Last updated: May 10, 2011 9:08 pm

Knocking at the door of tech heaven

On paper, the idea of putting together the world’s biggest internet voice service with Microsoft’s wide range of devices and software platforms looks like it could be a combination made in tech heaven.

Microsoft and Skype

Microsoft and Skype

But making the pieces fit together – and justifying the high $8.5bn price tag Skype’s investors put on the company – will prove a steep challenge for Microsoft as it tries to bolster its online capabilities against the likes of Google and Facebook, according to technology industry executives and analysts.

Tuesday’s announcement of a deal to buy Skype will give Microsoft one of the best-known consumer brands on the internet – though one that has failed to develop a business that matches its outsized name recognition.

“Skype is a verb – it’s the difference between Kleenex and being in the tissue business,” said Marc Andreessen, one of the investors who bought the company from Ebay 18 months ago for just $2.75bn.

With its brand and fast-growing group of active users, who last year averaged 145m a month, Skype is well on the way to achieving a Facebook-like dominance of its particular market, according to its supporters.

“There’s a strong network effect and it’s growing fast,” says Mr Andreessen.

Linking that network to Microsoft’s large groups of consumer and business users could boost the value of Microsoft’s existing devices and software, according to Steve Ballmer, Microsoft’s chief executive officer. “We have big customer bases we want to connect,” he said.

Products like the Xbox games console, Windows Phone operating system and Outlook e-mail software figure high in the software company’s plans. By owning Skype outright, Microsoft is in a better position to integrate the software tightly with its products, Mr Ballmer said in an interview with the Financial Times.

However, the acquisition raises considerable operational challenges.

One will be to create the sort of service with Skype that Microsoft’s many small and medium-sized business customers will be prepared to pay for. The internet company had already set its sights on this as a key part of its efforts to generate more revenue but had made little headway, leaving it to Microsoft to prove that a disruptive service that has succeeded by being free can also form the basis for a sound business.

Also, at the start of this year the Skype network suffered a prolonged outage, raising doubts about its readiness for business use. “There is a big question over whether it can make the Skype solution a business grade offering,” said Fred Huet, managing director of Greenwich Consulting.

A second challenge will be combining Skype with Microsoft’s various devices and software platforms in a way that allows the service to continue growing as an independent service and brand, while also combining it with other Microsoft products.

“It requires a lot of integration across the business divisions at Microsoft – it’s definitely a challenge for them,” said Al Hilwa, analyst at IDC.

Microsoft signalled its intention to protect the value in the Skype brand and management team by running the business as a separate division.

The deal could also face strategic problems. High on Microsoft’s list of priorities is integrating Skype with Windows Phone, something that could add to Microsoft’s efforts to fight back against Apple and Google in smartphones. While both the iPhone and Google’s Android devices carry Skype, Microsoft believes it can achieve a far greater integration and ease of use by owning the software outright, adding to the appeal of Windows handsets.

But achieving that advantage while protecting Skype’s attractions as a broadly available, cross-platform service will take careful management.

Also, Skype’s free voice service has caused consternation with some telecoms carriers, who see it as a threat – something Mr Ballmer acknowledged. Despite that, some observers said the popularity of smartphones meant Skype’s wide use in the mobile world was now likely to be inevitable.

Though a high price, the figure will make barely a dent in Microsoft’s $38.2bn net cash mountain. The company was also able to make the acquisition using part of its cash reserves held outside the US – money that has essentially been “dead”, since tax would have to be paid to bring the cash back into the US.

Buying Skype, even at such a high price, also had strong defensive attractions. “If Microsoft did not buy Skype it may end up in the hands of a competitor such as Google who might be able to use it to strengthen its ecosystem at the expense of Microsoft,” said Mr Hilwa.

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