Skype's lessons

Ebay has admitted what equity analysts have long known - that it paid over the odds for Skype. I reckon there are three general lessons to be learned here:
1. Innovative companies don't often make money. As William Nordhaus showed (pdf), the benefits of innovation flow to consumers, not shareholders. Instead, firms make money by having the power to exclude rivals and kill competition. And Skype can't do this. Not only are there lots of competing Voip systems, but it's also hard to compete against cheap call charges in the US.
2. Synergies are over-rated, diseconomies of scale are under-rated. Ebay hoped that Skype would somehow drive traffic to its auction business. This never happened.
This corroborates one of the messages of this paper (pdf) - that mergers work best when they aim to cut costs, rather than raise revenues through synergies; remember AOL-Time Warner?
3. The price elasticity of demand is very high between a free service and a paid-for one.  If you try charging customers for something they can get for free, they'll often leave. Just ask the FT or New York Times. This is entirely consistent with this; once you  charge for something, you break the norm of reciprocity, and signal to customers that we're in the realm of homo economicus, so they act accordingly.

Comments

[dearieme]

Terribly cynical, no doubt, but I assume that the Boards of companies overpay for other companies because it is not really their intention to do their shareholders a good turn, but themselves.

[jameshigham]

Clearly Ebay are learning from Rupert Murdoch.

[Chris Williams]

All very well, but isn't there a better phrase than 'diseconomies of scale'? Not poetic, is it?

[dreamingspire]

Along with others that I know, I installed computer to computer Skype and found the connections of poor quality and unreliable. Conference calling would have been a significant bonus if it worked properly (volume levels were quite different from different participants). So I gave up. Then along came Vonage advertising with its box to plug into my home network, small monthly fee and not too bad joining fee, so I tried that - and its great for calls to landlines, uses phone numbers (not funny account IDs as Skype did), but not so good quality on calls to mobiles. Not a logical decision to just go for it without analysing other market offerings (including Skype's phone number level), but low risk to get started and its been successful for me. Vonage rightly targetted those of us with significant investment already in equipment (that home or small office network).