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Phone Service the "Zero Cost" Way

Niklas Zennstrom is a big believer in the power of peer-to-peer networks. The creator of the KaZaA file-swapping software that became the bane of the music industry, Zennstrom is now trying to apply P2P principles to voice communications. In August, Zennstrom and KaZaA co-founder Janus Friis released Skype, a P2P voice program that to date has logged 5.2 million downloads. While it remains a gnat on the back of the $200 billion global telecom industry, Skype provides a model of how P2P software could replace the expensive and cumbersome infrastructure of public phone networks.

BusinessWeek Online Technology Editor Alex Salkever interviewed Zennstrom on Jan. 5 to get his view of where the voice-over-Internet-protocol (VoIP) movement is headed and where Skype fits in. Following are edited excerpts from that conversation:

Q: Do you see applications like Skype ever replacing the legacy phone networks?

A: That network is based on a 100-year-old technology. We see now that the Internet is a much more efficient infrastructure for any kind of communications, be it voice, text, video, or whatever. Our vision is that at some point in the future, the Internet will be the primary communications infrastructure and that all applications will run over the Internet.

That will take a very long time to happen. But we think the most efficient way to accomplish this is to have software at the end points [on desktops] and to run communication via peer-to-peer networks. That's our vision. I don't think it will completely replace the public telephone network, but certainly at some point the Internet will carry the majority of communication, and that will happen using Skype-like software.

Q: Why would a model like yours work as opposed to a more evolutionary model like that of Vonage [an Edison (N.J.) startup that offers VoIP using standard phones]?

A: They're using your broadband connection to replace the last mile, and they're offering a calling plan that may be a little bit more attractive than the local phone company's. But it's still a similar product, and they're using the PSTN (public switched telephone network).

We think it's much more efficient to use the Internet to make calls between two Internet end points. Instead of using the PSTN to route the calls, you can use simple software like Skype to make those calls over the Internet. And that's the most cost-effective way to do this. That's why we can offer this free of charge.

Q: But you do need to make money. When do you plan to become profitable?

A: If you look at a business model of a phone company or even Vonage, they're spending a lot of their money on marketing. I worked for eight years for a telecom company and have worked for a joint venture between AT&T (T) and four other European telephone companies.

What I learned from that is when you're a phone company, you have marketing and customer-acquisition costs. When you have a customer, you have an operational cost of running the network. Then you have a cost for billing systems. That's an operator business model.

The business model of Skype is completely different. Skype has a software business model. We don't have any distribution or marketing costs for each user -- our software is spread virally. And when we have a new user, we have zero cost for serving that user because they're using P2P software and their own bandwidth. So we have zero costs of getting new users and zero costs of running traffic. Our costs are only business development and software development.

We could minimize our development and show a profit very quickly if we wanted to by adding some premium services, which we plan to do in the next few months. We could also focus on making the software better. That's what we're doing now. We're increasing software development, and we're going to try to spend more money to reach new users. So our focus is not to reach profitability in a short time frame. But if we wanted to, it would be quite easy to do that.

Q: When I talked to Jeff Pulver of Free World Dialup, he had mentioned that Skype is in conversations with other VoIP providers about interoperability.

A: We are looking at interoperability. We think ultimately it may be important to have connections between different providers of Internet telephony for the network effects. But there's nothing imminent in that area. We're also looking at working with ISPs for them to promote Skype to their customers.

The biggest hurdle for people who want to use Skype right now is that they don't have microphones, headsets, and USB telephones. We're talking to manufacturers right now in hopes of making it easier for people to get them.

Q: Would you consider interoperability with the PSTN?

A: Absolutely. Our vision with Skype is that ultimately people will be using the Internet to make calls to other Internet end points, but it will still be useful for people to make calls to the PSTN network.

Q: Once you head in the direction of offering features such as voice mail or conference calls, won't you also have to pay the costs of management and billing for those premium services?

A: Most of these things are software-based features. If you think of buying antivirus software or something like that, it's a very simple billing system. You pay a subscription. That's a lot simpler than billing on a monthly basis or a per-minute basis, as most telecoms do now. You don't need complicated systems to manage this. So we don't anticipate facing the same operational costs.

Q: Could Skype become a landline replacement?

A: Right now, we don't see it as that. We see it as an add-on rather than a replacement. We think it's an additional technology option but not the main voice line.

E-mail hasn't replaced fax. It has become a complementary service. Having said that, I think that there will be a shift where people will be conducting more and more of their communications over software such as Skype and using the old phone network only when the other party doesn't have Skype or a similar type of IP voice communication. Just like the shift from fax to e-mail, it will take several years to happen.

Q: Do you plan to offer an 911 service on Skype?

A: No, and we don't think we need to, since we don't expect to replace landlines for the foreseeable future.

Q: Is there any chance that the ISPs will start blocking software-telephony applications?

A: I don't think so. They aren't restricting other Web-based services, and those are the same thing. If you start to restrict what people can do, then you're going to lose subscribers as long as there's competition. In fact, we talk to many ISPs, and they want to promote Skype.

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