Skype lands a blow in VoIP battle

I originally wrote this for the Globe and Mail — and Mark even linked to it, which I thought was quite nice of him — but I thought I would reproduce it here for people who might not get to the Globe that often. For you tech-savvy blog readers out there, please ignore the dumbed-down parts designed for non tech-savvy newspaper readers 🙂

The bare-knuckle bout for VoIP supremacy is still in the opening round, but Skype has thrown what could be a haymaker punch. The voice-over-Internet pioneer that eBay acquired from founder Niklas Zennstrom last year for a mind-boggling $2.4-billion (U.S.) – and up to $4.1-billion if Skype meets certain performance targets – is now allowing users to make VoIP calls from their computers to any landline number for free.

The freebie for what the company calls “SkypeOut” calls is only a short-term offer, however. It expires at the end of the year, and is clearly designed to suck new users into the Skype vortex. But is it a smart move by eBay to build a customer base and take on Vonage, or a desperate move to justify that multibillion-dollar cheque it cut?

Skype said in its release that “completely free calling in the U.S. and Canada will expand Skype’s increasing penetration in North America and solidify Skype’s position as the Internet’s voice communication tool of choice.” And there are those who believe it will make the service – which is based on P2P or “peer-to-peer” technology originally developed for the Kazaa file-sharing network – a lot more appealing to non-geeks, since the previous free VoIP service only included PC-to-PC calls.

Phil Wolff of SkypeJournal.com wrote after the announcement was released that “in one stroke [it] simplifies the choice to try Skype. No need to whip out a credit card or think about minutes. Just download and call. No trying to understand SkypeOut rates.” The move will “starve small competitors,” he added, as well as forcing Microsoft, Yahoo, AOL and Google to match the free outbound call offer or fall behind.

The VoIP player it really puts pressure on, however, is Vonage. The company is currently the leader in what some call the “hardware-based” VOIP market, since it sells users a box (and/or a handset) that plugs into their Internet connection, rather than just software that runs on a computer. But selling those products and marketing its service as a replacement for traditional phone service costs a lot of money – much more than Vonage makes by charging for its VoIP service – and so it is currently hemorrhaging cash, even as its costs continue to grow. The company’s marketing costs alone totalled more than $88-million (U.S.) in the first quarter of this year, contributing to a loss of more than $85-million on revenue of $118.9-million.

Skype’s announcement couldn’t come at a worse time for Vonage, since the company is trying to market a public share offering despite its money-losing ways. And yet more than one analyst has noted that the VoIP provider is being squeezed by Skype on the low end with its free services, and the cable companies on the higher end with their all-in-one VoIP services.

Andy Kessler, a former hedge-fund manager who now writes about technology and investing, wrote on Om Malik’s blog that the free SkypeOut announcement was a “classic, high-stakes, Wall Street sucker punch” to Vonage. He described the impetus behind the offer as a case of “why not play with the mouse before you kill it,” and added that eBay must have been thinking: “What better way to do away with the Vonage IPO and raise their cost of capital then/ scare investors even more.” (Telcos are likely feeling just as glum as Vonage, of course, since Skype continues to push the cost of phone calls down closer and closer to zero).

Over the past year, while Vonage’s customer base has grown, the cable companies have grown faster in terms of VoIP adoption, to the point where some are wondering whether Vonage is likely to become the TiVo of VoIP – a pioneer that winds up struggling to turn itself into a lasting business. As of February, surveys from both UBS and TeleGeography showed that cable providers had taken more than 52 per cent of the voice-over-Internet market, while independents including Vonage only had about 37 per cent. Vonage was still the largest single provider, with 1.2 million customers, but Time Warner was close behind.

eBay, meanwhile, is obviously trying to boost market penetration for Skype to the point where it becomes the de facto standard for free or low-cost VoIP. The company has been adding services to keep its product the leader as AOL and Google add voice-calling features to their instant messenger offerings. It has also been doing deals with hardware companies to sell Skype-branded handsets such as the Netgear-Skype Wi-Fi phone, a cellphone-like device that allows users to make Skype calls from any wireless hotspot or Wi-Fi network.

Skype’s news may be bad for Vonage, but it has its own battle to fight against Microsoft, AOL and Google, not to mention the cable companies, all of whom have very deep pockets. Call this the first punch in what could be a long slugfest over the VoIP market. The good part for consumers, of course, is that it means using the telephone continues to get cheaper.

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