By STEVE LOHR Published: May 10, 2011
In agreeing Tuesday to pay $8.5 billion to buy Skype, the pioneer in Internet phone calls, Microsoft is embracing a technology that is transforming the way people communicate at home and at work. And by stitching Skype technology into Microsoft products, used by hundreds of millions of people, the software giant could hasten the mainstream adoption of video communications, especially in businesses.
Microsoft, although rich and powerful, lags in new fields like smartphone software. Skype could help it better compete with the new giants of technology, like Google and Apple.
“Skype has been a forerunner, and this deal is Microsoft trying to become relevant in this new age of Internet communications,” said Berge Ayvazian, a telecommunications consultant. “It could really change things for Microsoft and accelerate the spread of this new technology.”
The future of communications, industry analysts and executives say, will be animated by Internet technology and rests increasingly on video calls, as well as voice and text messages. Skype started on personal computers less than a decade ago, but is now beginning to make its way onto smartphones. As it heads for living rooms with applications like at-home videoconferencing on digital televisions, it could change the way people make even the most routine calls.
This next generation of communications is both a threat and an opportunity to telecommunications and technology companies — a focus of energy, investment and anxiety for corporations including AT&T, Verizon, Apple, Google and Facebook.
Microsoft is betting that Skype can help change its fortunes. Skype is a leader in Internet voice and video communications, with 170 million users each month connected for more than 100 minutes on average. In the last year or two, video use has surged, now accounting for 40 percent of Skype’s traffic.
That large and active community of users represents a major asset, said Steven A. Ballmer, Microsoft’s chief executive. “It’s an amazing customer footprint,” Mr. Ballmer said in an interview. “And Skype is a verb, as they say.”
Mr. Ballmer never mentioned Google, Microsoft’s archrival whose name is used as a verb for Internet search. In that market, Microsoft is spending heavily to try to catch Google, and making some progress with its Bing engine, but at great financial cost.
Google, like Skype, has a free Internet phone call and video messaging service. So Microsoft, analysts say, is taking a bold step to grab a leadership position instead of risking falling behind Google in a crucial market and then facing the difficult task of trying to catch up.
“Skype gives Microsoft instant size and scale in this emerging market,” said Howard Anderson, a senior lecturer at the Sloan School of Management at the Massachusetts Institute of Technology. The merger with Skype, if successful, could give Microsoft a leading consumer Internet service — something it has lacked — and help lift its other businesses, like smartphone software, Office productivity programs and Xbox video game consoles, analysts say.
In doing so, Microsoft aims to keep people seamlessly connected at work or at home. “We want to enable communications across people’s lives,” Mr. Ballmer said in a press conference in San Francisco.
Skype, founded in 2003, is a creation of the new technology that is transforming telecommunications. “For some time, it has been clear that telecommunications is going to move to all-digital Internet technology,” said Kevin Werbach, an associate professor at the Wharton School of the University of Pennsylvania and a former official at the Federal Communications Commission. “Skype shows what can be done.”
Skype was founded by two entrepreneurs, one Swedish and one Danish, with software developed by a small team of programmers in Estonia. They deployed a version of peer-to-peer software, initially associated with illegal file-sharing of pirated music and movies. The voice and video travel over the Internet rather than dedicated phone landlines or cell tower networks.
Skype has had a bumpy ride as a business. EBay bought it for $2.6 billion in 2005, and then sold most of it to a private investors’ group in 2009, after eBay could not figure out how to make money on Skype.
Despite changes in ownership and management, Skype was a hit with users, offering mostly free calling between Skype users, while charging for some services to corporate users and for calls to traditional phone numbers. It also now sells advertisements.
Skype, based in Luxembourg, has recently made steady progress as a business. Its revenue rose 20 percent last year, to $860 million, and operating profit climbed to $264 million, though it had a net loss of $7 million after making its debt payments.
Skype also has built a formidable technical prowess. Most of its software programmers are in Tallinn, Estonia. “The secret sauce of Skype is its engineering team,” said Marc Andreessen, a founder of Netscape, which made the first commercial Internet browser, and one of the private investors in Skype. “These are world-class guys, every bit as good as anyone in Silicon Valley.”
Mr. Ballmer emphasized that Microsoft planned to expand Skype’s offerings and increase investment, and not cut back free offerings. Skype technology, he added, will help enhance Microsoft products. Mr. Ballmer said the Xbox Kinect, a game device with gesture-recognition features, could add Skype to become an at-home videoconferencing system. And Skype can also be linked to Microsoft’s business software including Office productivity programs and Lync, multimedia software for workers collaborating on projects.
Microsoft, whose growth has been lagging, could find a lucrative revenue stream in selling the service to companies. It might also benefit from placing advertisements on Skype. “There are a lot of great opportunities to optimize Skype services in Microsoft products,” Mr. Ballmer said.
Skype, analysts say, is evidence of the recent pattern of innovations coming first to the freewheeling consumer market — like instant messaging, social networks and video chat — and then cascading to businesses. “This deal is another sign of the consumerization of information technology,” said Ted Schadler, an analyst at Forrester Research.
The Microsoft-Skype deal, analysts suggest, also points to a rising wave of digital disruption in the telecommunications industry, as low-cost Internet-based communications put pressure on traditional carriers, especially their landline phone service. Says Mark R. Anderson, chief executive of the Strategic News Service, a technology newsletter, “The computer guys are going to teach the telecom carriers about the future of communications.”
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