Microsoft Buys Skype

All these b$%^s and [email protected]#$%s still hatin’
I used to be ballin’, but now I’m Bill Gate-in
—Lil Wayne, Bill Gates

Shortly after we started Andreessen Horowitz in mid-2009, we, along with our partners at Silver Lake Partners and Canada Pension Plan Investment Board, bought majority ownership of Skype from eBay. The investment generated a tremendous amount of controversy for us. Marc and I were known as angel investors, so investing a lot in one deal surprised people. While consistent with our stage-agnostic strategy, it was a very big deal very early on in the fund. To make matters more exciting, other investors and writers broadly criticized the deal. Joe Nocera of the New York Times wrote:

Many people on Wall Street — and a number of telecommunications experts I spoke to this week — were stunned by the price Skype sold for, and not just because we’re in the middle of a recession.

That controversy ended this morning when Microsoft announced that it was buying Skype 18 months after we bought it from eBay.

What it looked like back then

Let’s look back at the original decision and see why it turned out well. At the time, people criticized us for two primary reasons:

1. Ebay might not have owned Skype’s underlying intellectual property.  Skype’s founders, Niklas Zennstrom and Janus Friis, held an IP claim against Skype. Many speculated that the founders would use their claim to shut down Skype and leave investors with nothing. This made the company theoretically impossible to buy.

2. The shifting technology landscape would tilt the playing field away from Skype. While Skype won the original Internet telephony wars, they did so with a classic fat desktop client. From a technology standpoint, at the time, it was impossible to field a high-quality web client or mobile product, but that time wouldn’t last. Many observers believed that as the world inevitably transitioned to mobile and web, Skype would be left in the dust.

With a company as complex as Skype, investors draw different conclusions about the same facts. In this case we had the same data as everybody else, but we had a radically higher opinion of Skype’s founders and employees than the doubters and naysayers. We believed that we could work with, rather than against, the founders. And we believed that Skype’s amazing engineering team, led by the original Eastern European software wizards who created the service, could compete and win against anybody.

We specifically thought that Niklas and Janus, two of the preeminent technology entrepreneurs of our time, wanted Skype to be a huge success and would do everything in their power to make that happen. As a result, we did not think the doomsday scenario that greatly concerned others — that the founders would attempt to shut down the company through the courts — was an actual possibility. Based on the founders’ motivations, we felt that we’d quickly settle the IP litigation. Both sides wanted to get on with the business of making Skype more competitive and could not afford to waste time bickering about IP ownership.

And after quickly settling the litigation, both founders immediately made major contributions to the business through their energy, insight, and intellectual prowess. And boy did we need them to do that, because we soon faced full frontal assaults from the both Google and Apple.

When giants attack

In a direct attack, Google offered a free competitor to Skype’s U.S. paid product and a heavily discounted competitor to Skype’s international product. Google then aggressively promoted these cheap products to their enormous Gmail user base by forcing every Gmail user to view Google’s Internet telephony advertisement before allowing them to access their email. What was the result of this effort? Skype users and usage has accelerated since Google’s launch.

On the mobile front, Apple built video calling right into the iPhone, making their Facetime product the default offering for iPhone users. How did that impact Skype’s usage on the iPhone? 50 million users so far have downloaded Skype’s iPhone product since the release of Apple’s Facetime.

In retrospect, it was easy for people to underestimate the quality of the Skype engineering team and the power of Skype’s network effect. When we bought the company from eBay, many thought that Skype, like so many acquired technology companies, had lost its technical talent. Through our research, we found that Skype had a core group of engineers who were completely dedicated to the mission. They stayed through the eBay acquisition and were hugely determined to make Skype the communications company of the future. Over the past decade, this team consistently introduced groundbreaking technologies ranging from highly resilient and scalable peer-to-peer networking to radically higher sound quality through dramatically superior codecs. In doing so, Skype out-innovated the competition in the most important areas. When combined with its powerful network effect — how valuable is a video calling service if there is nobody to call? — Skype became a formidable competitor.

Smart move, Microsoft

Today, I tip my hat to an old rival, Microsoft. By acquiring Skype, Microsoft becomes a much stronger player in mobile and the clear market leader in Internet voice and video communications. More importantly, Microsoft gets a team, ably lead by the exceptional Tony Bates, that can compete with anyone.

The views expressed here are those of the individual AH Capital Management, L.L.C. (“a16z”) personnel quoted and are not the views of a16z or its affiliates. Certain information contained in here has been obtained from third-party sources, including from portfolio companies of funds managed by a16z. While taken from sources believed to be reliable, a16z has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation.

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