Skype MSFT In 2010, Microsoft purchased Skype for $8.5 billion, and at the time many observers were unsure of what value Skype had for the software giant (Bright, 2011). According to some, Skype's core VoIP business is subject to commoditization (Ricknas, 2008). Another issue that Microsoft must address is Skype's business model. Prior to the purchase, Skype had filed for an IPO and the filing documents reveal some major financial issues for the company. While it states that part of its strategy is to attract more users of both free and paid products, its income statement indicates that the users of free services are not making enough paid contributions to cover the cost of servicing them. Although the Skype user base was growing year-over-year, the company's profitability was declining. The company lost $1.4 billion on revue of $381 million in FY2007, turned a small profit in FY2008 and then proceeded to lose $269 million on revenue of $626 million in FY2009. These figures should be alarming for its new owners. While Microsoft can absorb losses of this magnitude without noticing much, the failure to reverse those losses would make the purchase of Skype an absurdly bad proposition for Microsoft. Therefore, Microsoft needs to understand Skype's business in order to remedy the problems and bring the company to profitability.

Making a Case

There is relatively poor congruence between the inputs and throughputs at Skype and the outputs. Part of the problem derives from the objectives, and part from the actual outputs. In a previous, paper, the inputs and throughputs were identified, while this paper will focus on the outputs. The grounds for the conclusions about the outputs will be the subject of this paper. Underlying these grounds is a set of assumptions. The first such assumption is that Microsoft needs Skype to be profitable. This assumption is based on conventional orthodoxy with respect to acquisitions -- that the price paid for the purchase should reflect the net present value of the future cash flows. There has been some speculation that for Microsoft most of the "positive" cash flows from the transaction come in the form of loss avoidance that would have occurred had a competitor like Google or Facebook acquired Skype.

Outputs

In the Nadler Tushman Congruence Model, the inputs and throughputs lead to the outputs. The company's success will be dictated by the degree to which these elements are congruent with one another. Outputs are described as being "what the organization produces, how it performs and how effective it is" (Nadler & Tushman, 1980). The first issue for Skype is what it hopes to produce, because its objectives are going to be the basis for the strategies it employs. In the SEC filing in 2009, Skype outlines the four pillars of its strategy. The first is that it wants to grow its user base, so the user base is a key output. From this, it can be extrapolated that market share is also important. It is assumed that the company wants to grow its user base at a rate faster than the total market is growing.

The second objective is to "increase the usage of our free and paid products and extend our relationship with our users." The third is to develop new monetization models and the fourth is to add more business users. Several outputs reflect these objectives -- the number of business customers, the amount of use each customer gets out of Skype and the revenue. Even from these objectives, it is worth noting, Skype does not indicate hope of expanding revenues significantly from the existing users and technologies.

Based on these objectives, the outputs of Skype can be evaluated. The latest year for which financial information is available is FY2009, in the SEC filing. After that point, Microsoft took over and was no longer obligated to reveal any information about Skype. By 30-Jun-2010, Skype had 550 million registered users. The growth rate in new users was...

This rapid growth in new membership certainly meets one of the firm's objectives. There is no indication about what the company's market share might be in VoIP, but with Skype on board Microsoft has a market share of 68% in instant messaging -- though the main list available does not appear to include Apple (No author, 2011).
The problem for Skype lies in the number of connected users, which at 124 million is much lower, and more importantly in the number of paid users. The number of paid users for Skype is 8.1 million, and this number has grown 10.9% in the first six months of 2010 and 25.8% in FY2009. These figures put the number of paying customers very low, and the growth rate of paying customers below the growth rate of new customers. This latter point is especially salient, since the potential pool for new paying customers includes both non-customers and non-paying-customers, a larger pool than the potential new non-paying customers, a pool that only includes current non-customers. Skype is failing, badly, to convince people to actually pay for anything on its system.

At this point, Skype does not identify its customers by any specific groups. Skype customers are located all over the world, and the company has only the main software platform as a product/service platform. The primary means of breaking the customers down, therefore, is by active, inactive and paying. It measures performance by the number of users in each group, whereas it probably should measure these groups in terms of costs and benefits.

With respect to the financials, Skype increased its revenue by 30.3% in FY2009 and has enjoyed strong overall revenue growth throughout its existence. Unfortunately, with the rapid increase in membership Skype has also faced mounting costs, which is another output category. Operating expenses increased 212% in FY2009, while the cost of goods sold increased 16%. This points to improving economies of scale with respect to the core service, but the overhead costs at Skype are out of control.

Why? A litigation settlement of $343 million in an intellectual property case regarding Skype's core technology led to the cost increases (Kharif, 2009). Litigation is an output that has to be considered, especially when it points to a chronic lack of innovation in the firm. Skype made no mention of innovation in its SEC filing, which is unfortunate because the key to its survival probably lies in ability to develop new products and to enhance its existing one. The company does not appear to place innovation as a high priority, so the key output of that part of the business is litigation and costly settlements, rather than valuable new patents.

The key individual functions at Skype tend to be functional, such as marketing or technological. There are performance measures for each individual, but there is no indication that such measures are particularly sophisticated or oriented specifically to any single corporate objective. This could cause problems, though, when employees do not necessarily know what they are intended to achieve in their roles. A marketer might have sales quotas, but might not have specific targets or a sense of how to build sales for the long-term.

There is not nearly enough congruence between the different outputs. In fact, the congruence appears to be very low. For example, the company's revenues do not grow quickly, even when the user base is growing quickly. There is no link between the number of users and the company's revenues. There is more of a link between the number of users and the cost of goods sold, as an increase in the number of users appears to provide economies of scale for Skype.

Another area where the outputs are not congruent, given out understanding of this business, is on the innovation side, or lack thereof. Without strong innovation capabilities, the…