Skype could be Ballmer's bargain

At $US8.5 billion, there is no question that Microsoft has overpaid for Skype in current market terms, but this acquisition should also be viewed as a grander strategic move by Microsoft to reinforce its stake in the IP future of communications, as well as a new weapon in the unified communications cold war taking place with Google and others.

In this respect, Microsoft has acquired a leading video/VoIP service that it can integrate into a raft of its key applications (Windows Phone 7, Xbox, Outlook, Hotmail, Messenger, and Lync), and use as a springboard beyond its Windows ecosystem with the potential for expansion across new devices for both consumer and business customers.

There is also value for Microsoft in Google not getting Skype, giving the company an opportunity to further strengthen its competitive position online against Google's Voice, Gmail, and Talk offerings. But Microsoft also sees mobile as an important platform from which to drive Skype's subscriber numbers.

While Facebook partnerships and a fresh drive into the living room, especially the connected TV, are expected, Microsoft CEO Steve Ballmer will be looking to boost Skype's existing mobile partnership program and establish a lead on mobile.

Falling behind here would provide Google with all the encouragement it needs. If Microsoft is successful in integrating, monetising, and productising Skype – and we'll likely need three-plus years to see the results of this – the cost of overpaying for Skype could be much less than the cost of not getting it at all, especially in a communications market where IP is ascendant.

The integration of Skype will boost network effects across Microsoft's existing assets as well as within the Skype network itself, potentially adding nearly 300 million active Windows Live Messenger accounts, as well as more than 350 million Hotmail and nearly 25 million Xbox Live accounts, to Skype's existing 170 million.

With Skype's share of international minutes called now nearly 25 per cent and growing, the company's network effects also have global reach. The resulting Facebook-sized user numbers, when combined with an expanded range of new computers, mobile phones, and devices in the connected and extended home, are bound to reinvigorate network effects for Skype, quickly attracting new users who value the new bigger and more accessible network.

If Microsoft is to establish a sustainable lead in IP communications, its video/VoIP offering will need to be available on multiple screens to enable its use in a choice of modes.

Clearly, if operators were open to partnerships with video/VoIP services – and this is by no means assured – then the video/VoIP service that establishes a sustainable lead on mobile could easily convert this into an overall lead.

Microsoft knows that the right kind of partnerships with operators have a chance of shutting out Google as well as providing a rich source of viewers for video advertising – a business model that Tony Bates, Skype's ex-Cisco CEO, is keen to develop.

If Microsoft does intend to lead on mobile, it needs to make it worthwhile for operators to partner with Skype – a service that on the face of it looks likely to cannibalise operator voice revenues and compete for subscriber attention.

In fact, some operators are already working with Skype through its mobile partner program. These include Hutchison 3G, Verizon, and Qtel Group, who will be looking to profit from reduced churn, more subscribers, sales of specialised data packages, possible ad revenues, and a share of "Skype-out" revenues billed directly to the phone bill.

Ballmer won't have missed the problems that Sprint and Google have had with their integration and, with Skype users eying Microsoft warily, he certainly can't afford to have the same problems, so the easier and more worthwhile it makes integration and partnership for mobile networks the better.

Microsoft, among major adjacent players, is the company with the most incentive to work closely with operators for mutual benefit. Indeed, the company has described operators to Ovum as akin to its traditional OEM partners in the way it wishes to engage with them in future.

There could be much potential for mutual benefit here, especially for the provision of applications and software infrastructure for value-added services. How it then stands by service offerings that compete directly with those of its operator partners remains to be seen.

As consumers and businesses demand more unified communications with easy switching between voice, video, and messaging, the faster mobile data transmission required will be delivered over new LTE and cable networks with IP increasingly providing the means of transmission.

Were Skype to sustain its market leadership and open up its technology, it could become one of the more palatable side bets that operators could make in a changing and IP-dominant future.

The market should bear in mind that Skype is no longer being developed as an investment to be sold off yet again. Microsoft now has to make Skype part of its own DNA in order to create synergy and added value for its services, the software giant will be keen to make its $US8.5 billion investment in Skype work and work well, resulting in a positive deal-making environment for operators.

Telcos should now consider but not necessarily enact a Skype partnership in detail, in order to fully understand the business and technological implications of a future where the sheer gravity of a very large video/VoIP chat network could start to attract mobile networks and become a major and immediate disruption to the traditional voice market. 

Mark Little and Tony Cripps are both analysts at research firm Ovum.