Why eBay Is Buying Skype

Rob Hof

Here's my quick take, below, an edited version of which will appear in a few hours at businessweek.com. CEO Meg Whitman & Co. gave an impassioned rationale for the deal. I can certainly see that if Skype meets its ambitious goals, the deal could pay off eventually. It's also a heckuva lot of money for a nascent business, no matter what the growth and the promise--and one in an entirely new area in which eBay has no experience. No matter how you look at it, it's a whale of a bet.

UPDATE: Ross Mayfield has a good reminder that markets are conversations, as the Cluetrain Manifesto made clear years ago now. I'm still not sure that's enough to make the deal pencil out without a lot of luck, but it's certainly true that eBay was built on the notion of keeping the lines of communication open. If Skype can put that dynamic into overdrive, it'll be worth it--at some point.

UPDATE II: John Hagel has an interesting analysis, asking why eBay couldn't have gotten the same benefits much more cheaply and wonder if eBay management might be leaning on their sizable market cap a little too much. Not sure about the latter, since eBay has been pretty disciplined in the past, but most of the questions ultimately get down to that multibillion-dollar pricetag. At a much lower price, it's easy to see why eBay would take a flyer. For up to $4.1 billion, there are a lot of expectations to fulfill.

With today’s $2.6 billion purchase of Internet phone service Skype International S.A., eBay Inc. is making its boldest bid yet to remain the most potent force in e-commerce. The online marketplace, dogged by concerns about slowing growth in its core U.S. market, said Skype will help it not only recharge existing and new businesses within eBay, but help it ride an entirely new online communications business. “Together, we can pursue some very significant growth opportunities,” eBay Chief Executive Margaret C. Whitman said in an early-morning conference call. “We can create an unparalleled e-commerce engine.”

It’s a marked departure for eBay, which to date has acquired only companies directly related to e-commerce. Whitman specifically denied that eBay is trying to become a broader Internet portal, like Yahoo! Inc. and Google Inc. But it’s clear that eBay views Skype, whose software lets people use their personal computers to make calls over the Internet, as a potential blockbuster business in itself.

As such, the Skype purchase expands eBay’s manifest destiny well beyond its roots as an online marketplace. Scot Wingo, CEO of ChannelAdvisor, which helps merchants sell on the major shopping venues from eBay and Amazon.com to Yahoo and Google, sees eBay trying to keep up with its more diversified rivals. “They’re all battling for the hearts and minds of Internet consumers,” he says.

Whitman did acknowledge that eBay’s buying a company to capitalize on an entirely new kind of business—in this case, communications. Indeed, Rajiv Dutta, eBay’s chief financial officer, said the company justified the pricey acquisition largely on Skype’s existing businesses. Those include services that give people the ability to call landline phones for about 3 cents a minute, voicemail, and providing a traditional phone number for Skype accounts.

That business is unprofitable and still a tiny fraction of eBay’s expected $4.4 billion in sales this year. Moreover, it faces new competitors such as Google, Yahoo!, and a raft of startups. But Skype is growing fast. It revealed that its revenue this year is expected to reach $60 million, up from $7 million last year. And eBay forecast that revenues could reach $200 million next year and that Skype would turn profitable at the end of 2006.

Still, eBay believes Skype also could help eBay accelerate its business just as the 2002 purchase of the online payment service PayPal did. The key appeal for eBay at the outset: the ability to offer its buyers and sellers an entirely new way for people to do business online: lead generation, or pay per call. In addition to paying eBay listing and completed-auction fees, sellers also could pay eBay a fee for getting an Internet call, or lead, via Skype.

It’s akin to how sellers pay Google for leads via paid ads in search results, except buyers would be calling—via their PCs--instead of clicking. Lead generation, Whitman said, holds the potential to accelerate some of eBay’s existing categories, such as used cars, business and industrial gear, and high-end collectibles—which together account for 40% of gross revenues worldwide. “A number of sellers do put phone numbers in their listings, such as in real estate, so there’s some apparent demand for this,” said Wingo.

eBay also will try to use Skype to expand its moves into new markets, such as new cars, travel, real estate, and personal and business services. Those markets already are accustomed to both paying for leads and talking directly to customers throughout the purchase process, Whitman noted. Indeed, Whitman said this new business model would be ideal for some of eBay’s new forays, such as its Kijiji international classified-ad site and its recent purchase of the shopping comparison site Shopping.com, which makes money from Google-style referrals.

That’s a particular advantage, Whitman said, in international markets such as China, Eastern Europe, and Brazil, where online trust isn’t as well-established and where haggling may be more of a cultural force. Indeed, Skype’s especially strong internationally, particularly in areas eBay has not yet penetrated to a great degree: Eastern Europe, the Nordic countries, and Asia, especially China and Japan.

For all that, buying Skype is a gutsy move for a company that for most of its 10-year history has stuck to its e-commerce knitting--even as other Internet leaders from Yahoo! to Google continue to expand their reach. Although Whitman took pains to draw parallels between the Skype acquisition and eBay’s purchase of PayPal, buying Skype is clearly a big departure from eBay’s previous expansions, all related to e-commerce in one way or another.

Even more challenging, eBay’s venturing into territory without the overt request or blessing of its buyers and sellers. Traditionally, they’ve guided eBay into new markets through their activities—such as embracing PayPal years before eBay bought it—or requesting new features. When eBay has gone off on its own, such as doing a deal with Christy’s for live auctions, its efforts have fallen flat.

In Skype’s case, it’s unclear whether the bulk of eBay’s sellers—small to medium-sized businesses drawn to the marketplace by the low cost of selling there—will be interested in voice services Skype might offer. Wingo, for one, talked to 50 top sellers and found little support from them. “They’re saying, ‘I can barely keep up with emails. I can’t afford to hire someone to take calls.’ I don’t think your average DVD seller will be too thrilled.” One top eBay seller, Jay Senese, last week told BusinessWeek that he couldn’t imagine any reason to use voice services.

Skype also would be eBay’s biggest acquisition yet, and could grow larger yet. Besides paying $1.3 billion in cash and $1.3 billion in stock, eBay’s on the hook to pay $1.5 billion more by 2009 if Skype meets aggressive growth and profit goals. Even the prospect of a rumored $3 billion price last week knocked its stock down nearly 5%, though it was up a fraction of 1% this morning.

For its part, Skype painted eBay as the ideal partner to help it fulfill its vision of becoming the prime communications power on the Net. CEO Niklas Zennstrom and cofounder Janus Friis will join the eBay executive team, and Skype’s results will continue to be broken out from eBay’s. “We can’t think of a more powerful platform to extend our vision,” Zennstrom said on the conference call.

eBay and Skype do share some similarities despite inhabiting entirely different markets. Mainly, they both share the coveted quality of becoming more valuable the more members they have. Indeed, along with PayPal, which had the same characteristics, this would be eBay’s third business that has grown from these so-called network effects. “eBay recognizes the value of network effects more than any of the other players,” says Legg Mason Wood Walker Inc. analyst Scott Devitt.

The big question remains whether eBay has overpaid for a business that’s unprofitable, beset by lots of competition, and unrelated to its core business. Whitman noted in the conference call that “our overarching goal is to grow faster than e-commerce” overall. Investors will have to decide in coming months and years whether she overreached in the pursuit of growth.

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