Gustav’s Mindshare

I know, old subject and long post. But I keep hearing this from so many people, VC, bloggers etc still, that I need to get it off my chest.

Ok, so first of all, you probably interpret the headline of this post to somehow be negative towards Skype, in the sense that being disruptive is widely regarded as a good thing in tech, so not being disruptive would be a bad thing right?

Well, I don’t think so, I’m an avid user and fan of Skype and love the application, but I don’t think it is disruptive. In fact, if Skype was truly disrupting the traditional Telecom model it would go bankrupt.

There are two things we need to define:

1. So what is Skype…REALLY?

Well, according to me, Skype is actually a very traditional network operator (really Virtual Network Operator – VNO) who makes it’s money by charging for voice minutes in the fixed telephony network, thea same model as any mobile or non-mobile operator.

Skype’s paid business (Skype in/out) is a traditional VNO business, with a small to mid sized userbase, targeting long distance callers with a price proposition (which,  together with pure arbitrage semi-VoIP players like Rebtel etc, HAS indeed put price pressure on the rest of the industry,). There is no difference here from any other traditional operator who competes on price.

But what about the rest of the userbase, who can make free calls (PC to PC) within the Skype network?

Well, unlimited”on-network calls” is actually nothing new either, many (especially mobile) operators have had this as a user acquisition strategy to make whole groups of friends move over from a competing operator, as well as reduce churn of existing users. Now, they may not have been totally free (in the sense that you may pay some kind of monthly fixed fee, and it may be limited to a certain set of friends etc), but the strategy is very similar – inside your own infrastructure, an operator can choose to price dump, eating the cost of the user using the network, and make it up somewhere else.

The true difference between Skype and traditional operators is that Skype’s ”unlimited on-network calls” userbase, i.e. their user acquisition funnel, is HUGE, because it is NOT geographically limited by a physical network and has DRASTICALLY lower underlying cost per user to Skype (i.e. servers and bandwidth cost) than for a traditional fixed operator.

The point is that the absolute majority of the user base, the so-called PC-PC business, which people consider the core business, is not really a business at all, it is rather one of the world’s largest user acquisition/conversion funnels into the traditional VNO business, financed by that business. If the conversion ratio of this funnel would drop below a certain point, the paid business won’t be able to finance the cost of the acquisition funnel (servers and bandwidth) and they will have to shut the free service down.

Caveat: Skype may be able to fund the free business stand alone with some type of adsystem, but there is little evidence that this works (if there was, they would have). Monetizing comms with ads is just very hard because it doesn’t reveal intentions very well, and comms is often used for productivity which means inserting ads is usually very annoying (subject for separate blog post though).

So to answer the question of what Skype really is, I would say:

– Skype is a tradtional VNO, with a non-traditional user aquisition funnel.

The customers are acquired in the ”new” world (i.e. on the Internet), but the money is made in the ”old” world (fixed PSTN). So if they indeed disrupt that old world, their revenue approaches zero.

In general, as ubiquitious, flat rate, mobile Internet access does happen, (e.g via 3G or WIFI) and if the operators and manufacturers allow unlimited VoIP, shifting to just making money off of bigger data packs (as ISPs did), Skype’s current revenue model will approach zero as there would be no need for Skype in/out. The ”emium” of Skype’s Freemium model will disappear….. So in that sense, Internet could kill Skype (or rather it’s current business).

I’m very excited to see what it will mean for Skype to get increasingly integrated into handsets such as the very popular INQ ”Skype” phone and the Nokia N97 announced at MWC this year.

The only way forward in that scenario is to get a cut somewhere else in the vertical value chain, i.e. either :

1. The device sales – because Skype increase the value of the handset, just as a manufacturer pay to license Adobe Flash on a device, or

2. The monthly flat rate the operator charges – because Skype increases demand for their data flat rate packages

Both of these ”vertical revenue shares” are very hard to get  (Apple got it from ATT though), and I don’t know if they exist at the moment for these devices (and if so the structure). I expect this is what Skype is trying to do or have done. Any comments from people more knowledgeable on this are welcome.

2. So what is disruptive…REALLY?

Well, what annoys me is that for several years I’ve gotten the impression that disruptive means killing an incumbent/existing business or business model using new technology”. That new technology usually being the Internet.

I don’t like that. To me, being truly disruptive means shifting revenue streams and spending for a certain service, such as retail, advertising, music etc , from one place/model , e.g. offline, to another place/model, e.g. online.

Internet advertising is truly disrupting tradtional offline advertising becuase the capabilities of the Internet such as interactive, measurable advertising,, direct purhcase and intention-revealing services such as search, are making the customers (the ad-buyers) shift their spending towards the Internet. But Google and Yahoo! and are not killing advertising as a business, they are just shifting the spending budget to online

In the same way, e-commerce is disrupting physical stores because features and benefits possible in electronic stores (“unlimited” inventory, recommnedations etc) are making customers shift their spend from offline to on-line stores, but Amazon is not killing retail as a business it is just shifting the spending budget to online!

VoIP however, is currently NOT shifting customer spend from traditional PSTN networks to the internet. All everyone talks about is simplyt that they will kill the traditional business, including the revenue and customer spend . And they eat cost and VC money to achieve that, for no apparent gain to themselves?…

Now, this is likely very good for human kind in the sense that it not only puts pressure on long distance call pricing, but more more importantly increases access to communication for more people, communication spurs innovation, peace etc. So it definitely speaks to me as a private person and a consumer! But from an investor point of view, that type of disruptive just doesn’t make any sense to me. On the contraty, I would stay away from companies who say ”Hey, we identified this lucrative business called communication, that people are evidentally prepared to pay for if it brings them value…..and we’re going to kill it!”

If I was a VC, I’d be looking for companies and business models that are, or at least have the potential of, shifting an existing, proven willigness to spend in some area into their product. I wouldn’t invest in a company who puts all my money towards killing an entire business for someone else….. What does that do for me? How do I get rich off of that?

A very common comment here is ”It took years for Google to find it’s model – so you have to make a bet”. Yes it took years, but Google’s value proposition was NEVER to simply kill some other existing business, it created entirely new value that didn’t exist before, and that’s always a good bet!

Now you might say that it turned out pretty ok for the Skype investors, and yes, I would’ve loved to be one of those 😉 But it is getting pretty clear that this was at the cost of Ebay, who are likely not going to be that well off as I think their sell price for Skype will be based on it’s paid VNO business – probably with some bonus for it’s amazing customer acquisition engine – but still, some sort of discounted cashflow estimate of the paid business.

A good friend of mine, Johan Gertéll, made the keen analogy to file sharing. File sharing is super successful as a service, and gives awesome user value! But it never managed to shift revenue and willingness to spend, and it’s consistently been a terrible investment for the VCs who went there…

Don’t get me wrong. As a end user, I want all this to happen! Free comms? Yes please! But I don’t want to be an investor in free comms…..