The news of Skype IPO was not a surprise as sooner or later any company owner with Skype’s business model has to bail out! Whilst Skype presents itself as disruptive technology, I would argue that their business model is more of a parasitic approach to price arbitrage in the market. Once price arbitrage disappears, they are dead in the water as they have no USP other than price. Invest at your peril!
What is Disruptive Technology?
Disruptive technology is a ground breaking technology or novel use of existing technology that breaks away from the traditional methods and delivers a breakpoint in the life-cycle of a product or market. Take the Digital Camera, which revolutionised photography for the man in the street enabling everyone to feel like David Bailey! Using technology which was already available, this turned the market upside-down and left traditionally strong companies such as Kodak, Fuji, Agfa, Canon and Minolta floundering and play catch up to the newcomers such as Sony & Samsung. All of a sudden these traditional market leaders were facing a new challenge from companies with a different background, highly skilled in mass marketing and used to short product life cycle. Some companies such as Kodak, Fuji & Agfa watched their core business of chemical film and processing whipped out within a few years, and were forced to rethink their business, product line-up and future direction. Now you cannot get more disruptive than this!
What is Parasitic Business model?
A business that is reliant on price arbitrage alone and its sole purpose is to exploit the price differential. In general these business models are reliant on the continued existence of the price arbitrage (or price gap) within a market.
This is not a derogatory term but it is the best attempt to explain the simple fact that without the price differential they have no unique selling point. This is about the business model and not technology, and it is strongly the case with Skype.
Skype came to existence and continues to exist because it can offer calls for free or at an unrealistically low price using existing technology. For Skype pricing policy to work and generate profits for its shareholders, it must continue to have access to a Zero-Cost network and rely on carriers to continue to charge high prices for calls therefore maintaining price arbitrage. Should a carrier decide to meet Skype pricing or prevent Skype from accessing its network, there will be no business model left.
In essence Skype is taking advantage of high prices charged by traditional carriers for making calls. Carriers need to make investment in their infrastructure to deliver new services and compete with one-another. Skype gets a free ride on this investment without making any investment of its own. So whilst carriers continue to invest in their network, they need to charge higher price levels to retain their cash flow and get a return on investment.
Skype also uses their customers’ PC as a hub and breakout point to route, redirect and deliver its traffic. Read your agreement with Skype, which you clicked as “I read and agree”. You have given them permission to do so and no, just shutting your Skype application does not stop it from chattering in the background with the network!
What is the difference between Skype and EasyJet or any other no-frills price-lead Airline?
Of course EasyJet and other budget airlines do compete on price, but there are a few fundamental differences.
1. The basic premise of the budget price airlines is breaking down the function and services of airlines into smaller pieces, Taylorism at work within the service industry if you will. They have separated the basic function of getting passengers from A to B, from all the supplementary services and have assigned a value to each part. They have stripped the unnecessary, sheer indulgence and the luxury from air travel, and brought air travel within the reach of a larger consumer segment.
2. They have given consumers a choice. You can have priority check-in, checked-in baggage, priority boarding, drinks, food, entrainment, etc. but you have to pay extra for each element. Of course we all know about Ryan Air and their attempts at pushing this to its limit with toilets charges and next they will be charging for oxygen!
3. They have taken advantage of the labour cost differentials as they have no legacy contracts with unions. The average BA cabin crew earns in excess of £30k per annum whilst an EasyJet cabin crew earns less than 15k. This is a 50% reduction in your operating costs alone.
4. Most budget airlines have also taken onboard standardisation by using a single aircraft model therefore reducing maintenance, training and purchasing costs. Of course EasyJet did step out of this model by ordering Airbus aircrafts a few years ago after using Boeing for many years, but never-the-less their fleet is made up of just two types of aircrafts rather than 12 different aircrafts at BA.
5. Finally, budget airlines have created a new market and have invested heavily in their own infrastructure. They have made a great contribution to the wealth of the nation, their shareholders and tourism industry as well as the national GDP of countries they operate within. Parasite businesses do not achieve any of these contributions or make such investments.
How long will the Arbitrage Last?
This is the “How long is a piece of string” question. Despite the popularity and growth of Skype, it only has a tiny market share of the global traffic. Skype at best is an irritation to the giant carriers and at worst not even on the radar. However, the day they start to make an impact on revenues of the carriers, the response will be swift, deadly and terminal. Carriers could deliver their own competitive products if the need arises, and can price Skype out of existence should Skype becomes a revenue drain.
Would the IPO be successful?
Not withstanding the ridiculous trademark issue with the B-Sky-B, I am sure it will be a success given all the hype and marketing around Skype. The question is whether the business is sustainable. If Skype continues to market itself as “cheap or free” alternative to carriers, then it is heading to the same end as many dotcom companies of the 1990s. Cheap or Free does not last for long and is not sustainable business model if you are relying on everyone else to make the investment in the infrastructure you intend to use! To be successful in the long run, Skype needs to bring something else to the party.
Delivering USP and truly sustainable value proposition requires investment which means changing the business into an orthodox model. The question is can Skype operate and prosper within an orthodox business model? The past history such as boo.com, e-toys, pets.com, etc., put a big question mark over this. Welcome to the Stock Market and business reality!