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Net Phone Calls, Free-And Clear

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DQI Bureau
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Eriksen Translations Inc. is a small business with a big footprint. The

Brooklyn company relies on 5,000 freelancers scattered around the world to help

translate business documents into 75 languages for US clients. That means phone

bills of about $1,000 a month. So when business development manager Claudia

Waitman heard about a new company called Skype Technologies that offers free

voice calls over the Internet to other Skype users anywhere in the world, she

jumped. Six months after signing up, Eriksen's phone costs already have fallen

10%. Even better, its employees and freelancers confer more often, allowing them

to work faster and more efficiently. "It has changed the whole way we

work," Waitman says.

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Stories like this are popping up all over these days. More than 12 million

Web surfers have downloaded the free Skype software and registered as users

since the program appeared 14 months ago. The software turns a PC equipped with

a microphone, speakers, and broadband connection into a 21st century telephone.

Placing a call to another Skype user is as easy as clicking on a name in a

pop-up window. Up to five people can pile into a free conference call, and the

sound quality is often better than that of conventional phones. Skype's growth

is accelerating as subscribers urge their friends to come aboard. The number of

new registered users is now 70,000 a day, up from 30,000 in May. "Skype is

leading the charge into Internet telephony," says analyst Katja Ruud of

market researcher Gartner.

Word of Mouth



Skype is the brainchild of two notorious iconoclasts. It was invented by Niklas
Zennström, a 39-year-old Swede, and Janus Friis, a 28-year-old Dane - the

same duo who infuriated the recording industry when they created the popular

KaZaA music-downloading service in 2000. Now they're doing it again.

With operations in London and Tallinn, Estonia, Skype is such a radical

departure from any previous phone company that it threatens the very foundations

of the trillion-dollar-a-year telecom industry. It has no phone lines or pricey

switching equipment of its own, instead using subscribers' PCs and the public

Internet to run its network. And rather than spending millions on marketing, the

70-employee company relies entirely on word-of-mouth. The result is a cost

structure major phone companies can't touch.

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CEO ZENNSTROM “Nobody else has a business model as good as ours”

While many outsiders think of Skype as a gimmicky way to get free calls, the

Scandinavian pair are serious about turning it into a real business. The

strategy: Accumulate as many subscribers as possible and then start selling them

services such as voice mail, call waiting, and follow-me calls. Zennström

compares Skype to Yahoo and Google, which also started out free and now rake in

money by marketing to millions of loyal customers. The company won't say how

much SkypeOut is pulling in, but 230,000 people have signed up, buying a minimum

of 10 euros, or $12.40, in prepaid calling time. That's at least $2.8 million

in revenues.

Next up is a push to attract more corporate customers. On October 6,

Zennström announced plans to roll out services next year aimed at small

businesses, such as larger conference calls, group billing, and software tools

to tie Skype user lists into company phone directories.

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To fuel its ambitions, Skype has raised $20 million in venture funding. Among

its backers: Draper Fisher Jurvetson, the firm that funded the free e-mail

service Hotmail and then sold it to Microsoft Corp. for $395 million. The

explosive success of Hotmail made venture capitalist Timothy C. Draper a

believer in so-called "viral marketing," where word of mouth can turn

startups into major players virtually overnight. He sees the same principle

working for Skype in Net telephony. "There's no question in my mind that

Skype will become a $1 billion company," Draper says.

The impact on the Old Guard could get worse. Gartner figures the number of

minutes of voice calls on conventional fixed-line networks will fall 10% this

year worldwide. The majority of that is due to a shift from fixed to mobile

calls and replacement of dial-up Net connections with broadband. But 15% of the

decline is from calls sent over the Net. All told, London researcher Ovum

forecasts that worldwide local and long-distance revenues will plunge by $15

billion, to $94.4 billion, by 2007. At the same time, revenues from Internet

phone calls will top $8.9 billion.

How Skype

Works

1

Just download a free piece of software and plug a microphone

into a PC, and you can make phone calls over the Net. You can

also send instant messages to other Skype users or connect as

many as five people in an ad hoc conference call.

2

Unlike other voice-over-the-Internet services, Skype uses a

unique “peerto-peer” approach to relay calls securely.

That means no expensive centralized servers or

switches-making Skype's cost of adding new customers

essentially zero.

3

Calls from one Skype user to another are free and unlimited,

just like instant messaging or e-mail. And a new service lets

users make calls to conventional phones for about 2¢ a

minute. Skype is now adding services aimed at businesses.

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To be sure, Skype isn't the only company offering phone calls over the Net.

The first such services emerged a decade ago amidst much hoopla, but they

foundered because the technology was immature. Now, thanks to growing

penetration of broadband connections that boost the quality of Net telephony,

startups such as US-based Vonage Holdings Corp. are signing up hundreds of

thousands of users for so-called Voice-over-Internet Protocol service. Some

telecom giants, such as AT&T and Britain's BT Group PLC, have jumped into

the field. And cable companies such as Comcast are offering VoIP services over

their networks to compete with local phone companies.

What sets Skype apart from rivals is its unique technology. Zennström and

Friis are apostles of so-called peer-to-peer networking, which does away with

expensive centralized computers. Instead, Skype weaves together a distributed

network from millions of connected PCs, radically lowering its costs. In

essence, the company has reduced telephony to a piece of PC software that

operates just like e-mail or chat. That means the network can expand

indefinitely -at almost no cost to Skype. It costs Skype less than 1 cents to

add a new user, vs. hundreds of dollars for a traditional VoIP provider.

Although Zennström won't discuss Skype's profitability, the company's

low costs mean that, with a large enough base of customers, it ought to be able

to make money even if only a small fraction of them pay for extras. The most

compelling question, though, is how quickly Skype's technology and business

model will begin to reshape the rest of the telecom business. It won't happen

overnight, but an inexorable shift away from the old way has already begun. Just

ask the folks at Eriksen Translations.

By Andy Reinhardt in Paris in BusinessWeek. Copyright 2004

by The McGraw-Hill Companies, Inc

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