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Did Microsoft pay for the wrong Skype?

When a company is acquired, the price paid is usually higher than what the company is worth. This is because there is a “control premium” that needs to be paid so that the acquiring company can control the destiny of the acquired company (while the seller loses that right). So the question has to be what does the premium (or excess cost) buy? What is the value of that control? What will be the new destiny? Whose destiny is changed?

Clayton Christensen succinctly defined the value in any company as the sum of three constituent parts: resources, processes and business models. Market value can be nothing more and nothing less than these three things.

An acquisition has to be positioned on one of these targets just like a product is positioned on a specific market. The problem with being deliberate about where the value lies is that once positioned a certain way, the integration team will begin to execute on that plan. This means that the thing you decided was worth most (e.g. resources) gets all the attention and the other potential sources of value (processes or profit models) are discarded.

This argument reduces to there being three separate companies being available. The buyer pays for all but gets to keep only one.

When you look at it this way you realize that the reason most acquisitions fail is that the buyer throws away most of the real value in the company.

For example, when looking at Skype through Microsoft’s eyes, they could be valuing it for its resources (employees, management team, customers, or intellectual property.) Or they could be valuing its processes (how it makes software and how it recruits customers) or it could be its business model (viral distribution, very low prices with wide distribution, plan to disrupt telecommunications). Each of these is a separate, mutually exclusive deal with separate integration plan and separate strategic justification. Each is targeting a separate Skype.

If Microsoft were to pay a premium for Skype’s resources then they will probably not make use of the processes or business models. There is some value in this Skype. Microsoft could use the customer base to sustain their existing businesses and to up-sell services.

But what if the real value is not in resources but in the business model? A model which would allow for Microsoft to disrupt its core business. Perhaps Microsoft could use the Skype approach to creating new customers, eliminating its partner network and expensive direct sales force. This would be a different Skype. It would have the potential to transform Microsoft. Microsoft could become what Skype is now: a communications network or carrier that disrupts the way people use network operators.

This type of value exists in Skype but its asymmetry with Microsoft’s core would make it a very tough sell internally. A recent article pointed out that when Skype was up for sale last time, Google’s acquisition was sabotaged internally by people who realized that peer-to-peer would be “incompatible” with the centralized architecture of Google’s services. If not for the effort of certain individuals, Google might have ended up with Skype and destroyed it with internal antibodies.

Chances are that Microsoft paid for Skype’s customers and engineers but will not apply the innovations of viral peer-to-peer distribution or disruptive voice pricing. If that happens then perhaps Microsoft will pay $8.5 billion for the wrong Skype and telecom disruption will find another home.

Notes:

Adapted from an answer published in Capital.bg. My thanks to Adrian Georgiev for asking the right questions.

  • http://www.z11p.com Robert Dodson

    Why are the three parts mutually exclusive? Also, can't I buy a company and put it outside my own firm and simply let it run and collect profits from it? Why are you assuming a total integration of the bought firm into the buyer is a must?

    • asymco

      In theory the three parts are not mutually exclusive. In theory a company could acquire a new set of resources, replace or amend its processes and redefine its business model with an acquisition. But from the practical complexities that come from integrating two companies, it's unusual for more than one of these parts to be integrated (often no part is integrated and the acquisition is a complete failure). When the company being acquired is smaller than the acquirer, the chances are that there is a very specific plan to integrate it and the plan does not involve rebuilding the core value system of the buyer.

      It's also possible to buy and keep autonomous. But that results in a conglomerate model which is unusual in technology companies (Cisco is only exception that comes to mind and they're re-thinking that strategy now).

      I should have prefaced this with a disclaimer that these observations come from empirical observations not a well-formed theory.

      • http://twitter.com/Niilolainen @Niilolainen

        Can you source the data that supports the empirical observations? I've read The Innovators Dilemma, but no other Christensen, so would be interested to follow up.

        Based on other reading and my own experiences then I am sceptical of this whole thesis.

      • asymco

        The discussion on Resources Processes and Values (RPV) was in the Innovator's Solution. There are examples given there. From personal experience I found it to be a useful method to think about acquisition.

      • Xavier Itzmann

        «I am sceptical of this whole thesis»

        I, on the contrary, finds that it dovetails very well with own experiences. Much of what made the target what the pre-acquisition target was is often discarded; and much has been written about the % of M&A's which destroy value.

        Nokia, for instance, was a great acquirer who slowly smothered much before it fell by the wayside on its way to oblivion. Didn't the asphyxiated Doppler guys say ""Nokia. Where good ideas go to die …""? Arguably, this hardware company simply couldn't understand, much less absorb, the processes and business models of software/web 2.0 companies.

        Extending the analogy, it is difficult to see how HP will ever capitalize on Palm/webOS. Sure, they got a brilliant OS and the outstanding team who invented it. But can HP mix up the secret sauce of processes and profit models necessary for it to thrive?

        Horace, this is one of your finest articles. Here's the theory you could build up upon to construct an entire theory, books, lecture circuit, etc.

      • http://twitter.com/Niilolainen @Niilolainen

        It's well known that a significant portion of M&A deals destroy value, but that doesn't mean all deals are bad.

        I'm happy to maintain a sceptical open mind on the "RPV" theory until I've had a chance to explore further. Sadly The Solution has remained unread on my bookshelf for several months now. Hope I get around to it soon.

  • http://www.loudscreen.com vinner57

    Interesting insight Horace. never thought of it that way before.

  • http://www.noisetech-software.com/Y.A.S.C..html Steven Noyes

    I consider the Skype to be purchased for the disruption effect. MS is in a unique position to potentially grow Skype's user base by deep embedding the technology in following products:

    1) Windows
    2) Windows phone
    3) XBox

    By providing video, push notification VOIP into these products while starting with a huge and active following of customers, MS has the potential to cause a disruption to many social media messaging and traditional telecom services.

    The question is can they do this integration fast enough with enough transparency (in use not implementation) to make it viable and attractive?

    • Ziad Fazel

      Agree with Steven, for the most part. I too think Skype's business model is the one Microsoft will change most. Horace, I noticed you also referred to it as profit model, but Skype has never turned a profit, to the dismay of several previous owners. For this, Microsoft will crucially need Skype's people, and something Christensen did not list specifically: brand value.

      Microsoft has more than experience with free viral distribution of software to not be interested in that from Skype. As a competitor (Netscape, Linux, OpenOffice, Apache, Chrome) and as a supplier (Internet Explorer, Windows Media Player, MSN, Hotmail).

      Ebay/Paypal were not able to provide new distribution channels for Skype, exploit its customer base, or create a synergy product from the poor overlap.

      Microsoft's plans to provide new distribution channels, and synergy products. On Steven's points about deeply embedding Skype into the following Microsoft products:
      1) Windows – already there, and competing with WIndows Live/MSN. Doubt Microsoft will allow Skype to become much more prominent than their internal product.
      2) WIndows Phone – yes, but not transformative. iPhone already has Skype and Facetime, and I doubt Microsoft will allow Skype on Android (unless its there and I missed it). Perhaps the Microsoft deal with RIM will put Skype there if they can work the security and government monitoring issues out for more proprietary codecs.
      3) Xbox – major disruptor if implemented right.

      Apparently Microsoft needs Skype's people to develop Skype for their own Xbox, and Skype's brand value, despite having the in-house talent that created MSN/Windows Live. Whatever brand value MSN had got damaged by Microsoft's constant renaming/rebranding.

      I do worry about Embrace, Extend, Extinguish. Microsoft will embed a "better" version of Skype in its own products, and let the free viral Skype waste away. Perhaps even impair the free product's ability to use Windows devices for its network, or delay full feature compatibility with the Windows software. This will likely cause the resources and brand value it bought to leave, and cause its Windows version of Skype to follow the free product into irrelevance a year or two later.

      • UNLK A6

        I wonder if MS values Skype's brand. It will be interesting to see if they keep the name "Skype" or rename to "Windows Phone Linking and Embedding" or some such silly thing.

      • r.d

        ballmer said that Skype was verb. so yes they will be using Skype.
        I guess he didn't like that google was verb…

      • Steko

        Looks like we're in for more excruciating moments like these: http://www.youtube.com/watch?v=nfHuZ5qrYX4

      • Ziad Fazel
      • davel

        LMAO

      • Hamranhansenhansen

        Microsoft now has a "Skype division." It is Microsoft Skype.

    • Paulo Silva

      But all of that for what? 8.5 billions to just have a service like Gtalk for MS? I guess what MS did was to bring some relief to telecoms or at least make room for a new disruptor candidate.

      • http://www.noisetech-software.com/Perspectives.html Steven Noyes

        I did not say they did not over-pay for Skype. Personally, I think they paid about 5-7 billion too much.

        That said, I still think MS has potential to do some really great things with Skype if they want to/are included to. That said, deep integration into all of their product lines even if it marginalizes previous offerings like MSN Messenger.

        They can already build on the networking effects that Windows already has. Google Voice with billions of users.

        Now, how do you make money on any of this? I have trouble understanding the "free" model personally. I like being able to be a customer and not a product but given the ad supported Kindle is selling better than the non-ad supported one, it is plain most people are willing to be targeted for as little as $25.

      • Steko

        They paid for the userbase, someone did the math it's $50-$60 a user which is a good deal.

      • Darren Martz

        MS already has a Gtalk competitor called MSN Messenger. At one point it was the primary chat tool for people, but today I rarely see it used (anyone know what the actual market share numbers are?).

        Gtalk, iChat/Facetime, and Skype were all advancing the online chat/talk market. It's yet another area MS has been loosing ground. Bringing MSN Messenger to the MSPhone platform seems like a weak play. Bringing Skype is a different story, especially if it's marketed as "Microsoft Skype". This does leave RIM standing with a plain old chat technology, or borrowing others.

        It seems to me, this M&A is about the technology and the pillar it plays as a major mobility competitor.

  • MattF

    A different example: Apple's acquisition of Next. Apple got Next's software resources and processes and then actually replaced existing Apple resources and processes with Next's. Hard to imagine Microsoft doing anything like that.

    • asymco

      Good example. Resources was the pitch but with Jobs' return came an overhaul of most of everything else. I don't think that was "the plan" however.

      • Xavier Itzmann

        The Apple/Next example is remarkable. Let's see if we can summarize:

        Next
        resources: engineering team & OS
        processes: the necessary ones to put out the OS
        business model: burning platform! – sw sales only

        Apple
        resources: brand & customers
        processes: HIG philosophy?
        business model: burning platform! – sw sold as part of hw bundle, but model was starved of viable product. Real genius to not jettison what at the time looked to many as a failed biz model.

        The share price return on this M/A has been… what? $50 x $1?

    • Hamranhansenhansen

      That is an unusual acquisition, though, because NeXT was a fork of Apple. The NeXT team was like an Apple management-in-exile.

    • http://mexepos.tumblr.com/ Marcos El Malo

      I've long contended that it was NeXT that acquired Apple for negative $429 million. I think only an operator like Jobs could have pulled off a deal like that.

      If one insists on the common wisdom that Apple acquired NeXT, and did so for it's OS and engineers, one should also look at Steve Jobs as the "hidden" resource. Part of that $429 million was, de facto, for recruiting Jobs as Chairman and CEO. Remember that not only was Apple lacking a modern OS, it had also been lacking a competent CEO for many years. The only evidence at Apple that Gil Amelio was worth his salary was that he bought NeXT/recruited Jobs.

  • r.d

    Skype is run using Linux and non microsoft tech.
    First thing Microsoft has to fight is use of non-tech, if
    they try to replace with microsoft tech then they will turn
    it into Danger or Hotmail.

    Skype also is a hail-marry pass for microsoft. arstechnica article
    said that Skype was not compatible with LTE so thought of using
    it as the next gen solution for cellphone is not correct. but may
    be they can squeese out everyone using the patent. but I don't
    know what patent Skype brought forth except for may be p2p.

    Microsoft also might want to use it as ad driven solution because that
    is only way they can get any money from the free users. This is also problematic.

  • Steko

    Skype and it's 150 to 250+ million mostly non-MS users and their contacts, along with perhaps another 300-500 million microsoft customers (hotmail, windows messenger, xbox live, etc.) and all their contacts form the basis of a huge Facebook competitor.

    A year from now, Microsoft can flip the switch and introduce a unified login page for Skype, Windows Messenger, Hotmail (heck make it the default hotmail page but give it a universal mail client like your phone). That login would be a webview that becomes the users new Facebook page.

    If this prediction is right I'd expect to see Microsoft go after deals for (or with) Qzone (China's Facebook, half billion users) and Yahoo (300 million email users).

    • Bill

      Yet in 2011, I still have to type @hotmail.com or @msn.com when checking my email because M$ is the King of unified logins…

      • Steko

        Good point but that is what I would do with Skype if I was MS and as far as I can gather the only justification for the pricetag.

    • Scott

      Right, so exactly what I can already do with Gmail. Sounds like $8.5 billion well spent.

  • http://twitter.com/Remiel @Remiel

    Maybe you'd shoehorn this into "business models", or call it an extension of the "control premium", but there is a fourth type of value to be had from the Skype acquisition:

    Microsoft ensures no one else (Google, most prominently) can ever get their hands on such a potentially disruptive platform.

    • Ziad Fazel

      Or Apple, which now has this confusing mess of iChat and FaceTime, whose technology has not been opened up for standardization yet as promised. Skype could have consolidated all 3 at Apple, in a difficult software development which both companies have the combined resources to have implemented.

      • Hamranhansenhansen

        FaceTime is only 11 months old, and already it is better than Skype at the things it does. Apple simply has to expand the feature set until it completely eclipses Skype. FaceTime has also paid for itself, while Skype hasn't. It is likely FaceTime cost Apple less than a billion dollars to build — probably much less, knowing them — so why buy Skype for 8.5 billion? And FaceTime matches Apple culturally: zero setup, high quality, built on open standards.

        As for standardization: again, it's 11 months old. That is like 11 hours in standardization time.

      • Ziad Fazel

        Difficult to achieve standardization when you don't release the specifications, and promised to do so the day after publicly announcing it at last year's WWDC.

        http://www.subfurther.com/blog/2011/05/10/long-pa

        Walt French said the same thing to you on JL Gassée's blog

        http://www.mondaynote.com/2011/05/15/ballmer&rsqu

        I wonder how different the VOIP competitive landscape and acquisition price for Skype would have been if Apple had published FaceTime's specifications as promised last year.

    • asymco

      What's the typical return on spite?

      • http://mexepos.tumblr.com/ Marcos El Malo

        Hopefully a number of noses greater than one.

  • danthemason

    OT but There is a rumor with some substance over at Engadget that says Microsoft will begin talks to purchase Nokia's mobile operations. Really wild.

    • Hamranhansenhansen

      I thought they already tried to buy Nokia and there was some regulatory problem or something. My understanding was the software licensing deal was a consolation prize.

  • Sergio

    Well, if Microsoft is buying Nokia as well, as rumoured, maybe Ballmer had a plan all along, after all. If MS can get cost-effective MS/Nokia handsets running WP7 with seamless Skype integration…

    • Hamranhansenhansen

      Microsoft can't make seamless anything.

      • claimchowder

        So sad, so true…

        What really upset me at the time when I still cared (i.e. before I could by a Mac running OSX) was that with all the money MS had they just wouldn't make a single (software) product that actually worked. They never seemed to care for quality at all. Don't think they'll ever learn.

      • sve

        I don't agree that they don't care about quality. But I think they are always weighed down by the legacy baggage they carry. They're always trying to be backwards compatible with all their prior stuff. And that leads to bloated spaghetti code.

  • OpenMind

    It is possible that Microsoft not only pay the wrong price, but also destroy its Windows Phone 7 platform. Operators would be very uncomfortable to have a phone supplier (Window Phone 7) also being service operator (Skype). Some of they may not want carry WP7 at all.

  • Hamranhansenhansen

    They bought it just for the name. Today, they feel famous and successful again.

  • westechm

    I think Microsoft has come to realize that their business model of licensing software will not work for cell phones, and the only way they can make real money in this business is by suppling hardware. I believe that the Nokia deal is a prelude to acquisition, and that they will bundle Skype with Windows and try to monetize it for all uses.

    These seem to be desperation moves because their pipeline of good new products is empty.

  • claimchowder

    When I first read about MS acquiring Skype my immediate reaction was to delete my account. Why? Because I don't want MS to get my social graph with their acquisition. I have about 600 contacts in my address book, and the Skype client (at least on the Mac) has access to all of them; it imported them.
    I was never concerned about Skype (mis)using this information, but I absolutely object to MS using it.

    According to Wikipedia Skype had 663 Million registered users in 2010. I thought it was an obvious goal for MS to go after the Skype users' social graph info rather than the VoIP part.

    So now they have one less :)

  • claimchowder

    Here in Germany if a buyer buys more than a certain percentage (I think 30%, but don't quote me on that) they HAVE to make an offer to the rest of the shareholders. I guess that's what MS did, essentially.

  • davel

    If what is written above is true that Skype is built on Linux then MSFT has a problem.

    I recently read that Balmer and company kills anything not built on top of Windows and Office. I have been a long time critic of Balmer. He is probably a good MBA manager, but that is not the type of CEO you want for a tech growth company.

    PS

    I did not realize how virulently anti-microsoft this readership is.

    Wow.

    • http://www.mauricekessler.com Moeskido

      It seems to me that Microsoft's Windows division deliberately kills anything—whether a new acquisition or a new project developed by another division—that it perceives as any sort of internal threat to Windows. I'll be interested to see if Skype survives them in any recognizable form.

  • Tom

    It’s pretty simple. They bought it for the tech (they need their own version of FaceTime, gchat) as someone pointed out above. In addition, they get the user base as a bonus. They get a solid mobile VoIP client with cam support today. And the brand recognition / user base that comes along with it.

    I use FaceTime 10% on my iPhone and skype 90%. So much more flexible than FaceTime. I can skype with virtually anyone since skype client is so wide spread while FaceTime is restricted to apple products.

    They paid a lot – yes! But I think they also get a lot from this acquisition.

    • http://twitter.com/Niilolainen @Niilolainen

      "They bought it for the tech"

      – They could've copied it or bought any number of Skype competitors for a lot less. Tech is at the bottom of the list of reasons they bought Skype

  • VocabularyTest

    "Category: Theory" need to be changed to "Category: Hypothesis"