Online Extra: Skype Is "What Evolution Is All About"

Co-founder Niklas Zennström explains the technology behind peer-to-peer networks and their market implications

Swedish entrepreneur Niklas Zennström achieved notoriety in 2000 when he and his Danish buddy Jonas Friis launched an Internet file-sharing service called KaZaA that quickly overtook Napster as the leading venue for swapping music files. They eventually sold KaZaA to Sharman Networks and went underground to fight off lawsuits by the recording industry.

But in 2003, Zennström and Friis reemerged with another radical concept: Free phone calls over the Internet using the same peer-to-peer networking technology that KaZaA employed.

The telecom industry has been no more welcoming of the incursion, but the duo's new venture, called Skype (as in "hype") has struck a cord with the digital set. More than 28 million copies of the software that powers Skype on PCs, Macs, Pocket PCs, and Linux machines have been downloaded in the last 14 months -- making it the fastest-growing Internet application in history. Nearly 13 million people have registered to use the service.

On Oct. 20, Skype announced two new milestones: More than 2 billion minutes of talk time have been logged on Skype since it went live in late August, 2003. And for the first time ever that week, it handled more than a million simultaneous conversations.

Zennström spoke by phone (on a conventional line) in July with BusinessWeek's Paris-based European technology correspondent, Andy Reinhardt about peer-to-peer networks, telecom regulation, and European innovation. Here are excerpts from their conversation:

Q: A lot of people think peer-to-peer (P2P) is about illegal trading of copyrighted materials. But clearly, you've seen another opportunity with Skype. What is the potential of P2P?

A:

It may be a bit boring, but peer-to-peer is just a term for a computer network architecture. Either you have peer-to-peer or client/server. What happened was that file sharing was the first consumer media application that took advantage of large-scale peer-to-peer technology. If you asked any computer scientist, he would tell you that they were doing peer-to-peer networks 20 years ago. Basically, you're just connecting two computers.

Peer-to-peer has nothing to do with copyrighted songs, or MP3s, or MPEG. It's just an architecture -- and it's the best architecture, in my mind -- for widespread networking, where you can locate addresses and transfer large amounts of data. It's very generic.

What that means is you can find a file, a document, a music file, a movie, whatever, and then download it. With voice, you're doing exactly the same thing: You're locating an individual, and then you're transferring is a stream of data, which happens to be voice communication.

That's why the same underlying peer-to-peer architecture can be used for both of these things. Obviously, it could be used for a whole lot of other things, too.

Q: I guess P2P has the potential to make a lot of new things possible?

A:

Precisely. It opens up the door to a whole range of opportunities that we could never do before. It has very interesting economical implications. A peer-to-peer architecture affords zero marginal cost to transfer large amounts of data. It's more interesting now than it was 10 years ago because now we have a worldwide broadband Internet infrastructure, which basically is a pure pipe.

But there are still huge problems with the Internet. You can't just address people easily by IP [Internet protocol] addresses because they're behind firewalls. So you need to have some kind of smart mechanism to search for and locate people, in order to send them data. That's what KaZaA used to locate files, and now Skype uses it for people.

Q: Where else could this go, beyond files and people?

A:

It could be other resources -- you know, storage, video streams. But this really works on two levels. First there's the peer network, and I've been stressing that because it's the enabler for everything. But then there are the applications. We could not have foreseen -- wow! -- all the things that could be developed on top of P2P.

For instance, when we first used peer-to-peer technology, we didn't foresee that we could do voice. It became obvious to us after some time, but when we started we didn't know what the applications would be. But when we applied the technology to various industries, we realized we could create a sustainable competitive advantage.

That's because, in the normal system you have a marginal cost for every unit you add. If your network is client/server-based, you have to add a new network card for each new Web server, central switch, and so on. But in a peer-to-peer network, you're reusing the system resources in the network, so the marginal cost of producing a phone call or a file transfer or something else is zero.

That's why it's a great enabler, because now we can have free voice communication. It's possible because the world has already made investment in the broadband Internet, and consumers are paying for broadband connections. This allows them to take more advantage of the investment they've made.

Q: Are the opportunities to pursue your vision greater in Europe than in the U.S. because of potential legislative or regulatory issues there?

A:

I don't think there's any regulator who would even dream about regulating peer-to-peer, per se. That would be devastating for the evolution of technology. But they might try to regulate applications of it, like file sharing or telecommunications.

Q: But even though the underlying technology is unregulated, there seems to be a backlash against stuff happening at the application level when the implications of P2P begin to hit various industries. They circle the wagons.

A:

This is nothing more than a technological evolution. Maybe it's a disruptive technology, which means the evolution takes a leapfrog. But that means you can do something better than you could before because you do it completely differently. That's what evolution is all about.

If you try to kill these kinds of breakthroughs with regulation, you're going to set back technological evolution and set back society. Especially when it comes to communication, which is what this is all about. Communication is the infrastructure that makes economies stronger. You're not doing your country a favor by trying to regulate this. These technologies are having an impact on legacy industries, like telecom or media distribution.

And whenever there's disruptive technology, the default reaction among the incumbents in an industry is fear and trying to stop it, rather than embracing it and working with it. They try to lobby and legislate against it.

Q: Is there any difference, as far as you tell, in how far those efforts are getting in the U.S. vs. in Europe?

A:

In Europe telecom regulators are pretty much saying the same thing, which is that they want to have a hands-off approach and don't think it should be regulated. But other voices want to apply regulations. They're saying this is a technology that allows people to talk to each other, and since we have existing regulations for the telephony network, let's apply them to this completely different technology because people can talk with it. That's not a good thing to do.

There are reasons why we have regulation, and one is that telecom is an industry that was historically heavily monopolized but has recently been opened up to more competition. The former monopolies had an unfair advantage because they had the network and all the customers. So you needed the regulators to open up the network and allow competitors to tap into it on a fair basis. But obviously, voice-over- IP [VOIP] -- or any of these new technologies -- aren't monopolies.

The telephony industry is subject to regulations about emergency calls. There are some people who say that, if you're using an application over the Internet that's for voice communication, it should be subject to the same requirement to provide emergency service.

But that's a bit narrow-minded. Nowadays, people communicate in so many different ways. Why not make sure that emergency centers can accept communications from a variety of different sources, so that you could send a text message instead of making a phone call? If there's a burglar in my house, I don't want to pick up the phone: I want to send a text message because it's quiet.

Q: What it is about the Internet, technologically or culturally, that has made possible the emergence of technologies as disruptive as VOIP?

A:

The Internet is simply a network built to take a packet of data from one place to another. There are no services on the Internet itself: It's just a carrier of data. And it's completely open, which means you're allowing anyone in the world to innovate new services and applications. There are no barriers, because you don't have to manufacture big machines or switches. And you can innovate anywhere in the world -- in India, Estonia, the U.S., or France -- and you just upload the application to a Web server, and it's available worldwide. It's the perfect open and free market, without trade barriers.

The great thing about the Internet is that it allows for open innovation. The speed of innovation is growing exponentially. What we've seen in the last five years is the same level of innovation we saw in maybe 20 to 50 years before that. It's possible because of the aggregation of technology and interconnected networks. So, the Internet is, in some senses, the fundamental infrastructure for speeding innovation.

Q: What about innovation in Europe? There's a huge amount of technical talent here, and Europe has produced lots of world-changing inventions. But there are negatives: The level of financial support for R&D by governments and corporations is low. So what are the advantages and disadvantages for you of being based in Europe?

A:

The advantage of being in Europe is that you're in neither of the huge markets. You're not in the U.S., which is very large and homogeneous. It's such a big market. If you make it in Sweden, that doesn't mean you'll make it in France. They have very different cultures and languages, and different ways of selling things. Europe is very fragmented. It's a fiction that the European Union has created a single market.

Q: That affects entrepreneurs in good ways and bad. It means they have small domestic markets, but they also have to learn how to be global sooner than American companies, which can grow up completely in a single domestic market.

A:

Take somebody like me, from a small country like Sweden with 9.5 million inhabitants. It could be an interesting market for some kinds of businesses, but not for the kind I'm doing. So you're forced to look outside your home country. People learn foreign languages early and know they have to do business elsewhere. There are a lot of very successful Swedish multinationals that have figured that out, like Ikea, H&M, Volvo, Ericsson.

American companies don't have to look outside. That's the advantage of Europe -- most of all for people in the smaller countries like Sweden or the Netherlands.

The disadvantage is that the environment in Europe is very bad for entrepreneurs to create businesses. There's too much regulation, too many taxes. And I think people in Europe are far less entrepreneurial than people in the U.S. or China.

Q: People say that the nature of innovation itself is changing, especially for big corporations. Things are getting so complex and expensive that many companies can't afford to go it alone. Could this prove to be an asset for Europe, given its long experience in collaborative ventures?

A:

The world is getting more complex, and with the speed of innovation you cannot do everything. In the old days, when we had poorer communication and access to information, big corporations had advantages because they could do everything in-house. Now, it's so easy to get information that you don't need to be big anymore. You could even say that today, being big is a disadvantage. It's no longer the big that beat the small. It's the fast that beat the slow. And big companies tend to be slower.

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