap minutes to make an outside call when necessary — or so the company hopes. Skype partnered with Nokia this year to preload its calling application on certain handsets, and also released apps for the iPhone and BlackBerry. However, that is spooking traditional carriers who are reluctant to let Skype access their networks for fear of losing out on voice revenue. Typically, carriers allow customers to make Skype calls over Wi-Fi networks but not their 3G networks, which are higher quality and provide better coverage.

AT&T in the U.S. is an exception. In October, it announced it would open up its 3G network for Internet calling applications such as Skype for the iPhone. Kaminer expects other carriers will eventually work with Skype, too. “It’s better for them if they control their future,” he says of the carriers, “otherwise they’ll become a dumb pipe.”

But Google could make things even more difficult. In November, it acquired a firm that offers a similar service to Skype called Gizmo5. The web giant already operates Google Talk for voice and video chat between users, and Google Voice, which offers a range of services, including voice-mail transcription and a single number for multiple phones. Combining those services with Gizmo5’s technology means Google could soon offer everything Skype can — and more.

Analysts say Skype needs to aggressively expand to secure more loyal users, making it difficult for Google to win market share. Small and medium-sized businesses are a particularly lucrative opportunity. But that would require Skype to address security concerns and boost its virtually non-existent customer service. “In the business space, that’s a huge red flag,” says Jayanth Angl, a senior research analyst with Info-Tech Research Group in Toronto.

Canadians should hope Skype makes headway. After all, the CPPIB’s stake means we’re all investors now.