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Forget the phone and Skype me!






July 28, 2005




Skype co-founder Niklas Zennstrom is turning the US$1 trillion telecoms industry upside down. BLOOMBERG


Last September, Tom Online, the Beijing-based Internet company controlled by Hong Kong billionaire Li Ka-shing, was ready to start a version of America Online's ICQ instant messaging service. At the last minute, executive vice president Elaine Feng agreed to meet Geoffrey Prentice, Skype Technologies' director of new business.

The latest brainchild of Swede Niklas Zennstrom and Dane Janus Friis, founders of file-sharing company Kazaa, millions were using Skype's software to talk for free on personal computers. Feng loaded the program on her laptop computer and forgot about it until the next day, when the computer rang.

Solina Chau, who holds a 24.5 percent stake in Tom Online, ''Skyped'' Feng, calling to prod her to drop ICQ and add Skype instead. Feng agreed - becoming another convert to a technology that's threatening to turn the US$1 trillion (HK$7.8 trillion) global telecommunications industry upside down.

''Skype is like a meteor heading for Earth,'' says James Enck, a London-based telecommunications analyst who wrote the first report on Skype in September 2003, a month after the software's introduction.

Since then, 80 percent of the 2,000 companies surveyed by New York-based Deloitte Touche Tohmatsu, the world's second-biggest accounting firm, say they're using, testing or planning to switch to Internet-based calls in two years.

``The loss of voice revenue is happening much faster than many people expected, and the big telcos have no choice but to respond,'' Enck says.

Zennstrom, 39, and Friis, 29, are veterans at staging technology incursions that shatter the status quo. They have turned their Luxembourg-based company into a global telephone service with 40 million customers, a feat that may change the scrappy Scandinavian outsiders into Internet capitalists.

Developed by the same Estonian programmers who built Kazaa, a Napster-like program that shook up the entertainment industry by letting people share music and video files, Skype software has been downloaded more than 140 million times, according to the company's Web site.

That's a pace second only to Kazaa's 390 million downloads. Skype is adding 130,000 registered users a day - in the process creating its own vocabulary, as in ``Skype me'' - all without spending a cent on advertising.

Zennstrom declines to say whether Skype is profitable. ``I don't release any financials unless I have to,''


he says.

Tony Kern, a Skype user who advises clients in the telecommunications industry as deputy managing partner at Deloitte, says: ``There is definitely a cool factor around Skype.''

Marc Vollenweider, co-founder and president of Bermuda-based research firm Evalueserve, says his firm uses Skype for about 50,000 minutes of phone calls each month, saving about US$60,000 a year.

When Skype increases security and flexibility, Vollenweider may switch another 800,000 minutes of voice calls to Skype for his more than 700 analysts in Gurgaon, India, outside New Delhi.

``Once they come up with a business model, they'll see more revenue,'' says Vollenweider, who outlined Skype's threat to the telephone industry in a January research note. Among his conclusions: ``The cost of a basic phone call will disappear.''

Like Kazaa, Skype relies on peer-to-peer technology, which taps the computing power of participants' PCs around the world.

There are no costs for centralized servers, switches or other equipment. Calls within the Skype network are free, and calls to regular telephones are cheap.


Zennstrom and Friis are betting that a telephone service, which avoids the copyright issues that dogged Napster and Kazaa, will evolve as a less controversial use of peer-to-peer technology.

They picked the name Skype, which has no real meaning, because it had a catchy ring in any language. ``It just sounded cool,'' Friis says.

Skype gets revenue in two ways. The first, SkypeOut, lets users place calls to regular phones for about 1.7 euro cents a minute. Callers buy prepaid calling cards for 10 euros (HK$93.37), which provide about 600 minutes.

SkypeOut works with the London-based Colt Telecom Group, Broomfield, Colorado-based Level 3 Communications and other companies to connect users to the public switched telephone network, the international system that regular fixed-line telephones use.

The second source of revenue, SkypeIn, provides users with a phone number so they can receive calls from regular phones. A customer in London can get a San Francisco number that lets friends and family in California call him or her at local California rates. The service costs 30 euros a year. Zennstrom says about 5 percent of Skype customers pay for one plan or the other.

Zennstrom estimates that as many as 30 percent of Skypers are business clients, such as Kern and Vollenweider. Nicole Channing, who runs a New York hedge fund company called Anomaly Capital Partners, says she Skypes people in her San Francisco office daily.

``We use it as squawk box,'' Channing says. ``It's on all the time. We also instant message a lot, and if we have to speak, we Skype.''


The world's largest telephone companies - Verizon Communications, SBC Communications and Tokyo's Nippon Telegraph & Telephone Corp - are racing to update their networks to handle Internet calls.

BT Group, Britain's biggest phone company, unveiled plans last year to invest US$20 billion to build a European network based on technology known as voice over Internet protocol.

VoIP breaks calls into packets of electronic ones and zeroes and sends the data over available routes, eliminating the expense of keeping a channel open to await a call - whether or not one is pending.

VoIP-only companies such as Edison, New Jersey-based Vonage Holdings have racked up about three million US customers. Vonage's 700,000 subscribers pay US$20 to US$30 a month. Internet powerhouses Yahoo, Time Warner's America Online and Microsoft's MSN online service are boosting their voice-messaging capabilities.


Carsten Schloter, chief executive of Swisscom's mobile phone business, says dropping the price of a phone call can ease defections to Skype.

``It's a question of when does it hurt so much that you react with a price structure that kills Skype?'' he says.

Price cuts can backfire and hurt the incumbents. Since May, Swisscom has reduced its fixed-line and mobile phone rates and lowered its earnings and sales estimates.

In the quarter ended March 31, sales from Swisscom's fixed-line traffic, including local and long-distance calls, fell 12 percent to 294 million Swiss francs (HK$1.37 billion) from a year earlier.

Telephone companies aren't about to get wiped out overnight. ``Skype destroys the value of telcos, but it is not building a replacement business,'' says Lars Godell, a telecom analyst at Forrester Research. ``Skype does not address any unmet needs.''


For Skype to be truly successful, it must offer a range of services, such as call forwarding and voice-mail alerts that pop up in e-mail inboxes. That would happen if a bigger partner, such as MSN or Yahoo, takes over Skype, Godell says.

Zennstrom declines to comment on takeover speculation except to say that he has read the chatter on the Web. In June, the buzz in online chat rooms was that Yahoo, the most-used Internet site, was about to acquire Skype.

Instead, the California company paid an undisclosed amount for Dialpad Communications to gain technology that will let Yahoo users make calls to a telephone from a PC.

``Competitive battles take place over years, not months,'' says Brad Garlinghouse, Yahoo's vice president for communications products.

``We at Yahoo are focused on the marathon and not on the sprint.'' He declined to comment on the possibility of Yahoo acquiring Skype.

Phone company rivals say consumers will look beyond Skype's free and low-priced services and, instead, demand offerings such as high-speed Internet hookups and movie downloads.


``We've been doing voice for a hundred years,'' says Michelle Swittenberg, who is responsible for Verizon's VoIP strategy as executive director for consumer products.

``When the time is right to turn on the engine behind our VoIP product, we'll integrate it across our wired and wireless network.''

Verizon, with 33 million fixed-line subscribers and 45 million mobile users, started offering VoiceWing VoIP service in July 2004 at US$34.95 a month. It has since introduced a US$19.95-a- month plan.

Swittenberg says that more Internet-based products are coming; she declines to discuss them.

Putting the world's phone-service providers on the defensive isn't bad for Skype, a company with 145 employees, including software developers, working out of a drab block in Tallinn, Estonia.

Skype's main office is in a former warehouse on a narrow street at the heart of London's Soho, with its theaters, clubs, specialist bookstores and two Virgin Megastores.

In typical Internet startup fashion, about a dozen employees hunch over laptops, sitting on cheap wooden chairs in the white, loft-style room a stone's throw from sex shops selling pornography and massages, and coffee shops serving Italian brews and biscotti. The only nod to luxury is a blue sofa near the main door, adorned with lime-green Tom Online promotional cushions.

With Skype, Zennstrom has a second chance to create a global Internet company like Google, the most-used search engine, or Amazon.com, the world's largest Internet retailer.

Tim Draper, managing director of venture capital firm Draper Fisher Jurvetson, calls Skype a classic disruptive technology.

The term, coined by Harvard Business School professor Clayton Christensen, describes a product that bubbles up and eventually overturns the dominant technology in its market.

Draper compares Skype to free e-mail company Hotmail, purchased by Microsoft in 1998 for US$450 million and now boasting 190 million users.

Contemplating how Skype has sparked a frenzy among the world's biggest communications firms, Zennstrom cracks a rare smile.

``What I seem to have done is to get the giants running faster,'' he says.









































BLOOMBERG






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