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September 23, 2005

eBay Overbid

That happens sometimes in auctions but Skype would have been overpriced for eBay at half the price. (Full disclosure: I envy and admire the Skype team).  Skype did manage to create a huge amount of value in a short amount of time.  Meg Whitman is usually both strategically and tactically astute.  eBay is a great company.  The price they paid won’t break them.  But it’s still a bad deal for eBay.

Because I didn’t understand the deal when the rumors first surfaced, I held off blogging about it in hopes that I’d eventually be able to figure out why it made sense for eBay.  It’s clear why it made sense for Skype.  I looked at the PowerPoint presentation; I listened to a lot of smart people.  I twisted my beard and thought long and hard.  I looked again.

The emperor has no clothes!  The deal doesn’t make sense.

The PowerPoint gives two justifications for the deal: “Expanding ebay’s share of e-commerce” and “A great standalone business.” (Note: always be suspicious of a deal – or anything else – for which more than one rationale is given).

Giving people the option of talking to each other does enhance certain types of complex transactions; it may well make transactions possible that weren’t possible before.  I buy that.  But speech-enablement is just technology and there are lots of companies that have it.  eBay could have rented it, licensed it, written to the Skype API, or just bought someone small like Deltathree.  No reason to pay billions of dollars to get this technology.  Skype’s unique value is in its installed base; not its technology.

eBay also talks about the potential for Skype helping it move into markets like China, India, Poland, Brazil, and Russia where Skype is strong and eBay isn’t.  A problem in these markets is that they don’t have a credit infrastructure and, in eBay’s words, they have “large grey markets” – in other words, people who don’t pay taxes (or don’t pay bribes) doesn’t want their transactions to be visible.  Skype does do well in these markets.  It’s free; it’s somewhat grey itself.  But I don’t see how that helps eBay with its bread and butter transactions which require the exchange of money.  PayPal, which eBay already owns, should help in these credit-challenged market – but not Skype.

OK, the presentation seems to say, if you don’t buy that, you can’t deny that Skype is  “A great standalone business.”  Huh?  Skype’s not a business yet; it’s an asset.  It doesn’t generate any significant revenue.  It has created asset value by building a huge closed user community – remember, Metcalfe’s law says the value of a network is proportional to the square of the number of endpoints (see here if you want a refresher).  Without this huge user community, eBay could have bought Skype for a fraction of what it actually agreed to pay.

Skype built this asset by single-mindedly creating better network value for the people who download their client (I blogged about that here).  They didn’t create obstacles to use like having to pay for either service or software.  There is no good reason to think that people who are used to freeloading – I’m not making a value judgment - are going to be a significant asset in eBay’s auction business.  Skype hasn’t proven yet that they are an asset in the telephony business – which may no longer be a business at all.  Moreover, it is a STANDALONE business.  If eBay tries to attach conditions to it which optimize eBay’s auction business or if Skype even loses its rebel élan, the asset may simply disappear.  No user has a long term contract with Skype.

Value is usually destroyed, not created by mega-mergers; AOL and Time Warner is a good (bad) example.  I’m not sanguine about the pending telco mergers either.  Horizontal mergers – especially those which create larger networks and leverage Metcalfe’s law – can succeed if management can get through the huge challenge of integration.  Vertical mergers or mergers of unlike entities are the hardest kind.  It’s a flattening world in which vertically integrated companies are at a disadvantage compared to horizontal players with good coverage of the layer they compete in (see here for why I think vertical integration doesn’t work anymore).

Summary: Skype brings technology which may well help eBay with its core business but was the most expensive possible source for that technology.  Skype has better geographic reach but, since it doesn’t usually involve the exchange of money, probably is not transferable to eBay.  Skype is NOT a great standalone business although it has built a great asset; it is much less likely to become a business as part of an organization with different goals and culture.  The very speed with which Skype was able to build an asset and eBay was able to build a business show how value creation is accomplished by those who are focused and nimble.  The slow death of AT&T with occasional divestiture revivals is an example of what vertical integration brings.

On the other hand, eBay has done a good job with PayPal.

And this merger WILL have some enormous consequences to other players.  It is already affecting many strategies.  More on that to come.

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