Microsoft’s Upside with Skype in New Markets

Microsoft’s $8.5 billion purchase of Skype is one of the Redmond giant’s boldest plays to create new markets in its 36-year history. The deal, Microsoft’s largest ever, is hard to justify on purely financial grounds — the company is paying 32 times operating earnings (EBITDA). Moreover, it may not have been worth the price to snatch the prize from Google, which already competes in this field with Google Voice. The upside lies in new markets that this combination can capture. What do lessons from successful market creators suggest about the blue-sky potential?

• Platforms enable new markets: Technology platforms can create new markets in unexpected ways. The designers of the first integrated circuits scarcely imagined the mobile phones, let alone the mobile applications, that their invention would make possible. By leading voice and video communications to become a core feature of Microsoft enterprise products, this deal could enable new forms of peer-to-peer collaboration. It could also displace business-oriented video conferencing services like Webex, and it may commoditize PBX systems that provide essential hardware but possibly superfluous software to manage enterprise calls.
• Go to the end user: Intermediaries tend to be disinterested in new markets; they create a near-term hassle and have uncertain long-term impacts. The PC gained traction with company finance departments, despite resistance from corporate IT officials who feared the decentralization inherent in desktop computing. If Skype services are sitting on enterprise desktops and are available via the PBX, how quickly could Microsoft become an IP-based telecom carrier? Pretty fast — it is buying a nascent Skype for Business offering that would be turbocharged through Microsoft’s network offerings and sales force. The ability to integrate voice and video calls with enterprise network management could be a big differentiator against carrier competitors, and demand from end-users could shake up this industry faster that an approach reliant upon convincing corporate IT administrators to change long-standing telecom practices.
• Market creators may need to destroy old businesses: Apple isn’t too worried about its iPad competing against netbooks, a product that the company doesn’t make. Vanguard didn’t fret about its index funds competing against costly active-management mutual funds, a field where it barely played. Skype has been similarly unconcerned about its impact on mobile networks. It needs their collaboration to put Skype services on subscribers’ phone screens, but beyond that it is happy to arbitrage the difference between voice and data phone tariffs to provide dirt-cheap services. With Skype, Windows Phone 7, and tightly-integrated hardware made through Microsoft’s alliance with Nokia, the company could ally with second and third-tier mobile networks to provide good-enough call quality at vastly reduced prices. Unfortunately, Microsoft and Nokia have strong incentives to curry favor with top-tier carriers given their ability to steer large numbers of subscribers their way. We may see Skype become a standard offering on Windows Phones and high-end Nokia handsets, but the full disruptive potential of the service might be exploited gingerly to avoid alienating these powerful allies.
• Network effects are most enduring when they create unique customer experiences, not just cost advantages: Skype 170 million active monthly users provide it with a big cost advantage vs. peer-to-peer rivals, which incur costs through inter-connecting to others’ networks. Yet low costs are seldom enough to capture new markets, where the nature of the offering can evolve rapidly. Atari had huge scale economies in video games, yet it let upstarts like Nintendo and Sega win through creating superior customer experiences. In this respect the Microsoft deal creates impressive synergies, as weaving Skype into Microsoft offerings builds powerfully unique propositions. Consider Xbox — the Kinect camera could be used for video calling, images of online competitors could bolster the gaming experience, and the TV could become a communications hub. It would be a far more satisfying place to conduct video calls than on small PC screens.

Each of these possibilities creates intriguing upside for Microsoft. The company can go far beyond its historic role as a software colossus to create new ways for both enterprises and consumers to interact. With a strong presence in corporate IT, consumer desktops, and the living room, Microsoft offered synergies for Skype that other rumored suitors such as Google lacked. We shall see if the execution of this deal lives up to its potential.

Story by Steve Wunker.

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