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Microsoft acquires Skype: smart move, challenges ahead



Microsoft acquires Skype: smart move, challenges ahead
Skype's acquisition by Microsoft for $ 8.5 billion is either being criticised for its cost (other bids were believed to be in the $ 3-4 billion range, more or less in line with the valuation envisioned in case of an IPO) and for Skype's lack of profitability, or hailed as an opportunity to enrich many Microsoft product lines with enhanced functionalities or services.

We believe both analyses are missing the key point. Indeed, this acquisition marks a turning point in Microsoft's online strategy, and represents a very smart move for the Redmond firm. It goes far beyond acquiring a technology, or even a client base; we rather see it as part of Microsoft's efforts to reorganise its products and services portfolio, and adapt to a changing market, primarily characterised by permanent and ubiquitous connectivity.

However, success will depend on execution and Microsoft will face a number of integration challenges. There will be much more at stake than just «making Skype profitable».

The « basic deal » makes reasonable sense

Agreed, the valuation is relatively high (but not ridiculous in the current market context); agreed, Skype is not yet turning out a profit (but made substantial progress towards it). It should also be noted that Microsoft is acquiring the Luxembourg-based Skype using cash reserves that would have been costly to repatriate back to the US...

It is also true that achieving synergies between Microsoft product lines and Skype can be done relatively rapidly. They can enrich business software lines as well as game console products, and Skype's true IP telephony expertise and competences can significantly improve Microsoft's Windows Phone 7 offering, and combine with Microsoft own VoIP/ToIP offerings.

Overall, Microsoft is acquiring a client base and a set of technologies that can combine nicely with its own offering, for a preemptive, but not astronomical, price.

A strategic move to align Microsoft's product portfolio with tomorrow's markets

We believe that there is much more to this deal, however. Microsoft is widely said to have «missed» the Internet opportunity to companies such as Google, Amazon, Yahoo or Facebook. It also took time to embrace the cloud market with Azure, leaving these grounds to the likes of Amazon. Similarly, Microsoft did poorly in the mobility market compared to Apple, RIM or the Android community, notably Samsung.

The Skype acquisition alone will not fix these «weaknesses», even though it may improve Microsoft's position significantly. Microsoft's online services division is still a major lossmaker, but at the same time it is one of the most strategic investment areas for the company. Microsoft obviously has the financial muscle to sustain such a key business for years, despite its current lack of profitability. Other acquisitions will definitely be on the agenda to help establish the market position Microsoft is seeking.

Seeking renewed leadership in a diversified, segmented online services market

However, with «online services» becoming a huge, heterogeneous market comprising of such disparate segments as social networks, mobility services, cloud computing, videoconferencing, etc., no player will be able to dominate every segment. Proper product and services portfolio management, as well as sound business alliances, will be key.

Microsoft has indeed much more experience in these two fields than most of the other above-mentioned competitors. Its Facebook investment (already resulting in a degree of integration between Bing and FB) makes sense from this standpoint, as does, in another market, the Nokia deal on Windows Phone 7. Another strong aspect of Microsoft's strategic position is its ability to federate a powerful distributors/resellers/integration partners network.

But Microsoft remains primarily a software and technology player. The forthcoming competition for today's «connected customers» (both corporate and consumer) leaves this type of players with less client «mind and wallet footprint» than in the past, while two other categories of players come to a more prominent role, and will shape the market: «Over The Top» (OTT) service suppliers (Google, Yahoo, Facebook, … and Skype, but also cloud providers such as Amazon or even IBM), and telecommunication operators, who strive to become value added service providers and will seek to protect / reconquer their margin share from OTT players.

Skype as a strategic asset

Skype is definitely one of the players that are competing head-on with telecom operators. As mobile telephony evolves towards LTE (which offers much more mobile bandwidth, and is also a full IP-based technology), operators will find it increasingly difficult to impose «no VoIP» contractual rules on mobile telephony subscriptions. As a result, Skype's technology and services will gain in market relevance – even for operators.

Skype strengthens Microsoft's capabilities as an OTT player, and it also brings products and technologies that can be leveraged in partnerships with telecom operators – directly or via partnerships (e.g. Nokia). Overall, Microsoft will enjoy accrued capabilities as well as bargaining power and «alliance attractiveness» in the online ecosystem.

On another note, Skype already has a partnership with another key Microsoft partner in mobile telephony, Nokia, on the moderately (at best) successful Nokia Ovi application store. With Skype offering Android and iPhone versions, it brings Microsoft and its allies a potential entry into other mobile phone OS environments...


Challenges ahead

Microsoft will still have to address a number of issues with this acquisition. As always, culture will be a key subject. Considering the potential synergies, cross-fertilisation is essential, but «over-integration» can lead to a disaster. The announced reporting scheme (with Tony Bates, Skype's CEO reporting directly to Steve Ballmer) makes sense from this standpoint.

The challenge is somewhat similar to that experienced by IBM, years ago, with the acquisition of companies such as Lotus or Tivoli: balancing autonomy with integration. Microsoft needs, to some extent, to return to more of a «startup» culture when managing Skype's integration and evolution – while leveraging its own capabilities and business momentum.

Impact on users

Users might fear that the «free» nature of Skype telephony goes away, or that prices for Skype's merchant services go up. We do not believe this risk is high, since Microsoft will focus on expanding Skype's client base and focus on adding cash-generating services rather than attempting to further «milk» the basic offering – that would be a suicidal move.

On the other hand, for corporate and institutional users, Skype becomes a more credible, hence attractive solution. It will definitely enjoy reinforced capabilities to develop its products and services. Most notably, Skype must address a perceived lack of security, which led a number of organisations to forbid usage of it on their infrastructures. This issue (largely addressable and mainly perception-related) will be much easier to address as a Microsoft company (or division) and product.

Microsoft will have to define and rapidly communicate on its intentions regarding the combination of Skype technologies with its own IP telephony and communication solutions, but we believe this should not create major complications. It will however be indicative of Microsoft's ability to achieve cross-fertilization across its business units and/or product divisions.

Bottom Line

One could see the Skype acquisition as an opportunistic move; there are, however, very few such opportunities in the market, and it would have been a major error for Microsoft to miss this one.

It is now confronted with the usual difficulties and challenges of any sizeable acquisition, but these challenges are probably more easily addressable than in many comparable operations. The acquisition enables Microsoft to reinforce its products and services portfolio. It will be a key enabler, although not sufficient in itself, of a more successful online services strategy.

Users will benefit from a move that clearly makes Skype a long-term viable solution, and (over time) from integration with other Microsoft products and services.


Wednesday, May 11th 2011
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Duquesne Advisory Ltd is a European firm, headquartered in the UK, dedicated to researching, understanding and advising clients worldwide on opportunities and trends in Information and Communications technology.

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Duquesne Advisory delivers in-depth analyses of Information and Communications Technologies, their implementations and their markets. Research is based on critical observation of the market by the analysts and their on-going contacts with the vendor community, together with hands-on, practical experience in consulting engagements.

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The analysts of Duquesne Advisory leverage the Firm’s ongoing market and technology research to undertake high added value consulting engagements for both ICT users and ICT providers. Focused on client service, their approach is rigorous and methodical, and at the same time pragmatic and operational.