Disruptive innovations—the simple, cheap, accessible solutions that create new markets and transform existing ones—make attractive acquisition targets. eBay's struggles to make its acquisition of Skype work, however, show how moving quickly is a critical component of making disruptive acquisitions work.
When eBay plunked down $2.6 billion for Skype in 2005, fans of disruptive innovation cheered. Indeed, in a 2005 analysis titled "Let Disruption Ring," we here at Innosight hailed the acquisition, praising the fundamental disruptive potential of Skype's free Internet-based telephony solution, how eBay users could flock to using Skype instead of email to communicate and the potential for eBay to use Skype to move into new businesses like lead generation.
We did raise one cautionary note: With a $2.6 billion tag, eBay was paying a pretty penny for Skype's disruptive potential. As we wrote: "eBay's acquisition might have been even sweeter if it had acted last year when Skype's price presumably would have been sharply lower."
In early October, eBay announced it was taking a $1.4 billion charge related to the acquisition. About $500 million of the charge was a payment to some of Skype's shareholders and management team, including founder and CEO Niklas Zennstrom. Zennstrom stepped down as CEO but plans to remain involved as Skype's executive chairman.
The other $900 million was an "impairment charge"—eBay admitting it simply paid too much for Skype. Even Zennstrom admitted that eBay might have "overshot in terms of monetization" for his company.
The write-down didn't affect eBay's stock—most analysts had already assumed the acquisition was overpriced—but analysts used the news as opportunity to castigate eBay's failure to find new growth as its core auction model slows. eBay has gone from one of the leading lights of the technology industry to a seemingly mature business whose stock has been essentially flat for the past four years.
Skype has had some successes over the past 24 months. Analysts estimate that Skype's revenues have grown from about $60 million in 2005 to somewhere north of $300 million this year. Skype has more than 200 million registered users (although analysts estimate only about 50 million users actually use Skype). Despite the positive developments, Skype's performance hasn't been enough to justify eBay's price tag.
What went wrong? Three of the assumptions we made when praising the acquisition don't seem to have panned out:
1. Skype has not created as compelling a standalone business model as eBay had hoped. While users around the world continue to revel in Skype's simple, cheap, convenient service, the company hasn't yet figured out a breakthrough business model to monetize that user interest. Skype calls between computers are free, meaning the majority of Skype's revenues come from charging users modest fees to call landline phones, a relatively low margin offering.
2. eBay's users were largely satisfied with the ability to communicate via email. When eBay purchased payments provider PayPal for $1.5 billion in 2002, it was the de facto payment mechanism for eBay purchases. eBay users didn't seem to migrate en masse from email to Skype.
3. eBay has been unable to move into lead generation. Two years ago one rationale for the merger was the ability for eBay to use Skype to help broker connections between consumers and local service providers, such as handymen or plumbers. Emerging providers like Angie's List and ServiceMagic have begun to generate traction in this space, but eBay has made no obvious headway.
It is possible these assumptions were just wrong. Not every acquisition or innovation turns out to be successful. While PayPal and eBay's recent $310 million purchase of ticket broker StubHub seem to be successes, by all accounts Skype looks like a disappointment.
Generally speaking, companies seeking to acquire disruptive businesses need to strike before the market recognizes the disruptive potential. Once the potential is widely acknowledged, price tags can quickly soar.
Who are some companies that got it right? Consider Cisco's 2003 purchase of home networking provider Linksys for $500 million, News Corp's 2005 purchase of the parent of social networking powerhouse MySpace for $580 million, and CVS's 2006 purchase of MinuteClinic, whose nurse practitioner based diagnostic kiosks are disrupting health care, for $175 million.
Note that these purchase prices are substantially smaller than the mega-deals that so frequently land on the front page of the Wall Street Journal. In the early days of a disruptive innovator's journey, the market is likely to undervalue its potential. Companies that develop the ability to recognize disruptors before market data makes the potential obvious can snatch emerging giants at very reasonable price points.
Returning to Skype, a final possibility is that eBay didn't put the right management team in place to realize the full value of the company. Zennstrom is a restless explorer, who also pioneered music sharing site KaZaA and emerging video provider Joost. Many times exploiting an opportunity requires a team that has different skills from the team that created the opportunity.
Don't close the door on Skype just yet. Many disruptive businesses take several iterations before they discover a compelling business model. If eBay allows Skype to continue to iterate and experiment, that winning business model—think social networking, advertising, or something that no one has yet dreamed of—just might emerge.