Skype: The ultimate network business

Skype is the largest VoIP service in the world. Its success has been driven largely by the fact that its user base effectively grows itself. The sheer size of this network provides ample opportunity for value capture.

Skype has been around for just over 12 years and is the largest voice over IP (VoIP) service in the world. Skype has been a boon for users the world over who use the service to communicate with friends, family and colleagues via voice, video and instant messaging over the Internet. With a user base of over 300 million users that continues to grow, Skype has definitely taken full advantage of direct network effects to create and capture value.

How does Skype create value through network effects?

It’s simple: free Skype voice calls, video calls, group calls, instant messaging and screen sharing! This value proposition allows Skype to effectively sell itself and grow its network organically. Why pay to make a phone call when you can download the Skype application and have the same functionality, for free?! Each Skype user benefits from each additional contact they have on Skype because the alternative is a phone call that they have to pay for.

Skype’s video capabilities create additional value in circumstances where an in-person meeting may be too expensive or inconvenient, but a voice call is not quite sufficient. Skype has managed to become the medium of choice for video calls in various situations. For instance, Skype has allowed viewers to call-in to their favorite TV shows and to appear on screen, allowing for a more interactive experience all around. Oprah was famously a huge proponent of using Skype to connect with her viewers on her talkshow. News networks such as CNN are able to receive receive reports or have live commentary from field reporters or experts via Skype. Even HBS uses Skype to interview potential admits who are unable to attend an interview in person.

In addition, Skype allows users to purchase “Skype Credit”, which they can use to make low cost calls to landlines and mobiles. These calls are considerably cheaper than making actual phone calls, especially international calls. I distinctly remember my first visit to the US. I had arranged to stay with a friend and we had agreed that I would call her on my arrival so that she could meet me at her apartment. However, on arrival at JFK airport I discovered that my international roaming was not working. My solution was to connect to the airport’s wifi and to call my friend using my Skype Credit. The call cost me less than a dollar, which was considerably less than what a call at international rates would have eventually cost me. Value creation? Absolutely!

How does Skype capture value through network effects?

Skype makes money from charging small fees for their services. For instance, even with the really low rates for paid calls made using Skype Credit ($0.023/minute for a domestic call in the US + a $0.049 connection fee), Skype makes money from each call. Skype also makes money from subscription services, where users can purchase 1, 3 and 12 month calling plans that allow users to make unlimited calls to selected countries. Other services include allowing users to purchase a Skype Number that allows them to receive phone calls via their Skype account, and Skype WiFi which allows users to connect to the internet from a public hotspot using Skype Credit.

What is unclear is whether the revenues generated from Skype’s services are particularly lucrative. Microsoft acquired Skype in 2011 for $8.5 billion and since then, there has been no breakdown of the revenues derived from Skype. Nonetheless, Skype’s network of users allow the company to capture value from the increasing user base that take advantage of additional services.

But what about competition?

Skype faces competition from the likes of Apple’s FaceTime application and Google Hangouts. One of the drawbacks of FaceTime is that it requires both users to be using Apple devices. While this is a great way for Apple to continue to lock users into the Apple ecosystem, it plays to Skype’s advantage in that Skype is platform-agnostic. Users can download Skype onto all major operating systems, on mobile devices, laptops and PCs.

Google Hangouts is perhaps a more viable competitor. Similar to Skype, Google Hangouts is free and is also platform agnostic. In addition, Google Hangouts takes advantage of Google’s readily available network of Google account holders thus providing an established user base. However, the requirement that Google Hangouts users have a Google account also hinders the strength of the network effects required to grow Google Hangouts into a veritable competitor to Skype.

What’s next?

Skype is in a significantly strong position given the size and strength of its user base. However, the company needs to be wary of the increasing number of players on the market that also offer free voice and video calls, instant messaging and screen sharing. As Skype’s product becomes less differentiated from other product offerings, the question is whether the strength of its network effects will continue to sustain the company?




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Student comments on Skype: The ultimate network business

  1. I’m a big fan of Skype because it allows me to keep in touch with my family in Germany. As you describe, the direct network effects are obvious, what’s interesting though is that I don’t care about the total number of users overall but specifically about the number of users in my own personal network (just like we saw in the Facebook case). I wonder if Skype also benefits from indirect network effects – I can’t think of any obvious stakeholders that would fit the “merchant” bucket in the diagram we’ve been using in class. Thanks for the post!!

    1. Thanks for your reply. I agree that for most individual users, what matters more are the users in your own network. I think that this is the initial pool. However, the applications can grow from there right? I conducted 3 interviews for my summer internship via Skype. I also did my HBS interview via Skype. Those aren’t users in my personal network per se, but certainly Skype then becomes an enabler for all kinds of other interactions with mere acquaintances.

      You bring up an interesting point on indirect network effects. I also can’t think of other obvious stakeholders in this case in order to assess value derived from indirect network effects, but certainly it would be interesting to explore.

  2. Thank you for you post. In my opinion, Skype has network effects without login-effect which might be its downfall. I love Skype and used it regularly but since Facebook/Whatsapp introduce it´s “VoIP-call” function my usage declined rapidly. The low switching costs to another VoIP provider enables Facebook to leverage its existing network, add a new application and might take over market dominance soon – everyone of my friends is on Facebook but only a small percentage of them is on Skype (or I added only a small percentage).
    When switching costs are low you might have to compete with quality – but can Skype provide a better experience/connection quality or scale than Facebook and its messaging app everyone has on his phone ? I doubt it and I think that Skype will face hard times in the future.

  3. I like Skype and use it frequently. After spending the summer with Microsoft I am certain they have the ability to technologically improve it to lead in ability, call and video quality and connectivity.
    Again, having the larger audience creates a critical mass and draws the attention of Microsoft for product development and monetization options.

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