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Microsoft Skype: How the VCs won and Ballmer overpaid

Is Skype his next aQuantive?

We own a verb!

This could change. Microsoft is renowned for its corporate reorganizations, and its current corporate structure is in a state of flux as two longstanding product groups have been broken up and not reformed. Skype could get shuffled into another unit in a future reorg with Bates losing his direct line to Ballmer and reporting to another Microsoft president with different objectives – such as selling more copies of Windows.

What does Microsoft get for Skype? This is Ballmer's third ballsy deal in the last few years in markets where his company is either struggling to catch Google or Apple, or just trying to make a buck – as in online ads. Ballmer effectively bought Nokia when the cell phone giant committed to Windows Phone 7 on its handsets and killing Symbian. Before that, Ballmer convinced Yahoo! CEO Carol Bartz to let Microsoft run her advertising and search by inserting Bing and swapping out the platform Jerry Yang built before her.

With Skype there were no clever deals, and Ballmer has actually had to dip deep into Microsoft's $48bn in cash and sign the biggest deal in Microsoft's 30-odd-year history. The price is a crazy overvaluation for a company priced at $2.7bn by the Valley VCs who spent $1.9bn for just a stake in the company, was thought headed for a $1bn IPO, and made $860m in revenue for 2010, according to Microsoft.

As ever with Web 2.0 deals, the value is the brand and future opportunity. Microsoft is buying a verb – something it's coveted since waking up to Google and creating Bing – and a claimed 40 per cent growth in customers year-on-year and 20 per cent growth in revenue.

Those number say enough: 40 per cent customer growth and 20 per cent revenue growth means only half of new users are paying for Skype. Eighty-six percent of any money Skype is actually making comes from the SkypeOut service for calls and video conferences from phones and devices to others not running Skype on their clients.

Ballmer and Bates on Tuesday talked of integrating Skype with Kinect for touch-free video conferencing on the TV in your living room for a few hundred dolars. There's also opportunity for integrating the Skype API with Xbox and Xbox Live for player-to-player calls.

But we can file those under "interesting futures". The moneymen will want something more tangible and less crystal ball–like. There are two possible reasons Ballmer agreed to make his investors faces turn white by spending $8.5bn to buy a tiny company that eBay couldn't make work. One is ads. After the users, selling more ads is the mantra, the ying and yang, the north, east, south and west of any Web 2.0 acquisition, start-up, or business strategy.

Under Microsoft, you can look forward to an acceleration of the work now going on inside Skype to serve more ads to the freeloading Skyping millions in an attempt to claw something back from the free service. Bates Tuesday called ads "a very powerful monetization scheme" for Skype, and said he wants a "rich immersive experience" – in other words, more ads and ad-like offers and teasers that you won't be able to resist clicking on.

Behind the scenes, Microsoft's Bing ads engine will be serving those "rich" ad experiences. Cheapos using video on Skype for free are the biggest target audience for this: 40 per cent of Skype customers now use the service's video-chat feature.

More important than ads, however, is the thing that Microsoft has that helps justify the deal and that could lead to Microsoft actually making some money from Skype: business hegemony.

Three years ago, Skype reckoned that up to 35 per cent of its then-37.9 million customers were business users. Skype's a good, free phone and video-conferencing alternative for customers, but not something you can actually rely on: service quality fluctuates and it doesn't let you manage calls with your other voicemails, emails, or contacts. Integration with Microsoft Outlook and Office via Lync Server would mean that Microsoft could potentially sell more copies of Office, Exchange Server, and Lync Server to business users working with Skype but not using Microsoft software. Or it could sell the cloud version of these inside Office 365.

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