Microsoft purchased Skype for $8.5 billion, and immediately critics of the deal questioned the value that Skype could bring to Microsoft (Bright, 2011). Skype was plagued with old technology that it did not even develop itself (Ricknas, 2008; Kharif, 2009). The company's 2009 SEC filing revealed that its financial condition was terrible. While the company has been rapidly increasing its user base, less than 10% of users are paying customers and the rate at which paying customers are growing is slower than the rate at which customers in general are growing. There are two feedback loops that are critical to Skype, one of which is negative and one of which is positive. These feedback loops can be identified through the analysis of the company's business and financial statements.
Making a Case
The key balancing feedback loop at Skype is that which keeps the company unprofitable, and this loop is negative. The positive feedback loop at Skype is the reinforcing loop that contributes to the rapid growth of the company's user base. Bellinger (2004) describes feedback loops, and the role that they play within an organization to deliver the outputs that are described in the Nadler Tushman Congruence Model. The grounds for this claim are going to be outlined in this paper. Underlying the grounds and the claim is the core idea that Microsoft, in order to extract value from Skype, is going to need to develop feedback loops that are positive. The one negative feedback loop is undermining the success of the positive feedback loop. Ultimately, the point of this exercise is to find ways for the company to develop two positive feedback loops, linked together, than can drive the company to achieving all of its strategic objectives going forward.
Balancing feedback loop.
Bellinger (2004) describes balancing feedback loops as "a loop in which action seeks to bring two things into agreement." If Skype were a profitable company, there would probably be a feedback loop that illustrated how it made its money. Since Skype is not profitable, there is probably a feedback loop to explain that. More importantly, Microsoft knows what works at Skype, what is more important is to find what is not working and fix it. The way a balancing feedback loop works is this (Bellinger, 2004):
Figure 7: Balancing Loop
The current state is the lack of profitability. The gap is that the company would like to make profits. The action taken is clearly going to be multiple actions that work in concert. The key is to know what actions being taken now are creating the gap. The first is giving away the service for free. There are good, sound reasons why Skype does this. The technology is not sophisticated so if they charge for it, others will give it away and win all of the customers. Plus, Skype wants to build market share as much as possible, as this contributes to the positive feedback that has the endgame of a near-monopoly for Skype. The gap is simple -- the company has customers, but few of them pay for the service. Skype boasts about having hundreds of millions of users, but it has only 8.1 million paying customers. The company says it wants to court business customers, but right now it is not attracting them and it has a relatively useless innovation pipeline, meaning that there is little chance that any future upgrade will entice corporate clients either. In short, Skype does not have a good business model and does not seem to have any big ideas how to improve that business model.
Yet the key to a balancing feedback loop is the action part. The action is what the company does to eliminate the gap, so that the current state is what the company desires. If Microsoft seeks Skype to turn that company into a profitable entity -- and this is not a given -- then it needs to find new and creative ways to monetize that massive user base. Dignan (2011) reports that advertising is a key form of revenue that Skype is pursuing, at least in its Windows client. The company must also develop innovation capabilities in order to develop superior versions of Skype that will compel customers to pay for the service, especially corporate customers, because they can be put on subscription and are less price-sensitive.
The other type of feedback loop is the reinforcing feedback loop. In this type of loop, according to Bellinger (2004), "the interactions are such that each action adds to the other. Any situation where action produces a result which promotes more of the same action is representative of a reinforcing feedback loop." There is one of these loops at Skype, the user base loop. The way that Skype is structured, users receive the ability to talk to other Skype users for free. This encourages people to have their friends and family sign up. The clumsy banking metaphor for this is "principal" and "interest." The principal is the user base, and the interest would be new users. The more users that Skype has, the more those users will want to have their friends and family sign up for Skype.
Logically, if all VoIP providers used this same business model, then the one that has the biggest market share will come to dominate. Skype would have started with no market share at all, but over time it has grown its user base, and at this point it is subject to rapid growth in its user base. The growth rate for FY2009 was around 45%, for example. This kind of growth can only be fueled by a positive reinforcing feedback loop. With Microsoft's purchase of Skype, the company has a dominant share in instant messaging and is one of the leaders in video calls and other forms of VoIP and telephony. There is going to be a point where Skype reaches a critical mass of users and becomes the dominate VoIP player, if the company has not reached that point already.
While this feedback loop is positive for the company, and it applies to a broad segment of the computing public, it is a market-specific feedback loop. Two groups exist outside this market, at least to an extent. The first group consists of corporate users, most of whom find the security on Skype too poor to convince them to use the service. The second group comprises Apple users, who have free video and chat with their Apple devices. There is Skype for Apple, of course, but as Apple users can chat with each for free, this represents a corollary business model to Skype. If Apple did not have high brand loyalty, this would not necessarily be a group outside of the feedback loop, but with Apple's high growth and high brand loyalty, it is worth seeing this group as outside of the loop and therefore a threat. Likewise, some companies do use Skype, but as the product does not meet a basic criteria for many corporate communications, this market is also largely outside the positive reinforcing feedback loop.
When feedback loops are analyzed, they provide opportunities for the organization to learn. Two opportunities for learning have been identified here. The first, in the balancing loop, is that the company needs to learn how to earn a profit. The presence of the gap is the learning opportunity, and in this case the presence of the gap is the lack of profit. Incorporating the Nadler Tushman analysis, the company needs to find ways to changes either its inputs or its throughputs in order to remedy the problem. The company needs, however, to develop the creativity and the learning capability. The reason why Skype has struggled over these years to be profitable is because it does not have the learning capacity within the organization to find solutions to a problem like this. Finding a solution to a problem like this is precisely where Microsoft needs to step in with its expertise -- that is a company that knows a thing or two about earning profit.
The second learning opportunity for the company comes from the reinforcing feedback loop. This feedback loop is positive, because Skype is moving towards that critical point where it has an unassailable market share, and the result of this is going to be that other firms begin to exit the market, because they cannot make money in VoIP. This is an admirable endgame, but Skype needs to consider how to make that scenario sustainable over the long run. The best way to make this happen is to be the technological leader. Market share, after all, can be eroded by a new entrant with superior technology.
For Skype, it needs to build a second reinforcing feedback loop, by fixing the problem with the balancing loop. Under this scenario, the rapid growth of the user base will combine with new revenue streams to make the company profitable. Once profitable, Skype can plow back profits into developing…