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MS Skype: The Real Deal

Microsoft announced it completed its acquisition of Skype late last week. The EU gave its stamp of approval the week before, and US regulators had already blessed the transaction. Some markets are still reviewing the matter, but little countries can't stop a deal this big. The hard part of closing the deal was writing the $8.5 billion dollar check, but now comes the real heavy lifting.

Microsoft now gets the pleasure of integrating its new subsidiary into its product lines and business strategy while maintaining and integrating a talented workforce distributed around the globe (mostly located in Estonia, Stockholm, and California). Integration is part of it, but also there's the matter of profitability--new waters for Skype.

There is a lot of excitement about the possibilities of MS Skype--the sheer potential of how Microsoft can leverage Skype's huge user base as a means to transform Microsoft from products to services. But this ain't no walk in the park, there are some serious risks ahead.

Risk of Integration
Microsoft has to absorb a separate company, in separate cities, with a completely different culture. None of this is trivial, just ask the folks from Danger. Microsoft acquired Danger in 2008; it seemed low risk as the smartphone revolution was taking hold. Danger had a loyal customer base, carrier relationships, and a clever product. Microsoft needed something new as Windows Mobile was dying and Windows Phone 7 wasn't ready. In addition to the Sidekick products with T-Mobile, Danger also produced the Kin. Danger was shut down last May. I want my WebTV.

Microsoft has numerous successful integrations under its belt, but the complexity and risk of integrating Skype should not be underestimated, particularly with such divergent cultures. Skype has always been a rebellious, stick-it-to-the-man type of company: phone bills are for suckers. Its initial services were all about a free alternative to established communication paths. Suddenly, Skype is the Man.

Risk of Regulation
Skype has enjoyed freedom from the regulation that most of its traditional competitors endure. Skype isn't a common carrier, it is an Internet based communications service. That's a huge distinction when it comes to things like 911, taxes, tariffs, and government wiretapping compliance. Due to changes in communications, e-commerce, attitudes, and similar laws and regulations, this could change--Oops, there goes the business model. It could significantly increase expenses and overhead for Microsoft, and eliminate its cheap rate advantages. The risk associated with this change just increased slightly, as regulators and consumers are less forgiving of multi-billion dollar corporations than fledgling upstarts.

Risk of Patent I.P. Suits
Skype is an intellectual property powerhouse. It has developed many, but not all, of its underlying technologies that enable real time rich communications over the Internet. Third parties have already claimed infringement, and more are expected. There isn't much interest in suing companies that don’t have cash, and Skype hasn’t had much. It reported a net loss of $269.1 million in 2010, and lost $99.7 million in 2009. But patent trolls may be more interested in Microsoft's $50 billion in cash. Does the courthouse accept reservations?

Risk of ROI
Microsoft spent $8.5 billion on a company that has less than a billion in annual revenue and operates at a loss. Clearly, the strategy for ROI isn't in keeping it a simple standalone subsidiary, but exactly what is the strategy? So far Microsoft hasn't provided any clear clues. There are lots of opportunities for MS/Skype integration including MSN, Lync, Office365, and X-Box, but $8.5 billion isn't a trivial hurdle to overcome. Will Skype really help Microsoft sell more X-Boxes? How much advertising revenue is realistic? A good strategy ends with profits. Skype isn't profitable, and Microsoft's cloud services are still young and unproven. Office 365 and Lync are young. MSN is reasonably mature, but has substantial overlap with Skype. Compare all this to Bing, which has a clearly understood model, yet continues to hemorrhage cash.

Risk of Abandonment
Microsoft just added to its payroll some impressive talent. These folks have some highly sought after skills in VoIP, mobile, and real time communications. After the acquisition announcement, there was a small round of terminations and departures including Vice President and General Manager for Skype for Business, David Gurlé; Doug Bewsher, Chief Marketing Officer; Russ Shaw, General Manager and Vice President; Anne Gillespie, Head of Human Resources; Don Albert, General Manager and Vice President for the Americas and Advertising; Christopher Dean, Head of Consumer Market Business Development; and the recently acquired talent from Qik: Ramu Sunkara and Allyson Campa. Who's next to leave? Tony Bates? All those IOS developers? The Android Team? Most of them likely have compelling options available to them and Microsoft isn't particularly known for its powers of retention.

Risk Around Scalability
Skype's user base size is hard to count, but no matter how you count them, it is big. Skype stopped counting actual users, as even they felt that was too exaggerated. It's a similar problem with other online services--creating an account doesn't make one a "user"--they have to actually use the service to be considered a user. Skype started using the term "Connected Users" and last reported 170 million. This represented the number of unique users over a three month period. Big, but not big enough. Microsoft wants to see that figure grow to 1 billion as stated in Microsoft's press release that announced the deal’s completion.

"By bringing together the best of Microsoft and the best of Skype, we are committed to empowering consumers and businesses around the globe to connect in new ways," Bates said. "Together, we will be able to accelerate Skype's goal to reach 1 billion users daily," Bates said.

Earlier this year, Skype starting experiencing some big outages. The service has grown tremendously this year, and the weak links buckled. Skype is a huge peer to peer network, highly unique in nature--pushing the boundaries of network scale. Above, Bates says 1 billion users a day--that's a far cry from 170 million quarterly. What needs to change to support a billion users a day? Does anyone really know? What will happen to Skype’s legendary quality? Reliability? Availability? Microsoft is thinking big, but the risks around scalability at this level are very real. That huge customer base will abandon ship quickly if the ride gets too rough.

Risk of Dilution
Making calls, even video calls via peer to peer clients isn't exactly novel anymore. Apple, Yahoo, Google, even Microsoft, all offer these services, and generally for free. Apple has its new iMessage. Polycom, Vidyo, Radvision, and LifeSize all offer video solutions for mobile devices and desktops. There are numerous companies nipping at Skype’s model such as Fring, Nimbbuzz, Viber, VoIPBuster, Truphone, Vopium, and CounterPath. T-Mobile has upped its Facebook voice play called BobSled, and the latest Android phones integrate with Google Video. Skype was revolutionary at one time, but not recently.

Risk around Focus
Microsoft has a few irons in the fire right now. The company is working on several new products including Windows 8 and a revamped mobile strategy. Windows, Windows Server, and Office are all facing real competition--far more than in the past. The company is facing uphill battles in mobile and search. Microsoft is already in defensive modes with major formidable competitors including Google, Apple, Amazon, and thanks to Lync, Cisco and Avaya. With Skype, Microsoft has to now partner with Google and Apple in new ways. Not to mention Microsoft will be changing its relationship significantly with major carriers--Sprint and Telecom Italia are visible Lync testimonial customers using Lync. Microsoft is working to convince carriers to invest and offer its mobile phones, which may now be perceived as a threat to their revenue.

Risk of Losing Focus
It is hard to imagine this now, but Microsoft could decide Skype isn’t for them. US companies have an ever-shorter attention span when it comes to areas not producing profits. Sound far fetched? Consider HP and WebOS, Cisco and Flip, Google and Wave, Microsoft and ResponsePoint or Danger. For Microsoft, this is is a new, unprofitable area, and success, if attainable, is going to take a lot more investment and time. Is that amount of time longer than Microsoft's attention span? We like to think that when a firm decides to exit an offering it sells off the asset. But, as these examples have shown, that doesn’t always happen.

Of course there is no reason to believe Microsoft won't be successful. The company has been very successful with arguably far harder goals. There are a lot of synergies between MS and Skype: X-Box already has a monitor, camera, and Internet connection. Office365 is gaining traction, and the reviews are positive for Windows Phone Mango. Skype could easily be the next big success for Microsoft--what could possibly go wrong?

Dave Michels is a frequent contributor and blogs about telecom at PinDropSoup.