Why Microsoft dug deep to snap up Skype

How will Microsoft benefit from its acquisition of Skype, and what does the deal mean for the enterprise?

This week Microsoft announced that it will acquire internet telephony service Skype for $8.5bn (£5.2bn).

The software giant already owns a voice and video messaging service in Lync, but as an enterprise product it is not something often used by consumers.

Skype, however, which will be rebranded as Microsoft Skype, is used by both businesses and consumers. So is this the end of the road for Lync? Leif-Olof Wallin, research vice president at analyst firm Gartner, thinks not.

"I think we'll see Microsoft integrating Skype with Lync. Users working inside the perimeter of the enterprise will be able to reach out and communicate with friends and colleagues in other organisations seamlessly. It will enable unified communications across the corporate border," he said.

Although Microsoft has not yet released details of the integration, Wallin expects that Skype will be added to existing Lync functionality.

"Lync allows you to mouse over somebody's email address to see their status. You can right click on their name and get a menu of how you want to communicate with them. So most likely, you'll be able to see if they're online on Skype, and then right click and get Skype voice and video options."

Forrester principal analyst Charles Golvin explained that the move will further unify previously separate communications media provided by Microsoft.

"The acquisition shows that traditional walls between communication networks and modes have been eviscerated – email, instant messaging, and voice over both fixed and mobile networks are becoming one massive river of communications. Skype will be integrated with Microsoft technology to further unite these communication lines, as well as consumers and businesses," he said.

And Ovum principal analyst Richard Edwards argued that Microsoft had to make the deal in order to keep up with its competition.

"With Apple FaceTime, a competitor to Skype, now available on the Mac, iPhone 4, iPad 2 and the new iPod touch, it is definitely now or never for Microsoft. Skype is arguably the most successful real-time social communication platform on the planet, and it's a great fit for Microsoft's business model," he said.

Why Microsoft dug deep to snap up Skype

How will Microsoft benefit from its acquisition of Skype, and what does the deal mean for the enterprise?

But while the acquisition may fit with the firm's strategy, how will Microsoft make any money from the deal? Given the size of the outlay, we can expect that the software giant has its eyes on a significant revenue stream in the near future.

"The basic service will remain free but they'll generate revenue through advertising. In addition, they will probably continue with the paid corporate version of Skype," said Wallin.

The paid version allows users to turn off "supernetting", a feature that turns a user's PC into a node on the Skype network, effectively drawing off computing power and using it for Skype's own ends.

"Microsoft will also continue to offer Skype outside calls to regular numbers. That is another revenue generator."

But besides advertising, nothing here is new. And Skype has made a loss so far in every year since its beta launch in 2003. So how does Microsoft expect to claw back its massive outlay?

"Skype almost made money in 2010, only losing in the region of $6m to $8m (£3.7m to £4.9m)," said Wallin. "Given that they have a growth of around 40 per cent year on year, unless they massively increase their cost base they would have become profitable in 2011 anyway."

And Wallin believes that the additional monetisation from advertising will provide a significant boost to this profitability. But that's just considering revenues, something easily measured. What's harder to measure is the ancillary benefit to Microsoft's other brands.

"When you include the added benefits to Microsoft of having Skype available within the Xbox platform and Windows phone, integration to Hotmail and Messenger, it starts to sound like a pretty compelling business case," said Wallin.

So it's not a case of expecting to see a rapid return on investment, but rather a mixture of benefits, only some of which are easily calculable.

But it seems that the marketplace was unable to appreciate these benefits, as Microsoft's share price fell about half of a per cent when the deal was first rumoured on Monday evening.

Wallin put that down to ineffective communication.

"They haven't been able to articulate the benefits of the acquisition so clearly that the market understands it."

In addition to the internal benefits of the acquisition are the benefits of getting one over on the competition.

"It's also great for Microsoft that competitors such as Facebook and Google didn't get hold of the technology. That might help justify the hefty price tag," said Wallin.

In fact, he believes that Facebook may well have been involved with Microsoft in a bidding war for Skype.

"I have a hard time believing that the price tag Microsoft paid comes from an unsolicited offer, where Microsoft contacted Silverlake and just offered $8.5bn. The large price indicates that there might have been some kind of bidding war."

He explained that Facebook has a strategy to extend its social networking software into email and chat, so a move into voice and video would be a logical progression.

And like Microsoft, Facebook is one of the few companies with the cash even to consider the purchase.

But why spend such a fortune on an acquisition when they could just develop their own competing technology? After all, both are large brands with a global following, giving them a head start with regard to creating a user base.

"You have a very large and loyal user base with Skype and this takes a lot of time to build up," said Wallin. "In addition, Skype has call-out capabilities in an awful lot of countries. It takes an enormous amount of time to get these operator agreements in place, even for a large enterprise. Skype has been building these capabilities for years."

It is this call-out capability that Wallin believes is key to the deal.

Finally, Skype falling under the trusted Microsoft brand should see more organisations relax restrictions over employee use of the free service, for example to contact friends and family while away on business travel.

"Those organisations that have been reticent to allow employee use of Skype due to security concerns may now start to reconsider their stance once it comes under the Microsoft banner," said Richard Ellis, director at integrator 2e2.