Skype Business Model Revealed at eBay Analyst Event

SkypeBlueLogo.150px Yesterday eBay held an analyst event at its San Jose headquarters location with a keynote by eBay CEO John Donahoe followed by presentations by various eBay executives and Skype President Josh Silverman.

Josh’s presentation broke a lot of new ground for Skype addressing issues such as:

  • How does Skype generate revenue?
  • What drives Skype’s cost model?
  • How will a software company change real time communications in ways that legacy telcos cannot?
  • How is Skype structured to address its various market opportunities?

In a long-term financial outlook issued by eBay in conjunction with this event, they state:

Skype is expected to more than double its revenue to over $1.0 billion in 2011. With more than 400 million registered users currently, Skype’s metrics continue to accelerate as the company further establishes leadership in free and paid Internet-based voice and video communications, with growth opportunities in core consumer, mobile, businesses and platform. Skype’s leadership position has strengthened over the past year, driven by a new management team and the launch of many innovative products.

SkypeMassiveUserBenefits.400px The overriding aspect of Josh’s presentation was repeated emphasis that, fundamentally, Skype is a software company. As verified by many of the presentations at eComm 2009 last week, Josh stated that there is a communications paradigm shift going on where hardwired networks and devices are gradually being replaced by software-based networks and flexible devices. Skype’s “opportunity is to become the world’s leading communications software company.” Josh’s analogy: It was not the railways that invented air travel; in a similar manner, software will drive the future of real time communications innovation and efficiencies going forward, not the existing telcos. To reinforce his point, Skype will not simply be on familiar telephony devices, it will show up in intelligent TV sets, car dashboards and intelligent public access terminals such as bank ATM’s all tied to a common network.

Josh continued: Communications is no longer just about voice; it’s now multi-modal: mood messages, chat, voice calling, multi-party calling, video calling (did I also hear him mention multi-party video calling?) and online screen sharing. Where and how we communicate is expanding: laptop, mobile phone, flat panel TV’s – “any connected computing device with the addition of software becomes a communication device”.

He went on: With hardware and network access becoming a commodity, the opportunity for margin is to capture it at the application layer. Software companies will drive the innovation in the industry, drive the demand for new hardware and better access. (Did he effectively read from the Voice 2.0 Manifesto?) Solutions must be device and network agnostic.

How big is the market? The $300B EBITDA of the $1.4T communication industry revenue is almost equal to the total revenue of global ecommerce and Search.

How did Skype build its business last year? Inherent reliability; it “just works”. While so much of Skype’s operating environment stands outside Skype’s control, yet Skype must try to provide the ability, through its software, to readily adapt to these conditions, especially at the user end point.

How does Skype make money?

  • From user services:
    • What’s free (at no cost to Skype)? Skype-to-Skype calling, video calling, Chat/IM, Multi-Party calling, File Transfer
    • What’s Paid? Subscriptions (unlimited calling), SkypeOut (pay-as-you-go), Online Numbers, Voicemail, SMS
  • From a partner perspective, licensing opportunities. The Skype-Nokia and Skype-MySpace relationships are two examples. Hardware royalties are another source. Carrier relationships, such as the 3 Skypephone example discussed below, are a third source for what are effectively licensing revenues.
  • The third leg of revenue generation comprises some advertising opportunities that have arisen.

Yet Skype has inherent fundamentals that have made it profitable for the past six quarters:

  • negligible customer acquisition costs (mostly word-of-mouth; compare with Vonage whose customer acquisition costs are in excess of $250)
  • negligible capital expenditures and network maintenance costs (being peer-to-peer it’s Skype’s users who invest in capital items, such as PC’s, routers and Skype hardware, and in network maintenance through their Internet subscriptions)
  • pre-funded accounts which result in negative working capital where subscriptions and Skype credits are paid up front but the revenue is recognized on a pro-rated quarterly basis (Have you ever noticed there’s no “phone bill” sent for payment once a month? – Skype has no collection costs)
  • strong free cash flow conversion ($1.00 of EBITDA for Skype is almost $1.00 of free cash flow)

The results: Skype’s profitability has grown to the point where they achieve 20% “segment margin” an amount that Skype contributes to eBay’s overall profitability (segment margin makes no allowance for allocation of eBay corporate costs).

Additional data provided:

  • SkypeGlobalReach.2008.280px Skype continues to add over 350,000 new account registrations per day
  • account registrations are distributed geographically as shown on the map to the right; he labelled North America as a “developing” market with rapid growth
  • A year ago Skype celebrated support of over 100B cumulative calling minutes since its launch; in 2009 Skype expects to do this same number within the year
  • Over 8% of the world’s international calling minutes are on Skype
  • from December 2007 to December 2008, video calls increased from 27% to 34% of calls
  • due to its peer-to-peer architecture only Skype can deliver a video experience for free, and at performance levels unequalled elsewhere.
  • while active users rose 39% in Q4 2008, engagement, defined as ‘calling minutes per active user’, rose by 72%
  • while calls under 2 minutes duration dropped from 41% to 33% comparing October 2007 to October 2008, calls in excess of 10 minutes rose from 37% of calls to 47%. Josh attributed this to higher reliability and call quality.
  • small changes make a huge difference:
    • increasing penetration of paid products by 1% brings in $60MM of additional revenue
    • to be a billion dollar business, Skype needs its existing paying users to make just one more call per day
  • Skype’s marketing approach was to drive awareness through embedding Skype into the “popular culture”, where it has been used on Oprah, Who Wants to Be a Millionaire?, CNN and other news reports.

Going forward Josh talked about three markets where Skype has barely scratched the surface: core consumer (size: $240B), mobile (size: $603B), and business (size: $203B).

For the consumer market, Skype has four approaches:

  • continue driving new users (by building “communities” or leveraging social networks)
  • better promote its paid products (make it obvious, upon registration, where paid products can be found – not buried three levels deep in the “My Account” tab)
  • increase revenue per paying user (encourage adoption of revenue services based on calling patterns; continued focus )
  • monetize free users via advertising (but be smart about it, do it tastefully and carefully all the while protecting the core business)

[Author’s note: Execution on the last will be interesting, given some experience with “free” voice services that have attempted to “blatantly” introduce advertising into calls themselves.]

Josh went on to discuss mobile, but that’s the subject of a separate post. However, take a look at the Skypephone on 3 success story:

  • Over 500,000 units have been sold; this generates a monthly revenue stream to Skype
  • 3’s margin on Skypephone is 20% higher than their average margin across all handsets
  • 79% of Skypephone customers are new 3 customers

As for Skype’s business offering:

  • SkypeCompellingBizOffering.280px 35% of users use Skype primarily, or often, for business
  • adoption into business often grows out of individual employees using  Skype to call friends and family when on the road, start using Skype for multi-party calls, do video calls with customers and vendors
  • leads to a call to Skype from IT managers who are getting pressure from their colleagues’ experiences (and, by the way, you can charge for it)
  • needs to expand from being a product to being a solution that fits with other PBX and software solutions they are already working with
  • create the infrastructure required to provide service and support services (revenue opportunity)
  • build out a channel that reaches out to businesses that are familiar with dealing with VAR’s

Going forward:

  • Act 1: (completed) one platform (PC’s), one revenue stream (SkypeOut), one market segment (long distance calling), one primary service (voice), one primary market (mature Internet markets – Europe and Asia) and one target user (consumers)
  • Act 2: (now to 2011) is about “Many” – many platforms (PC, mobile, TV, web), diversified revenue streams (subscriptions, licensing, advertising), including business subscriptions; many conversation modes (voice, video, chat, collaboration tools), many regions and many target markets
  • Act3: (2012 and beyond) “Any” – any mode, any platform, anywhere, multiple market segments, established products, regional ubiquity and mature target markets.

Josh’s forecast for 2011:

  • More than double revenue in excess of $1B annually
  • Maintain segment margins of 18% to 20%
  • More diversified revenue streams: telecom, service and licensing fees, advertising)

His summary:

  • Accelerating growth, outstanding fundamentals
  • Attacking an enormous opportunity and positioned to win
  • Business is getting stronger

Bottom line: For the first time a CxO level Skype executive has put out an extended set of benchmarks and guidelines against which their activities can be measured by all; the challenge now lies in the execution. And analysts finally get a more detailed view into this “mysterious” and oft-questioned Skype acquisition by eBay in 2005.

The audio recording and complete sides can be found for 30 days: click here and then select “Analyst Coverage” in the left sidebar. (viewer registration and Windows Media Player or Real Audio Player required). Or go directly to this link. Josh’s portion starts at 2:37:15 into the recording.

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About Jim Courtney

Bringing over thirty years' experience in the sales, marketing and management of cutting edge technology businesses.

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