There have been rumors flying around the Blogosphere that Skype intends to raise their prices tomorrow, charging a connection fee on top of their existing per minute fee. Everybody likes to make predictions. I believe something completely different will happen.

Tomorrow Skype will again try to be disruptive by offering ‘Flat Fee’ calling to Skype users in major markets around the world. Skype will be adding a fixed per-connection fee to calls in major markets, while doing away with the per minute fee. Users will be able to talk as long as they want for one flat fee ranging from $0.00 to $0.05 per call to place domestic calls in certain countries.

This move follows the recent managerial reorganization at Skype. The founders of Skype are still going after their $1.5 Billion bonus from Ebay. Skype’s growth began to lag six months ago. Ebay’s coming financials will betray just how slow growth has been. So something needed to be done.

From the outside it appears as though Skype is feeling incredible pressure to grow its revenue. The feeling within Skype is that Ebay slowed Skype’s growth after the acquisition. The recent return of many eBay executives back to the mother ship is a power grab by the founders and an attempt to lay claim to their remaining $1.5 Billion. They want to renew some of the disruptive behavior that Skype demonstrated when they launched just over three years ago.

But is Skype’s new Flat Fee strategy really disruptive? Will Flat Fee dialing raise revenue? The only answers are No and No.

Skype has done their math. They know that their average call time is around 7 minutes, even in markets where calls are free. Free is an incredible incentive for people to talk for hours at end, so if Skype begins charging a nickel per call they figure the number will likely stay the same. At an average of 7 minutes, Skype can cover the cost of a call with a nickel and maybe just barely break even.

But what is disruptive about this plan? Skype is still paying wholesale service providers for their services by the minute. They are not going to convince any of their service providers to just charge them a flat fee per call. Skype will not change the way the telecom business charges wholesale customers.

There is no guarantee that when people are paying $0.05 per call they will behave in the same manner as they did when the calls were free. Those who want to talk for long periods of time will continue to talk for long periods of time. But those who just need to check and see if somebody is available may revert to other free methods like IM or to alternative per minute services like TalQer.

Skype’s Big Gamble

So Skype is taking a gamble that this new plan will bring on new customers and increase revenues. I doubt it will. Skype is already cheap. SKype will not going to increase revenue by making an already cheap product cheaper. Chances are Skype will just end up with a wash, and in the end the limited growth they might achieve will be offset by lower prices and lower profit margins. Revenue will remain flat and profits go down (or in Skype’s case losses increase).

This is not to say that I don’t think Skype’s plan will be a success. I do. Consumers will love it. But the people who will love it are the same people who love Skype already and who are spending $1.26 per hour. SKype users will love this plan becaues it will lower their bill down to $0.05 or less. Of course they will love Skype!

But to the person who is not yet a Skype user their impression will be “That’s cheap! So what’s new? Wasn’t Skype cheap before?”

I believe Skype is completely missing their second and third biggest assets. After their massive user base, Skype’s biggest asset has to be their brand. When people compare Skype and TalQer there will be people willing to pay more for Skype simply because they have developed a brand that people know and recognize. Skype is the AT&T of VoIP where TalQer might be compared to Sprint. Skype is the SONY of voice communications. So why do they want to price their product like a Hyundai?

Skype’s third biggest asset is customer loyalty. People are passionate about Skype. Skype changes people’s lives. It changes the way people do business, the way people interact with each other. Were Skype to raise prices while reaching out to their community and explaining that they must raise their rates to cover their costs Skype would likely see loyal customers flock to Skype in droves to support the company they love.

Skype prefers to lower prices and let word-of-mouth do their marketing. Skype would be better off leaving prices where they were and improving the quality of their SkypeOut and SkypeIn services. The simplest way for Skype to raise their profits and increase their revenue is to raise their prices. Even if Skype raised their prices by ten percent they would still be incredibly cheap when compared to conventional telephony.

Skype is the antithesis of Vonage. Skype could plough money into a well thought out marketing campaign and increase revenue to become profitable. Instead they choose to cut prices and lower revenue. Vonage could cut marketing, slow growth and become profitable very quickly. Instead they choose to advertise everywhere. But you do have to love their commercials.

Loss Leader

Skype let the first shoe drop about a month ago when they announced what they were going to charge less than $30 a year for unlimited VoIP service in the United States. Right now Skype is selling an entire year of unlimited calling for less than what Vonage charges for a single month.

Skype is losing money. There is no way they can even break even with this kind of plan. Skype is charging $2.50 per month for unlimited service, but they are paying out 25% of that in commissions to their affiliates, leaving them with $22.50 before they pay for credit card services. At a penny per minute that is 188 minutes per month. Lets double, even triple that number. Will the average customer willing to go to the trouble of getting out their credit card and entering in all kinds of information use Skype for less than 20 minutes a day? Or will they going to use SkypeOut for more than 20 minutes a day (and cause Skype to lose money)?

I often come across companies which started out with a plan to use Skype for business purposes. They are coming to TalQer because they want the flexibility of the SIP industry standard protocol and the quality of the voice service we provide. But there WILL be businesses that build models based on Skypes unlimited VoIP product. All of them will come out with products that use more than 20 minutes a day. And these customers will cost Skype dearly.

When Skype first launched free SkypeOut in the United States it had a positive effect on their business. Revenue from the USA increased even though it was now free to make domestic phone calls. Then eBay changed their financial report structure and stopped differentiating international revenue, so we don’t know what happened next. But what is clear is a dramatic slowdown in Skype revenue growth and increase in costs during the third quarter 2006.

It appears as though Skype’s promotion program had a positive affect for the first few months and then gradually became a burden from a cost standpoint. Skype was giving away termination in the USA as a loss leader to pull in USA customers and get them to use Skype, hoping that they might purchase credit to make international calls. It would be really interesting to find out just how many new active users Skype gained during those seven months and how much the entire plan cost Skype.

Skype has the best voice quality product out there for peer-to-peer telephony and instead of capitalizing on that and selling a quality PC-to-Phone or Phone-to-PC product they choose to forge ahead as the cheapest in the market. This is kind of like Mercedes trying to compete with the Chinese and sell cheap hatchbacks.

From a revenue standpoint it is not at all clear that “free” is a good market to go after. When you first start out it can provide dramatic and valuable growth. But eventually you have to end the campaign. It makes no sense to continue to lose money on a stale marketing campaign that is no longer bringing in new customers. It makes no sense to charge $30 per year and guarantee losses. Rewarding customers for being loyal free users is not a viable strategy.

Counter SkypeOut Shops

This new policy of charging ‘per call’ does go a long way towards protecting Skype from companies that are creating banks of Skype accounts, converting them to SIP and then selling SIP minutes. There are dozens of companies out there who are building equipment to convert Skype to SIP and probably hundreds of individuals with servers set up to resell Skype traffic.

The economics of these SkypeOut shops is very persuasive. There are 43,200 minutes in a month. With 15 accounts these nefarious individuals will keep their accounts under 3,000 minutes per month and likely remain undetected. At $2.50 per account per month, they pay Skype a total of $37.50 per month. They pay another $200 for a server on which they can host 10 active accounts (150 accounts total) for a total $575 for 432,000 minutes. If they sell the minutes for 1/3 market value at $0.005 per minute they still make $2,160 per month. This amounts to a 4X return on investment each month or assuming they take time to ramp up their minutes a $15,000 return on a $500 to $1,000 investment over the course of a year.

I have heard of one company which had dozens of Skype accounts running on servers which were attached to an Asterisk PBX. They were selling SIP minutes and routing the calls through Skype. Skype caught on and shut down the accounts. The company went out and bought new Skype accounts along with non-sequential IP addresses and made sure that none of their accounts went over 3,000 minutes per month. From what I hear they are still up and running.

As CEO of an alternative VoIP service provider I would never purchase minutes from these kind of individuals and when offered the opportunity I turned it down. But there are plenty of customers who unknowingly purchase these minutes without asking for details about how the calls are routed.

Opportunities

Since my last Blog I have pretty much given up trying to remain objective in this space. I will settle for being rational. Skype probably did $180 Million in revenue last year. Skype probably lost between $37 and $40 Million last year. To me that just doesn’t make sense.

Skype: Stop selling at a loss, spend more on marketing, capitalize on your outstanding brand name and customer loyalty and earn your $1.5 Billion bonus! I do see a fantastic horizon for Skype. I believe their community will grow. It took Skype 69 days to grow from 7 million users online to 8 million. It looks as though it will take Skype around 78 days to grow from 8 million to 9 million users online. That is still an incredibly fast pace.
It seems that if Skype is going to ignore their second (brand) and third (loyalty) most valuable assets and cut their prices even further they must intend to focus on their most valuable asset: their user base. I see Skype leveraging its user base to earn revenues through e-marketing cooperation with eBay and advertising relationships with advertisers like Google. We may see Skype becoming a completely free service paid for by advertising, much like Kazaa, but in a more sophisticated manner.

There are many questions I would love to ask the Skype folks tomorrow:

1. What is disruptive about a business model that pay phone manufacturers abandoned ten years ago?

2. How will Skype increase revenue by lowering prices?

3. How will you make a profit providing unlimited SkypeOut service in the USA at a loss?

4. Why are you continuing to use price as your major marketing tool when your voice quality for peer-to-peer calls is so outstanding?

5. Will Skype become an advertising supported application in 2007?

I am the CEO of a Skype competitor. This is my personal Blog, not a corporate mouthpiece. But just because I work for a competitor does not mean I have it in for Skype. On the contrary I hope we can provide value to Skype users in the community who are looking for a more flexible alternative or are looking for services that Skype doesn’t offer. Kind of like the auto parts store selling performance equipment that doesn’t come standard with the car.

I only Blog occasionally because I am usually busier than a one-armed paperhanger building TalQer. I have related in a couple of past Blogs that I have been working on some pretty big things. Now it is time to tell everybody what we have been up to for the past nine months.

What we have been doing is ‘hacking’ SkypeOut and SkypeIn.

The latest version of TalQer integrates with the Skype User Interface to add a new gold dial button which allows Skype users to make outgoing calls using TalQer instead of using SkypeOut. TalQer integrates with the Skype UI so that users are able to call SkypeOut Contacts by highlighting the contact and then clicking on the gold TalQer dial button. Skype History entries can be highlighted and called in the same manner.

While our software by itself is disruptive, creating a software application is not that difficult. The truly disruptive thing is the integration of our software together with TalQer service and with Skype. It required an enormous amount of effort to integrate our software, our web site and our SIP Proxy together so they all function as one, and then integrate all of this together with Skype, our telephony service providers and with the different billing providers we work with.

We did not build TalQer just to be another also-ran next to Skype. We wanted to launch with a number of features that would make us equal or better than Skype. So we included features like:

1. TalQer uses the industry standard SIP protocol;
2. TalQer uses our own Media Relays (where we pay for bandwidth) instead of using Skype user’s computers as Media Relays (where Skype doesn’t pay for bandwidth);
3. TalqIn numbers from 38 countries with more coming, compared with Skype’s rather limited 12 countries;
4. Excellent DTMF quality for touch tone dialing in voicemail systems;
5. Free TalQIn numbers for every user;
6. Free Voicemail for every user;
7. Microsoft Outlook, Mozilla Thunderbird, Internet Explorer and Firefox Integration built in;
8. Prepaid billing in Euro or US Dollars;

One area where we invested considerable time and effort was in the design of a rock solid anti-fraud system. When we first launched our Google Talk Out service we were slammed with fraud to the point where 80% of our orders were fraudulent. We developed a system that eliminates fraud while still allowing legitimate orders through. This technology is invaluable in the VoIP industry.

When I say ‘hack’ I use it in the good sense of the word, at least from a Skype user’s perspective. We have not done anything illegal or immoral. We have not compromised the integrity or security of Skype’s software or telephony service. We have “altered and refined a computer program skillfully.” And I am definitely using the word ‘hack’ only as a Blogger and not in my capacity as CEO of TalQer.

What TalQer has done is offer Skype users new functionality that integrates together with Skype’s existing software and service. We have improved the Skype User experience insofar as users can receive telephone calls from more countries and make outgoing calls at cheaper rates. And we have become the first VoIP service provider to integrate with the Skype VoIP network.

If Skype is the AT&T of the VoIP industry then TalQer is kind of like Sprint, offering an innovative quality product at a cheaper price. Skype started out being a disruptive force in the telecom industry. Now they are an industry leader. And when you are the leader other players like TalQer will inevitably come along to provide competition.

According to the second quarter update of the US VoIP Report from TeleGeography.com, 1.23 Million new customers signed up for wire-line replacement VoIP services during the second quarter of 2006. Wire-line replacement VoIP subscriptions grew 21% during Q2 2006 to 6.9 Million subscribers, a 153% increase from Q2 2005.

The big news is that Comcast is now the fastest growing wire-line replacement VoIP service provider with 305,000 new subscriptions in Q2 2006, growing more than 1.7 times their size in three short months. Comcast’s growth rate was 25% faster than the 243,000 new subscriptions added by Vonage during the same time. Comcast is set to overtake Cablevision as the third largest wire-line replacement VoIP service provider during Q4 2006.

Comcast’s gain in market share is likely largely a result of their recent barrage of advertisements and PR promoting their service. It seems that Comcast is turning away low cost advertisers who frequent late night programming and converting a large percentage of the advertising time they are unable to sell into ads publicizing their triple pay packages: Enhanced Cable with Video On Demand, Comcast Digital Voice and Comcast High-Speed Internet. On July 24 they launched a new product bundle promoting each of these for $33 per month, or $99 per month for all three.

Comcast has taken the lead (away from Vonage) as the largest television advertiser promoting VoIP and has done so at a very low cost. Vonage’s market share has slipped from 36% in Q1 2005 to 26% today while Comcast has jumped from 0% to 10% during the same time. Om Malik warned this would happen when the cable companies finally jumped into the VoIP game. It will be interesting to watch how Vonage responds.

AlwaysOn is a leading technology and innovation journal bringing the latest insights and thinking from Silicon Valley and the world. The AlwaysOn Stanford Innovation Summit is an annual conference hosted by MIT/Stanford Venture Lab which explores the future of the Internet and stages a CEO Pitch Showcase which offers a stage to the most innovative companies. I was a speaker at the conference on the panel Where is Life After the Telephone? where we talked about some of the innovations on the horizon in the VoIP world.

BusinessWeek Online ran a story yesterday about a new venture called “the Venice Project” by Niklas Zennstrom and Janus Friis, the founders of Skype, which will inevitably / eventually compete with Skype.

Long ago this Blogger wrote about the advent of video broadcast merging with Skype. The two concepts are quite similar, really. For a video phone, computer A transfers audio and video to computer B, and computer B transfers audio and video to computer A. For video broadcast, computer A transfers audio and video to computer B, and computer B transfers audio and video to computer C.

Granted, it is not quite as simple as I described above. There are a host of other issues like load balancing required for clients which are upload bandwidth poor. But Skype already owns the fundamental intellectual property to act as a Peer-to-Peer video broadcast platform, they just haven’t ‘turned on’ this functionality yet.

The real challenge is NOT the technology end: the key is building up the user base to reach critical mass. There are already multiple(1) competitors(2) out there(3), the most well known being RedSwoosh(4). With tens of millions of active users, Skype already has critical mass. Skype could partner with major television networks and become the world’s largest video distribution network overnight with no geographical borders. Talk about renewed growth in Skype downloads!

So one must ask, why are Nik and Jan unhappy at eBay? Did Skype’s recent slowdown in growth mean the $1.5 Billion bonus is already out of the question leaving them no motivation to roll this feature into Skype? Or is Skype doing so well that they already have the extra $1.5 Billion in the bag. Did Meg Whitman forget to ask them to sign a non-compete? Did they pitch the idea and eBay decided to pass? Or is eBay somehow in on the deal?

As Skype board members I don’t see how they could invest in the Venice Project without giving Skype the first right of refusal. Perhaps the law is different in Luxembourg. Personally, I would bet my money that the Skype founders have already nailed the $1.5 Billion bonus (which means another substantial discount for eBay shareholders). It will be interesting to watch and see.

What would seem counterintuitive to most actually works at Skype. They managed to increase their sales by giving away free VoiP to North American customers dialing numbers in North America.

The idea was that if Skye gave away free VoIP services in North America more people would download Skype and give it a try. Once they tried it they would realize how great it is and some percentage of these people would purchase SkypeOut and SkypeIn services, resulting in an increase of sales.

From the numbers eBay released yestoday we know that this worked! While growth in the rest of the world was a meager 24%, growth in North America was 35%!

The only thing is, we have no idea at what cost! In their financials eBay notes: “Gross profit as a percentage of revenues was lower primarily due to the inclusion of eBay’s Communications segment in Q2-06.”