Microsoft Buys Skype $8.5 billion

Microsoft purchase of Skype a good thing? Who will benefit the most?
 Skype is particularly important for migrant workers communicating with their family in their homeland

Skype shares many of the basic defining elements of social media: namely, it is an online platform that allows people to communicate in a new way that costs less than previous communication channels. It is also a useful illustration of the business dynamics behind social media, especially following Microsoft's acquisition of the video and voice chat service for $8.5 billion, announced on Tuesday.

Initial reactions to the purchase were varied, with some analysts pointing to the potential for integration with the Xbox network and Microsoft Windows 8, while critics said it was a rearguard action, merely intended to keep Skype out of the hands of competitors like Google and Facebook. Meanwhile Skype CEO Tom Bates touted the potential of advertising, focusing on video ads: "We think advertising is a very powerful monetization stream for us, if you think about the size of our user base." And Skype's user base is admittedly impressive -- but it won't translate automatically into advertising revenues.

Like other social media, Skype has enjoyed rapid growth over the last five years, with the number of registered users jumping from 75 million in 2005 to 663 million in 2010, while the number of active monthly users jumped from 15 million to 170 million. Over the same period, the total number of minutes spent in online voice and video chats on Skype soared from around 12 billion in 2005 to 207 billion in 2010, and total revenues increased from $60 million to $860 million -- but ads were nowhere to be seen, until March of this year.
Skype's revenues (up until now, at least) have been based entirely on people paying subscriptions for certain premium services, including calls to non-Skype phones and unlimited international calling. In other words, it is an enormously successful social media service that had never employed advertising as part of its business model until very recently (March of this year). Moreover, the vast majority of Skype's users haven't contributed to revenues: the total number of paying subscribers in 2010 was 8.8 million, paying an average subscription fee of $8.14 per month.

This relatively small group of paying subscribers has carried Skype financially, in effect subsidizing free access for hundreds of millions of non-payers. In this context, it's not surprising that Skype (and now Microsoft) would like to squeeze some revenue out of the great, unmonetized masses with online video advertising, following the introduction of display ads two months ago -- but judging by the record of other social media, it will be an uphill battle.

For example, Facebook -- the largest social network in existence -- is still struggling to make online advertising "work." Facebook delivered just over one trillion display ads in 2010, collecting total ad revenue of $1.21 billion, or 13.6% of total display ad revenues, according to figures from comScore and eMarketer. In 2010 some estimates put Facebook's average CPM as low as $0.56. Meanwhile click-through rates for Facebook ads declined from about 0.06% in 2009 to about 0.05% in 2010, according to Webtrends. Simply put, despite its impressive reach Facebook still doesn't seem to be a particularly effective display advertising medium.

Or consider YouTube, which may be a better comparison for Skype because it is a video-based platform. According to Citi Investment Research analyst Mark Mahaney, YouTube's total net ad revenues, after revenue shared with publishers was deducted, came to $544 million in 2010, with an average CPM of about $1.02. Click-through rates, while higher than the industry average for display, are still less than 1% for pre-roll and overlay ads, according to recent figures from the U.K. IAB. And since both of these formats would probably be considered intrusive by Skype users, the company may look to alternatives like video banner ads, where click-through rates tend to be even lower.

 Moreover the issues facing YouTube will be even more challenging for Skype, considering that video chat is more of a "lean forward" activity for which users will consider any advertising (pre-roll, overlay, static banner, video banner, etc.) an unwelcome distraction. If someone is anticipating a video chat they are probably even less likely to click on ads that will interrupt the chat experience.