Why buy Skype?

By M.G. | SAN FRANCISCO

“IRREPRESSIBLE” is a word that is usually used to denote something that is hard to control or restrain. Steve Ballmer, the boss of Microsoft, is obviously very fond of it. At a press conference on May 10th to announce the company's whopping $8.5 billion purchase of Skype, an online phone and video-calling service, he used the word several times to imply that Microsoft was still a dynamic company. But the firm's shareholders may end up wishing that Mr Ballmer had shown considerably more restraint when negotiating the firm's largest ever takeover.

The way the deal came about shows how desperate the software giant was to get its hands on Skype. The target company was heading for a stockmarket flotation until Microsoft suddenly lobbed in an unsolicited offer for it. The amount Microsoft ultimately coughed up for Skype was generous enough to convince the firm's investors, which include Silver Lake Partners, a private-equity fund, and Andreessen Horowitz, a venture-capital firm, to jettison the planned public offering in favour of Microsoft's all-cash deal.

Yet it is hard to see how the company can justify splashing out the equivalent of 400 times Skype's operating income last year for its prey. Although Skype's service has become so well-known that its name has become a verb, it has struggled to get users to pay for premium services such as calls to mobile phones. It had 663m registered users last December and made $860m in revenue in 2010, implying revenue per user of a mere $1.30. And it has singularly failed to develop a convincing advertising model.

Announcing the deal, Mr Ballmer (pictured, left, with Skype's boss, Tony Bates) tried to spin these as opportunities. But people chatting away on video calls are unlikely to pay a great deal of attention to ads, no matter how expertly sold by Microsoft's salesforce. And the company will have to come up with incredibly compelling offerings to persuade folk who have been conditioned to getting a wonderful service for nothing to dip into their wallets and purses.

The corporate market may be more promising. Microsoft has a big footprint here thanks to its Windows and Office products. And its Lync service, which combines various different communications tools such as video chat, instant messaging and web conferencing in a single package to spur collaboration inside companies, has proved very popular. Splicing Skype onto it could allow it to compete even more effectively with offerings from rivals such as Cisco.

There may also be potential for the company to come up with new offerings by linking Skype's service with, say, its Xbox 360 gaming consoles and its Kinect motion-sensing devices, allowing gamers to see the outrage on friends' faces when they zap their online characters for the umpteenth time. And by integrating Skype with the operating system for its Windows 7 phones—which is also likely to become the operating system for phones from Nokia, with whom Microsoft has an alliance—it can better compete with video offerings from rivals.

But why buy Skype to achieve all this? After all, had the start-up gone public, it would no doubt have been keen to work with Microsoft on these and other offerings to drum up revenue. Perhaps the answer is that Microsoft desperately wants to be seen as a place that is home to cool consumer technologies and hopes that owning Skype outright will give it more credibility as a hive of edgy innovation. The snag is that the firm has fallen so far behind the likes of Google and Apple in the consumer arena that its fall from grace there may well be irrevocable.

Read on: Reports of the death of the phone call are greatly exaggerated (Dec 2010)