What the Skype deal means to the rest of us…

Since so much of this column’s print has been devoted to VOIP this year, I’d be remiss if I didn’t try to make sense of our industry’s latest big news: Ebay buying Skype for 2.5 billion. (For some perspective, that’s one third of what Verizon will pay for MCI.) Skype, as you probably already know, is a ‘peer-to-peer’ software service that lets anyone BYOMSB (Bring Your Own Microphone, Speaker and Broadband ; my acronym – sorry) and make voice calls to each other for free.

Whenever I hear “for free”, I cringe. After all, why pay around $150 for each of the estimated 20 million active subscribers if they don’t generate any revenue? At first glance, this looks like déjà-vu-all-over-again. Didn’t Microsoft buy Hotmail (another free service) for $400 million a few years back? Is this the same kind of ‘market-share-is-everything’ gamble? The answer is no. Here’s why:

1. First of all, other “free” services (like Hotmail) didn’t threaten any entrenched monopolies. Yes, a few people (like AOL) were making some money charging for e-mail at the time, but this was pre-Broadband and most people were happy to fork over twenty bucks a month just to get on-line via dial-up.
2. If $150 dollars per subscriber sounds like a lot, remember that large ILECs are typically valued at something approaching ten times that number. A traditional POTS customer pays a monthly annuity, so the valuation is a lot higher.
3. Let’s not forget about the cost to acquire a new customer. Here, ILECs, Cable and Wireless companies often peg this number somewhere in the $200-$500 range – a fee that includes marketing and hook-up charges. Skype isn’t encumbered by these costs since – as I mentioned earlier – each new customer brings their own equipment and bandwidth to the table. One point of view on this Judo tactic is that it presumably shifts the ‘cost’ of the service to those last-mile providers of POTS and ISP services. It’s not clear that those services have managed to effectively convey their true cost structures to regulatory boards, without sounding like whining kids who’ve had their toys taken away.
4. Skype has expanded into the “paid” arena. “Skype-IN” and “Skype-OUT” are paid services that interconnect to the POTS network. Clearly, Skype users occasionally still talk to people on the POTS network, and that entails a myriad set of interconnection charges at some point. (Check out our archives for a discussion of what happens when this goes awry, and an unsuspecting carrier is caught trying to figure out where all this phantom traffic is coming from!) So, if Skype could turn 5% of users their into paying customers dishing out $5 per month for interconnection fees (and I guarantee you Ebay will find a way), then – suddenly – there’s a newfound $60M revenue stream, which is about Skype’s forecasted revenue this year.

So who wins, and who loses, in this new deal?

1. I’m reluctant to jump on the “end is nigh” bandwagon for the ILECs, since the ‘last mile’ is still a key piece of the puzzle. The real issue is that ‘one- trick-voice’ ponies are going to feel a lot of pain as voice becomes more and more of a commodity. Interestingly, this may not be the ILECs who – despite their sluggishness – are deploying different services, and getting a bit more of a revenue mix. (Fully 1/3rd of SBC’s revenues are not derived from voice.)

2. More likely, Mobile operators (who typically derive more than 80% of their revenues from voice) are going to feel the pinch. In their (often) misguided rush to build 3G networks (data networks that will easily handle VOIP traffic as well), they’ll probably hand over the keys to Vonage, Skype and others whose customers will use these new networks to float their voice traffic – significantly undercutting the Mobile operators’ voice revenues.

3. Incumbents who try to fight this trend will lose. Madison River, an ILEC, was fined recently for blocking access to the Skype web site. Cable companies’ attempts to distribute cable-modems that block competitive VOIP IP addresses (such as Vonage) will also take it on the chin.

4. Intermediary players that provide Tandem and Media Gateway services (e.g. Packet8, Level3) will gain, since VOIP/PSTN traffic-ferrying is now an important piece of the puzzle.

5. Software providers (like us) will do well by providing greater interconnection validation and clearinghouse functions. The nature of this new traffic is too complex to rely on old-style CABS billing systems. Other Revenue Assurance tools, including network testing tools, will need to be rethought in the VOIP world. After all, conformance to state tariffs – a driver for traditional RA activities – may not apply in the new order. But, the correct validation of routing, provisioning, call types and intercarrier billing still play a role. In other words, there are still real network elements under the Marketing department’s fanciful portrayal of the IP network as a mere cloud.

6. Carriers who jealously safeguard their last-mile monopoly will lose, if they don’t separate their ‘physical service’ (outside plant) from the ‘application services’ (Voice, ISP, TV) that ride on top of them. More and more, these application services will simply flow over the cheapest bandwidth to the consumer. Better accounting of their ‘physical’ costs may even give them some regulatory relief if the FCC realizes that the costs of handling IP/PSTN calls are unfairly being shouldered by the ILEC. This will probably play out first in the Tandems, where much of the cost currently sits.

7. Finally, I’m tempted to say the VOIP providers lose unless they fix their Quality of Service problems. I’ve uncovered that most people who proselytize about VOIP have never actually used it. It sure doesn’t have the quality of POTS yet, but it’s probably on the way to getting better. Besides, the Wireless industry proved that quality isn’t everything… how many dropped calls did you experience last week?