Skype's Offer Of Free Calling: Desperation Or Smart Business?

Skype's announcement yesterday that it was offering free SkypeOut calls to landline and mobile phones in the US and Canada was either an act of desperation, part of a well-thought-out, long-term business plan, or an attempt to sabotage Vonage's upcoming IPO -- and possibly a combination of all three.

Skype, naturally, says the move is smart business, and nothing else. Skype spokesperson Erica Jostedt told Networking Pipeline, "This initiative has always been in our business plan for the US and Canadian markets."

Previous to the announcement, SkypeOut users paid two cents per minute for the calls to the US and Canada. Skype is forgoing that revenue as a way to gain new customers --- rather than spend money on advertising to gain new customers, Jostedt says, the company uses these loss-leader phone calls.

That begs the question, what's the point of having a customer if he's not paying you anything? The plan is to turn freebie customers into paying customers. Skype upsells a variety of premium products, including Skype Voicemail, ringtones, and SkypeIn, which gives customers a number for receiving inbound calls from conventional and mobile phones. So it's betting that premium services it can sell new users will outweigh any revenue loss.

Albert Lin, an analyst with American Technology Research, told Business Week that Skype gets an average of about nine cents in sales a month of these premium services per customer. So Skype's plain is to rope in enough new customers as a way to offset its revenue loss.

Will the numbers pan out? It's hard to tell, but they better for Skype, because there's no way the company can start charging for calls to US and Canada now that it's offering them for free. Skype says the freebie promotion lasts until the end of the year. You can bet it'll last forever. Skype's offer of free calls to the US and Canada can be seen not just as part of a business plan, but an act of desperation as well. In particular, it may feel the AOL behemoth breathing down its neck.

AOL announced two weeks ago that it is getting into the VoIP business, with AIM Phoneline, which gives AIM users a free local telephone line at which they can receive incoming landline and cell phone calls when they are online. That's similar to the SkypeIn service, which Skype charges for.

In addition, AOL is releasing a for-pay version, AIM Phoneline Unlimited, which will cost $14.95 a month and include unlimited outgoing calling to local and long-distance numbers and 30 foreign countries.

Skype dismissed the competition. Jostedt says " The AOL Phoneline offering is not free and is subscription-based…Skype’s product is absolutely free."

Of course, SkypeIn isn't free. And AOL could eventually offer free calls as well.

In addition, Skype faces other competitors. Vonage, for example, is now offering its customers free phone calls to many countries in Europe -- and one of Skype's big selling points has been its low cost of international calls.

And other low-cost or no-cost VoIP competitors recently launched as well , including Jajah, which has the backing of the big Silicon Valley venture capital firm Sequoia Capital, and on whose board sits ICQ co-founder Yair Goldfinger. Yahoo and Lycos have also both announced VoIP products.

Making matters worse, analyst Lin estimates that Skype growth may be as much as 20% to 25% behind its original plan.

Put all this together, and you have a desperate company, looking for a quick way to juice growth -- and free phone calls fit the bill as a way to do that.

The Vonage IPO

There may be one final reason for the Skype move -- an attempt to sabotage the Vonage IPO. Vonage will be offering up to 31.25 million shares that it hopes to sell for between $16 and $18 a share. The IPO will be underwritten by Citigroup, Deutsche Bank Securities and UBS Investment Bank, and if things go the way Vonage wants, the company will be valued at about $2.6 billion.

The IPO would give Vonage lots of cash, which would in turn give Skype lots of headaches.

But so far, things aren't going the way Vonage hopes. The company has had to resort to sending out messages to its customers -- some call it spam-- as a way to drum up interest in the IPO.

Skype announcing free calling to the US and Canada in advance of the IPO could only hurt the share price, which in turn would give Vonage a smaller war chest.

The Bottom Line

So what's the bottom line for Skype? Whether the move was part of its long-term plan or not, giving its customers free calls to US and Canada was a smart thing to do. It will help it fight back competition, may do some harm to the Vonage IPO, and will certainly gain it new customers.

Whether it will be able to get enough revenue out of those new customers to offset the revenue loss, though, remains to be seen.