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Impact of Skype on Telecom Service Providers

An Evalueserve Report January 06, 2005 © 2005, Evalueserve. All Rights Reserved

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Impact of Skype on Telecom Service Providers

Contents

Evalueserve Marc Vollenweider [email protected] Tel: +43 (4245) 65183 Austria Sameer Shetty [email protected] Tel: +91 124 515 4000 India India Team Vaibhav Khera Sumit Gupta Suchi Mehrothra

1 2

Executive Summary .....................................................................1 Introduction - Skype ....................................................................3

2.1 2.2

Skype – The Product .............................................................................. 3 Skype – The Company ........................................................................... 3

2.2.1

Business Model......................................................................................................................3

2.2.2

Competition ............................................................................................................................3

3

Future Outlook – Skype...............................................................5

3.1

Skype Penetration................................................................................... 5

3.1.1

Growth Drivers .......................................................................................................................5

4

Impact of Skype on Telecom Service Providers .......................6

4.1

Telecom Operators will witness a significant decline in their profitability . 6

4.1.1

Fixed line revenues will decline due to reduction in long distance and local revenues .........6

4.1.2

Mobile revenues will decline due to a reduction in roaming revenues.................................10

4.1.3

Though reduction in mobile and fixed line revenues will not be significant, the impact on profitability will be significant................................................................................................10

4.2

VoIP providers will need to change their business models.................... 12

5

Conclusion .................................................................................14

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Impact of Skype on Telecom Service Providers

1 Executive Summary Skype, by far the most successful P2P VoIP solution, clocking almost 45 million downloads in 2004 is expected to have a major impact on the entire Telecom industry. Skype has revolutionized VoIP telephony by offering unmatched quality and by reducing cost for Skype-to-Skype calls to zero and to a fraction of current longdistance rates for Skype-to-Fixed/Mobile network calls. Skype might reach between 140-245 million regular retail users by the end of 2008 depending on the market scenario. These figures do not take into account business users, who might switch to Skype and other VoIP business solutions. This report analyses the impact of Skype and VoIP in general on the profitability of incumbent fixed line and mobile operators as well as non-P2P VoIP players. The profitability of the high fixed-cost telecom operators is likely to be hit significantly and permanently due to the following effects: • Reduced fixed line revenues due to; ­ Migration of long-distance retail customers and local loop retail customers to free Skype-to-Skype and low-price Skype-Out services ­ Reduction in long-distance calling charges forced by Skype’s pricing to avoid loss of market share ­ Migration of fixed line customers away from fixed line to a combination of cable internet access and mobile phone resulting in lower subscription revenues ­ Reduction in wholesale revenues due to a decline in voice traffic ­ Reduction in revenues from the enterprise segment due to business solutions offered by Skype and VoIP providers in the future resulting in the same effects as in the retail segment • Reduced mobile revenues due to ­ Reduction in revenues from roaming fees due to Skype/Wifi combinations ­ In case of Skype introducing a solution that can be used over 3G/GPRS, the mobile voice traffic will decline further By 2008, incumbent telecom operators offering fixed and mobile services are likely to face a significant risk of permanent reduction in overall profitability and revenues of at least 22-26 percent and 5 percent respectively over and above previously communicated expectations. Another additional reduction of profitability will come from an erosion of long-distance revenues in the business customer segment, once Skype and other VoIP providers offer viable solutions in this segment. A recent survey showed that 30 percent of Skype retail users also used Skype at work. VoIP solutions offered by incumbents will not be able to offset the lost profits and will instead accelerate cannibalization of existing profits too. Moreover, at this stage, it is not quite clear whether such VoIP solutions will actually remain competitive against Skype or not. European operators are much more at risk due to certain characteristics of the European telecom markets. For instance, calling and roaming rates as well as the share of roaming calls are higher in Europe. Further, local calls are charged by the minute rather than through a flat monthly fee, as in the US. In a base case scenario, fixed line operators, especially long-distance operators, will be much more exposed to risk than mobile operators. Additionally, a combination of mobile phones and Skype via Internet delivered by cable may make fixed line access altogether redundant, thereby, reducing revenues from subscription access fees. © 2005, Evalueserve. All Rights Reserved

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Impact of Skype on Telecom Service Providers

However, mobile operators will face much more significant decline in both roaming fees and mobile voice traffic significantly, once Skype and other VoIP players offer mobile solutions. VoIP players that do not use P2P technology in the retail segment might not be able to survive on their current business model, since P2P has an inherent cost advantage and is likely to retain a quality advantage as well. However, Skype’s performance and its ability to compete in the business segment will be seen, only after it introduces its business solutions in the market. The value proposition of Skype and its revenue model will improve further, once it starts offering and pricing value-added services in the business and retail customer segments. Overall, Skype represents a massive discontinuity in the telecommunications industry driving the convergence of voice and data much faster than originally anticipated. Skype could also be a major step towards a change in the business model of the telecom industry, --- a model in which basic voice services are offered free of cost, and a bulk of revenues is generated from value-added services.

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Impact of Skype on Telecom Service Providers

2 Introduction - Skype

2.1

Skype – The Product

Skype is a peer to peer (P2P) Internet telephony software, in which, the call is routed directly between the computers of the two users, instead of passing it through a central server. Skype allows free calls to other Skype users through out the world and calls to fixedline telephones at a fraction of traditional international calling rates

Skype allows users to make free unlimited phone calls to other Skype users worldwide. The software offers a feature, SkypeOut, which allows users to make calls from PCs or PDAs to conventional fixed-line phones or cell phones. However, SkypeOut is not free and a user is charged 1.7 Eurocents per minute for making calls to North America, Western Europe, China and Australia; the rates being higher for calls made to mobile phones and other countries. The Skype software can be used on different platforms like Windows, Mac OS X and Linux. It allows the user to make conference calls, wherein up to five people can be connected at the same time irrespective of their geographic location. It also allows file transfer across platforms and instant messaging to other Skype users.

2.2 Skype has over 13 million users worldwide and has clocked more than 45 million downloads

Skype – The Company

The Skype software was developed by the same people that created KaZaa, the P2P music file-swapping network. The software was launched in August 2003 and since then, it has clocked 46.7 million downloads. At present, Skype has two million users in the US and 13 million users worldwide. Further, the company claims to add 80,000 new subscribers daily.

2.2.1

Business Model

Skype offers its users free unlimited worldwide PC-to-PC calls and aims to keep this basic functionality free forever. The company’s main source of revenue is SkypeOut. Currently, SkypeOut is the largest source of income for the company, with 200,000 users paying a minimum of USD 12 in order to buy calling time. The sale of cyber phones and PC headsets also contribute to the company’s revenue. In the future, the company plans to introduce features and services such as voice mail, etc., which will require a paid subscription or pre-payment. Currently, Skype does not have any offerings customised for enterprise clients. According to Kat James, Public Relations, Skype, “We are currently working on a Skype for Business offering to be launched in 2005”. However, the exact nature of the announced solutions both in terms of technology and economics is still to be disclosed. Skype aims to generate revenues through its enterprise solutions.

2.2.2

Competition

At present, the company is competing with the following: • Traditional service providers: Traditional service providers will face stiff competition in long-distance services. This is because making calls using Skype is cheaper, as compared with traditional long-distance calling. However, the impact and degree of threat that traditional service providers face will depend on the penetration of Skype and broadband. • Other VoIP application providers: Skype offers better services at lower prices when compared with other VoIP application providers. Therefore, VoIP providers like Vonge and 8x8, have started offering more competitive call rates. Currently, Skype does not have any offerings for business customers.

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Impact of Skype on Telecom Service Providers

• Internet service providers: Internet service providers like Earthlink etc. are coming up with products similar to Skype. Earthlink has launched free online calling and plans to offer a paid service similar to SkypeOut by next year. • Other P2P services providers: Voiceglo has introduced a similar product called glophone, that uses the P2P technology for making calls.

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Impact of Skype on Telecom Service Providers

3 Future Outlook – Skype

3.1

Figure 1 depicts the growth of the retail user base for Skype till 2008.

Figure 1: Worldwide Skype Subscriber Base (2003 – 2008) 300 250

214.81

245.66

200

Million

The number of retail Skype users is expected to reach between 140-245 million by the end of 2008

Skype Penetration

160.29

100 50

182.49 145.06

150 82.09 1.27

0 Dec-03

52.42 43.47

19.20 17.40 15.54 Dec-04

98.33

Dec-05

Conservative

142.54 113.85

78.35

Dec-06

Base Case

Dec-07

Dec-08

Aggressive Source: Evalueserve Analysis

As shown in the Figure above, the Skype user base is expected to grow rapidly from about 130,000 by the end of 2003 to about 182 million by the end of 2008.

3.1.1

Growth Drivers

As compared with other telephony providers, Skype enjoys significant advantages due to its use of P2P technology, giving it considerable competitive advantage and thus, contributing to its growth. Some of these include: • Cost advantage: Skype software can be downloaded for free and enables customers to make free Skype-to-Skype calls worldwide. The company charges only 1.7 Eurocents per minute for Skype-fixed line calls to most European and American countries. Rates are higher for calls to other countries and for Skypemobile calls (more information on SkypeOut rates can be found at http://www.skype.com/products/skypeout/rates/). Skype users only incur the cost of the dial-up or broadband connection. • Better sound quality: Since Skype calls are routed directly between the users’ computers, instead of being passed through central servers, they offer better sound quality and higher call completion rates than other VoIP applications like Net2Phone, AIM, ICQ, etc. • Improved security: Skype calls are encrypted end-to-end and therefore, offer a more secure connection than other VoIP applications. • Easy and low installation costs: For making calls using Skype, a user needs a PC, a sound card, a microphone, a headset or speakers, and an Internet connection. Thus, Skype can be used with a minimal investment. Moreover, it is easy to install and works behind most firewalls, unlike most other VoIP applications.

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Impact of Skype on Telecom Service Providers

4 Impact of Skype on Telecom Service Providers This chapter outlines the expected impact of Skype on telecom service providers.

4.1 Telecom Operators will witness a significant decline in their profitability The profit margins of telecom service providers are expected to decline considerably due to a reduction in revenue. Since telecom operators have a high fixed cost base, a decline in the topline will have a direct impact on the bottomline. The sections below outline the various factors that will have an effect on the profitability of telecom operators.

4.1.1 Fixed line revenues will decline due to reduction in long distance and local revenues Fixed line operators will feel the immediate and maximum impact of Skype uptake by users. However, the impact will vary from one region to another. The impact will be due to: • A decline in long-distance revenues from retail customers: SkypeOut (at 1.7 Eurocents/min) is much cheaper compared with traditional long-distance call rates and Skype-to-Skype is free. This will have an impact on the revenues of fixed line operators as: ­ Subscribers will shift from traditional operators to Skype resulting in the direct loss of long-distance calling traffic ­ Fixed line operators will need to reduce their long-distance calling rates to slow down the migration. This will affect their existing customer base, regardless of whether the customer segments switch to Skype or not • Decline in local revenues from retail customers: Local calls in many countries are charged on a per minute basis. In such cases, subscribers will shift from fixed line operators to Skype as SkypeOut is a cheaper option compared to other offerings from local call providers. In addition, Skype-to-Skype calls are free. However, local revenues will not have a major impact on operators in countries such as the US, where local calls are not charged on a per minute basis, and any number of local calls can be made on payment of a monthly fee. • Decline in wholesale revenues: Wholesale traffic for operators will decline along with a decline in retail traffic. This will result in an additional decline in revenues. • Decline in retail access subscription revenues: Some customers with access to ISPs, which do not require a fixed phone line (e.g. through cable modems), may decide to substitute their fixed line subscription for a combination of Internet access through cable and a mobile phone, thereby reducing the fixed line operators’ recurring subscription revenue. This effect is, probably, insignificant in the short-term, but may increase in importance, once the penetration of mobile phones reaches saturation and the calling rates from mobile-to-fixed networks become competitive. Some European countries as well as the US have witnessed this change. The impact of Skype will be felt primarily on the retail segment. Although Skype does not have any offering for the enterprise segment as of now, the entry of other VoIP players will have an impact on the revenues of this segment as well. According to Kat James, Public Relations, Skype, a recent survey showed that 30 percent of Skype retail users also used Skype at work. It is, therefore, quite likely that the uptake of Skype business solutions will also be swift.

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Impact of Skype on Telecom Service Providers

4.1.1.1

Long Distance revenues for US based telecom operators is expected to decline by about 35-40 percent by 2008 due to the impact of Skype on the retail segment alone

The US

Fixed line operators in the US will face a significant decline in long distance revenues. This decline will be due to two factors: • Decline in Retail Subscriber Base: US fixed line operators will witness a reduction in their international long distance subscriber base as subscribers with access to broadband will find SkypeOut a much cheaper option as compared with ILD services. This will result in a 9-12 percent decline in long distance revenues depending on the scenario. • Reduction in Calling Rates: US fixed line operators will need to reduce their ILD rates in order to retain remaining customers. We estimate that rates will need to be cut by about 35-40 percent. This will result in a further reduction of 19 percent in long-distance revenues by 2008. Further, wholesale ILD revenues will decline by 37 percent due to a reduction in retail ILD traffic. Overall, we expect long distance revenues from retail customers for operators such as Verizon to reduce by about 35-40 percent by 2008. The estimated impact of Skype on revenues for Verizon, a leading operator in the US is shown in Table 1 below. Table 1: Decline in Long Distance Revenues for Verizon due to impact of Skype on the Retail Segment (Base Case)

Total revenue (USD mn) Revenues from long distance (USD mn) Number long-distance subscribers (mn) (assuming no impact of Skype) Number of subscribers (m) (providing for impact of Skype) Reduction in long-distance revenues (Due to reduction in subscribers) (USD mn) % Decline due to a reduction in subscribers Long-distance rates (USD/min) Revised long-distance rates (USD/min) Reduction in long-distance revenues (Due to a reduction in prices) % Decline due to a reduction in price Reduction in wholesale revenues % Decline in wholesale revenues Revised long-distance revenues (USD mn) % Decline in long-distance revenues Revised total revenue (revised for net impact of Skype) (USD mn) % Decline in total revenue due to Skype

2003

2008

67,752 3,788

75,731 5,332

17

28 23.7 480 9%

0.48

0.24 0.15 1,046 19.6% 455.5 37.1%

3,788

3,351 37.1%

67,752

73,750 2.6%

Source: Evalueserve Analysis

In addition to these, Network Access Revenues will also reduce due to a decline in traffic. The decline in overall revenues, however, is not expected to be significant

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Impact of Skype on Telecom Service Providers

(about 2.5 percent) as international long distance services comprise a relatively small part of total revenues. However, this effect will be much stronger for long-distance operators. Enterprise long distance revenues for US based telecom operators will decline by about 40 percent due to customers switching to VoIP solutions

In addition, we estimate long distance revenues from the enterprise segment to be impacted even more strongly, due to subscribers shifting to other VoIP providers. Revenues from the enterprise segment might decrease by about 40 percent due to customers switching to VoIP solutions. Further, price decreases in business calling rates might further reduce revenues from enterprise clients by about 20-30 percent. The impact on total long distance revenues will be approximately 11.5 percent. It remains to be seen how much market share will Skype be able to capture in this segment, but it is clear that Skype will have to adapt its offering to business customers by offering value added services such as VPNs, enhanced conferencing services, etc. as well as seek compliance with existing corporate IT policies. 4.1.1.2

Long Distance revenues for European operators will decline by about 41 percent due to the impact of Skype on the retail segment

Local fixed line revenues for European operators will decline by 7 percent due to the impact of Skype on the retail segment

Wholesale revenues will decline 37 percent, while retail access revenues will decline by 5 percent as a result of retail subscribers shifting to Skype

Europe

Fixed line operators in Europe will witness a decline in both long distance and local revenues. In addition to a monthly access fee, European operators charge a per min fee for providing fixed line services. Operators will witness a decline in these revenues too. • Retail Long Distance Revenues: European operators, like their counterparts in the US, will face a two-fold decline in revenues. However, the impact on European operators will be much higher, as broadband penetration is much higher in European countries. Long distance revenues will decline by 41 percent due to: ­ Decline in Subscriber Base: European fixed line operators will witness a 23 percent reduction in international long distance revenues by 2008, due to a reduction in subscriber base. ­ Reduction in Calling Rates: European fixed line operators will need to reduce their ILD rates in order to retain remaining customers. We estimate that rates will need to be cut by about 38 percent. Rate cuts will result in a further 17 percent reduction in long distance revenues by 2008. • Retail Local Fixed Line Revenues: European operators charge local calls on a per minute basis. Subscribers with broadband access will find SkypeOut a cheaper option compared with local calling rates and will shift to Skype. This is expected to result in a 7 percent decline in local calling revenues • Wholesale Revenues: European operators will witness a 37 percent decline in wholesale revenues due to a decline in national and international traffic. • Retail Access Revenues: In addition to charging callers on a per minute basis, operators in Europe charge monthly access fees for using PSTN lines. It is most likely that many subscribers using broadband through cable will cancel their PSTN subscription and opt for a combination of mobile phones and Skype. Subscribers using dial-up or broadband through ADSL will not be able to cancel their subscriptions as operators offer bundled services. We estimate 50 percent of subscribers using broadband through cable will cancel their fixed line subscriptions resulting in a five percent decline in access revenues. In addition, some subscribers will shift from ADSL to cable for their broadband needs resulting in a further decline in access revenues. The estimated impact of Skype on revenues for Swisscom, a leading operator in Switzerland is shown in Table 2 below.

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Impact of Skype on Telecom Service Providers

Table 2: Decline in Long Distance Revenues for Swisscom due to Impact of Skype on the Retail Segment (Base Case)

Total revenue (CHF m) Revenues from long distance (CHF m) Number of retail long-distance subscribers (m) (assuming no impact of Skype) Number of subscribers (m) (providing for impact of Skype) Reduction in long-distance revenues (Due to a reduction in subscribers) (CHF m) % Decline due to reduction in subscribers Long-distance rates (CHF/min) Revised long-distance rates (CHF/min) Reduction in long-distance revenues (CHF m) (Due to reduction in prices) % Decline due to reduction in price Revised long-distance revenues (CHF m) % Decline in long-distance revenues Local revenues (CHF m) Reduction in local revenues (CHF m) (due to reduction in subscribers) % Decline in local revenues Wholesale revenues (CHF m) Reduction in wholesale revenues (CHF m) % Decline in wholesale revenues Access revenues (CHF m) Reduction in access revenues (CHF m) % Decline in access revenues Revised total revenue (CHF m) % Decline in total revenue

2003

2008

14,837

9,634

306

285

1.79

1.79 1.19 67.9 23.8%

0.24

0.24

0.24

0.15 50 17.6%

306

167 41.4%

1,203

1,102 79

755

7.2% 450 168.6

1,488

37.5% 1,927 96

14,837

5% 9,172 4.8% Source: Evalueserve Analysis

Enterprise revenues for European operators will decline by about 30-50 percent due to customers switching to VoIP solutions

Here again, we estimate revenues from the enterprise segment to be impacted even more strongly, due to customers shifting to other VoIP providers. Revenues from the enterprise segment might decrease by about 30-50 percent due to customers switching to VoIP solutions. Corresponding price decreases in business calling rates might further reduce revenues by about 15-30 percent. Total international revenues are expected to decline by about 18 percent.

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Impact of Skype on Telecom Service Providers

4.1.2 Mobile revenues will decline due to a reduction in roaming revenues Currently, Skype does not have a product that can be used in mobile devices with GPRS/3G networks. However, Skype has introduced a product called PocketSkype, which enables users to make calls using PDAs and WiFi networks. PocketSkype enables Microsoft Pocket PC 2003 handhelds users to make free unlimited SkypeSkype calls over Wi-Fi networks. Skype is also in the process of evaluating various mobile platforms such as Windows Mobile, Symbian and PalmSource. Further, Skype is attempting to develop products for use over mobile networks such as 3G. Mobile operators in the US will face a 1.7 percent decline in mobile revenues by 2008 due to a reduction in mobile roaming usage. European operators on the other hand will face a 6.8 percent decline in mobile roaming revenues due to the same factors

In the short run however, revenues for mobile operators will not be impacted significantly. The decline will arise from a reduction in roaming revenues, as business travellers shift to Skype on WiFi enabled devices for making mobile roaming calls. We estimate mobile revenues for mobile operators in the US, such as Verizon, to decline by 1.7 percent due to the impact of Skype. European operators, such as Swisscom, will witness a 6.8 percent decline in mobile revenues due to Skype. The impact on European operators is higher compared with US operators as roaming revenues form a higher proportion of revenues in Europe. We expect roaming revenues to be impacted by about 27 percent for both US and European operators. However, in case a commercially viable product like Skype is developed for usage over 3G/GPRS, the mobile operator space will see a significant shift from voice traffic to data traffic. This will necessitate mobile operators to unbundle voice and data services due to a shift in demand. Mobile operators might need to offer standalone data services as compared to combined voice and data services.

4.1.3 Though reduction in mobile and fixed line revenues will not be significant, the impact on profitability will be significant 4.1.3.1

The net impact of Skype adoption by retail customers on US based operators will be a decline of 3.4 percent in net revenues

The US

We estimate revenues for US based operators such as Verizon to decline by 3.4 percent by 2008. However, this is a conservative scenario and Verizon might be less exposed to Skype than other fixed long-distance oriented operators. Table 3 below shows the break-up of this decline. Table 3: Decline in Verizon’s Revenues due to Impact of Skype on the Retail Segment (2008) DECLINE IN REVENUES

2008

Total revenues (USD mn) Reduction in long distance revenues (USD mn) Reduction in mobile revenues (USD mn) Net reduction % Decline in total revenues

75,731 1,980.7 576.5 2,557.3 3.4% Source: Evalueserve Analysis

Profits of US based operators are expected to decline by 17.4 percent due to the 3.4 percent decline in revenues

Though, Skype adoption is not expected to impact the topline significantly, its impact on the bottom-line will be much higher. Operators have invested heavily in setting up their infrastructure, which accounts for the largest part of the fixed cost base. Hence, a reduction in subscribers hence will not result in a significant reduction in the overall costs. This will result in a magnified impact on the bottomline, with a 3.4 percent decline in overall revenues resulting in a 17.4 percent decline in overall profits. Moreover, due to business clients shifting to other VoIP providers, profits are likely to decline by 20-25 percent.

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Impact of Skype on Telecom Service Providers

Figure 2: Impact of Skype on Fixed Line Operators’ (Verizon’s) Profitability (2008)* (Effect of Retail Segment only)

100

Forecasts

80

Impact of Skype

3.4% decline in Revenues

60

40

17.4% decline in Profits 20

S ev en ue s R

C

O

G

A SG

Pr of its D ep re ci at io n

e D

ec lin

of its Pr

SG D A ep re ci at io n

S G O C

R

ev en ue s

0

Source: Evalueserve Analysis *All figures are normalized by forecast revenues for 2008

4.1.3.2

Net revenues for European operators will decline by 7.9 percent due to the uptake of Skype by retail customers

Europe

We estimate revenues for European operators such as Swisscom to decline by 7.9 percent by 2008. Table 4 below shows the break-up of this decline. Table 4: Decline in Swisscom’s Revenues due to Impact of Skype on the Retail Segment (2008) 2008

Total revenues (CHF mn) Reduction in long distance revenues (CHF mn) Reduction in local telephony revenues (CHF mn) Reduction in wholesale revenues (CHF mn) Reduction in access revenues (CHF mn) Reduction in mobile revenues (USD mn) Net reduction % Decline

9,634 118 79 169 96 300 763 7.9% Source: Evalueserve Analysis

European operators will face a 22.9 percent decline in profits due to the 7.9 percent decline in revenues

The impact of Skype on European operators’ topline, at 7.9 percent, will be higher compared with their US counterparts. The impact on the bottomline will consequently be much more pronounced. We estimate European operators’ operating profits to decline by 22.9 percent, as shown in the Figure below. Here again, profits are likely to decline further by more than 25 percent due to business clients shifting to other VoIP providers.

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Impact of Skype on Telecom Service Providers

Figure 3: Impact of Skype on Swisscom’s Profitability (2008)* (Effect of Retail Segment only)

100

Impact of Skype

Forecasts 80

7.9% decline in Revenues

60

22.9% decline in Profits

40

20

R

ev en ue s C O G S Pe rs on ne l O th er D ep s re ci at io n Pr of its D ec lin e Pr of D its ep re ci at io n O th er s Pe rs on ne l C O G S R ev en ue s

0

Source: Evalueserve Analysis *Numbers are normalised by forecast revenues for 2008

4.2

VoIP providers will need to change their business models

Unlike other VoIP technologies, P2P technologies providers such as Skype do not have to invest in setting up and maintaining infrastructure such as servers, etc. Thus, Skype enjoys two inherent and fundamental advantages over centralized models: • Cost advantage: Skype can offer its services at a much lower prices due to its lower cost structure • Scaling: Scaling of the subscriber base is easier as no additional infrastructure is required to accommodate additional users. Non P2P VoIP players will witness a 94 percent decline in their retail revenues due to the impact of Skype

Hence, VoIP providers not using P2P technology in the retail segment will witness a significant decline in projections for 2008 in revenues due to: • Retail subscribers shifting to Skype will result in a significant erosion of their user base • VoIP providers will have to reduce their prices to compete with Skype. This will result in a further reduction in revenues. We estimate that VoIP providers will need to reduce their prices to approximately four Eurocents per minute to remain competitive. This will result in a 94.5 percent decline in revenues for VoIP providers as shown in Table 5 below.

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Impact of Skype on Telecom Service Providers

Table 5: Decline in revenues for VoIP providers due to Skype

Revenues (USD bn) No. of subscribers (mn) (assuming no Skype) No. of subscribers post Skype Reduction in revenues due to reduction in subscribers (USD bn) % Decline in revenues Reduction in revenues due to reduction in price % Decline in revenues Revised Total VoIP revenues (revised for impact of Skype) % Decline in revenues

2003

2008

2.5

12.0

0.5

71.1 46.2 4.2 35.0% 7.11 59.5

2.5

0.65 94.5% Source: Evalueserve Analysis

Retail VoIP providers not using P2P technology will probably not survive on the current business model • VoIP providers will need to bring their end user charges down to the level of SkypeOut (1.7 cents per minute) for local and long-distance calls, which might not be feasible given the technologies used • VoIP providers will need to invest in improving their technologies to bring service levels to the same quality as that of Skype The above steps imply a simultaneous decline in revenues and increase in costs. Hence, VoIP providers will need to scout for additional revenue streams and markets. A few alternatives are summarized below: • Business customers: Skype currently does not have any offerings for business customers. VoIP providers are already addressing this segment. Skype plans to roll out services for enterprise customers by mid 2005. These services will include value added services such as video conferencing, user groupings, etc. Skype will charge business consumers for these services. However, given its use of P2P technology, Skype poses some inherent issues for enterprise clients. The Skype software routes calls through a self-propagated network. This might result in fluctuations in call quality, depending on network usage at different nodes. Enterprise clients demand robust services with built-in redundancies and are ready to invest money in dedicated lines for the same. Further, it would result in the enterprise’s network being used to route calls made by other Skype users. This will take up some part of the enterprise’s bandwidth. Whether or not, Skype’s business solutions address these issues still remains to be seen. • Value added services: VoIP providers could move on to a model of offering basic telephony services for free or at very low prices and generating revenues on value added services such as video conferencing, voice mail, etc. Skype plans to introduce these services for a fee. VoIP providers could also offer these solutions at comparable prices.

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Impact of Skype on Telecom Service Providers

5 Conclusion Incumbent telecom operators offering fixed and mobile services are likely to face a significant risk of permanent reduction in profitability of between 22-26 percent by 2008 due to Skype on the retail segment alone. There will be a significant reduction in profitability due to an erosion of long-distance revenues in the business customer segment, once Skype and other VoIP providers offer viable solutions in this segment. European operators are much more exposed due to the characteristics of European telecom markets, since calling and roaming rates are higher and since local calls are charged by the minute. Additionally, a combination of mobile phones and Skype via internet delivered by cable may make fixed line access redundant altogether thereby resulting in a decline in subscription access fees. In a base case scenario, Fixed line operators will be much more exposed than mobile operators, as a much larger share of the fixed line traffic will be exposed to Skype. However, mobile operators will face much more significant exposure, once Skype and other VoIP players offer mobile solutions by reducing roaming fees and mobile voice traffic significantly. VoIP players not using P2P technology in the retail segment might not survive on their current business model, since P2P technology has an inherent cost advantage and is likely to retain a quality advantage as well. Skype’s competitiveness in the enterprise segment will have to be seen, once Skype introduces its business solutions. In conclusion, Skype represents a major disruptive force for all telecom service providers and will result in a faster than expected convergence of voice and data traffic. Skype will accelerate the already underway change in telecom business models, to one where basic voice services are offered free of cost and are subsidized by revenue generated from value added services.

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Impact of Skype on Telecom Service Providers

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