September 12, 2008

At eBay, Is Skype There to Stay?

Josh Silverman is on the defensive. As the head of eBay's Skype unit, he's happy to talk about his company's more than 330 million users and six straight quarters of profitability. But the topic he has been asked to address more frequently in his six months at the helm is how eBay could have so grossly overestimated Skype's value when in 2005 it paid more than $2.5 billion for the Internet calling service. "There is this perception gap related to eBay and what people thought eBay would do with Skype," Silverman says.

The gap is more than just a matter of perception. Executives at eBay (EBAY) bet Skype's cheap and easy-to-use Internet calling tools would help eBay users land more sales. But it turns out many of the small business owners who market their wares on eBay had little time to sit by the phone to take questions, and in October, eBay was forced to concede it overpaid [, 10/1/07], recording expenses of $900 million.

Silverman's task now is to ensure that Skype earns its keep, giving eBay executives reason to retain the business rather than sell it to the highest bidder. So far, eBay Chief Executive John Donahoe says he'll keep Skype. "We know Skype is a great stand-alone business that's experiencing explosive growth in terms of its financials and in terms of its user base," Donahoe said during a conference call with analysts earlier this year.

Growth Slowing Down Yet, even as Skype grows at a faster pace than eBay's core online shopping business, it accounts for a sliver of total sales. And like its parent, Skype is undergoing a growth slowdown. Skype's revenue rose 51% in the most recent quarter, vs. more than twice that pace a year earlier. Donahoe could jettison Skype to focus on bigger areas of need. Analysts have speculated Google (GOOG) might be a suitor. Google refused to make an executive available to discuss the matter.

Silverman's order is a tall one. Skype gained a wide user base with technology that lets users make calls for next to nothing over the Internet. But bigger, more established players are getting Internet-calling religion and Skype is losing some of its price advantage. "They are up against some very established players, and the competition is getting much stiffer," says Elroy Jopling, research director at Gartner (IT).

Skype's first challenge is proving its telephone service is better than what the big guys offer. Skype provides free calls among its users anywhere in the world. It makes money by charging about $3 a month for unlimited calls to landlines and cell phones in North America, and about $10 a month for unlimited calls to landlines and some cell phones in 36 countries around the world.

Better Than the Big Boys? Time was, those prices beat the per-minute prices charged by telephone companies. They still do, but the advantage is diminishing as phone companies such as Verizon Communications (VZ) and cable companies including Time Warner (TWX) charge flat fees for unlimited calling when it's purchased along with other services, such as high-speed Internet access.

Silverman says Skype's calling plans include more features than those offered by rivals. Skype has videoconferencing and file transfer along with its voice service -- not to mention unlimited global calls. About 30% of Skype's members use videoconferencing. Skype also boasts an instant message-like service that lets users know when another subscriber is by the phone. "Communication is being transformed without people realizing it," Silverman says. He adds that many people already communicate online via instant message and sending files. "The telephone companies are not going to invent the communications of the future."

Perhaps not. But in the U.S., it's the cable and telephone companies -- not the new Web players such as Skype, Google Talk, and Jahjah -- that have taken the lead in providing Voice over Internet Protocol [VoIP] services. These include Comcast (CMCSA), Time Warner, Vonage (VG), and Cablevision (CVC), according to research firm Telegeography.

Mobile Phones a Must Moreover, in the U.S., the telephone companies still largely control the key communication device of the future: the mobile phone. For Skype to truly go mainstream it needs to become common on the device most associated with voice calls and the future. Until then, it will be difficult to gain the traction needed to grasp a significant share of the $1.7 trillion global calling market that Skype sees as its main market. "Without question more people are using their mobile phone and they are using it much more even within their home," says Jopling. "The players that can control that game are very much the Verizons, the AT&Ts (T)," and other providers of cellular calling, he says.

Skype is helped in the mobile arena by recent moves by Google and Apple to open up handsets to third-party software. Google's Android mobile operating system and Apple's decision to allow third-party software applications give users the ability to easily install VoIP software, such as Skype, on their phone. Once installed, Skype users can make international calls for between 2% and 40% a minute, depending on the location, plus whatever charges apply from their carrier for a local or national call. [Calls to remote places such as Guinea-Bissau can cost as much as $1 per minute]. Skype has an application for the iPhone and is working with Google Talk on partnerships, though no Android application has been announced.

Already, Skype has seen some traction on the mobile phone. More than 7 million people downloaded the new version of Skype for Microsoft's (MSFT) Windows Mobile operating system since its launch last spring.

Skype 4.0 on the Way Silverman notes that Skype's success, to date, has been without marketing. In the future, the company plans to get more aggressive about promoting its service in hopes of bringing in new paying customers. Only about 10% of Skype's users pay to talk to non-Skype users, says Silverman. He believes that the new Skype 4.0 version, now being tested, will be reliable and simple enough to encourage more existing Skype users to join the ranks of paying customers.

To prove its worth to eBay investors, however, Skype will have to show it can reaccelerate growth in its own business -- perhaps flirting again with the triple-digit numbers it posted each quarter last year. Then maybe the company considered by some to be eBay's biggest mistake could start to be viewed as one of its saviors. If not, Skype may become a cheap buy for somebody else.