SKYPE
In the hands of eBay, Silver Lake, and Microsoft
Larry Fan, Aly Kassim-Lakha, Betty Liu, Cristina Peruyera, and Kimberly Yao
December 12th, 2014 Professor Emilie Feldman MGMT 249

Fan, Kassim-Lahka, Liu, Peruyera & Yao | MGMT 249

Executive Summary Skype was founded to build and provide a telecommunications application, and despite many changes in ownership, its core business has not drastically changed over the years. Over the past decade, Skype has seemingly thrived to varying degrees under the leadership of eBay, Silver Lake Partners, and now Microsoft. The different visions each acquirer had for Skype and its integration made all the difference in Skype’s value at each stage. In the following paper, we will investigate how each of the three companies chose to acquire, integrate, oversee, and potentially divest Skype, and thus unlocking or creating value through the process. By analyzing information databases and news archives regarding Skype as well as utilizing course frameworks and scholarly papers discussing merger and acquisitions, we will argue that Microsoft has been more successful in integrating Skype than eBay has, though Skype’s long-term success in the hands of Microsoft remains uncertain. In addition, Silver Lake Partners was able to unlock value in Skype using a different set of perspectives as a financial acquirer. Throughout it all, Skype has continued to innovate and provide free services to millions of users globally.

Introduction In 2002, Scandinavian entrepreneurs Janus Friis and Niklas Zennstrom founded Skype, which offered free, high-quality computer-to-computer calls between private users (Aamoth, 2011), and in the course of doing so, revolutionized the Voice over IP (VoIP) provider industry. At the time, the VoIP industry of providing “real-time communication services that deliver communication through a web-based software platform” was limited to businesses due to high prices (Kahn, 2014). The founding of Skype consequently launched the “second generation of Voice over IP” companies that tailored towards consumers rather than businesses (Das, 2008).

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A small company operating out of Estonia, Skype released its first beta version of a peer-topeer voice calling application software in August 2003. Skype was able to extend the VoIP technology to consumers using a “freemium” model: Skype users could either call each other for free or call phones at low rates (Gobry, 2011). The few users using the proprietary service could then pay enough to cover the majority of users who would enjoy a free service. The strategy allowed Skype to be highly scalable at a low cost since it relied only on a closed, Internet-enabled network and, most importantly, benefited from the network effect (Kahn, 2014). Skype avoided incurring significant marketing expenses when its users themselves encouraged friends and family to sign up so they could call one another for free. With its peer-to-peer voice calling and instant messaging capabilities, Skype was able to capture about 3 percent of the international call market within its first two years (Porterfield, 2013). Skype’s ability to successfully gain international scale and ensure software compatibility across multiple computer platforms allowed for the company to expand rapidly. Its success captured the attention of Internet giant and e-commerce company, eBay, which purchased Skype for $2.6 billion in October 2005 (eBay Inc., 2005). During this period under eBay, Skype developed the videoconferencing capabilities it is known for today (Porterfield, 2013). Though Skype was earning annual revenue of nearly $200 million by 2006, eBay decided to replace the founders with new management and divest Skype after four years of ownership (Statista, 2014). Silver Lake Partners, a technology-focused private equity firm, bought the majority stake in Skype from at a valuation of $2.75 billion in October 2009 (Silver Lake Partners, 2009). After turning Skype around, Silver Lake sold Skype to Microsoft for $8.5 billion after only two years, and Skype remains under Microsoft’s leadership today (Skype, 2011). Using the valuation of Skype as a proxy for what each of the three companies intended to Skype for, Skype’s three acquirers evidently saw vastly different amounts of value in the same firm.
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Objective We will investigate how eBay, Silver Lake, and Microsoft chose to acquire, integrate, and manage Skype differently and therefore achieve varied results. We aim to support our conclusion using class concepts such as needs assessments, sources of value, due diligence, six elements of integration, and divestiture methods among others.

Argument Through detailed analysis and extensive research, we have determined that Skype has performed better under Microsoft than eBay due to more logical acquisition rationale and successful integration. Furthermore, Silver Lake was able to unlock much potential in Skype as a financial acquirer by focusing on improvements to its core business rather than attempting to create synergies.

The eBay Years Founded in 1995 as an online auction website, eBay emerged from the dot-com bubble as an e-commerce giant and Internet success story. At the time, the e-commerce industry was booming due to growing customer adoption of the computer and the Internet, as well as online shopping from both Generations X and Y populations (Lerman, 2014). This led to increasing competition as more and more innovative start-ups were established, but eBay remained an industry leader largely due to its loyal customer base and vision of cutting out the middleman by directly connecting buyers and sellers. Under CEO Meg Whitman, eBay experienced rapid, double-digit growth for a decade by expanding products and services (eBay Inc., 2008). As early as the late 1990s, eBay expanded its range of products and services to become an all-encompassing online auction website. In addition, eBay undertook its initial public offering (IPO) in 1998 with its stock price tripling on the first day alone and consequently raised more than $60
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million in capital, demonstrating consumer excitement and investor awareness for profit (Hsiao, 2009). Lastly, eBay identified and acquired several high-growth technology companies for potential complementary products and services—the largest being online payment company PayPal, which eBay acquired for $1.5 billion in 2002 (Hsiao, 2009). eBay and PayPal were truly stronger together, as many eBay users needed a trusted way to exchange money, and the two companies grew through the complementarities that each other provided. Driven by PayPal’s noticeable success, eBay began to search for another company that could add major complementarities and synergies. Meg Whitman and the eBay leadership believed this company was Skype, as it had potential to generate significant value based on its high revenue growth and shared a “similar vision in connecting people and cutting out the middleman,” according to a personal interview with former Skype CEO Josh Silverman (2014). Facing choices of how to best utilize Skype’s potential, eBay decided to go with the acquisition route. Several key factors served as reasons to why eBay preferred to acquire Skype. For one, eBay was driven to obtain Skype’s hard resources, its patent-protected VoIP technology innovations, so an acquisition made more sense than an alliance (Hsiao, 2009). Furthermore, reciprocal synergies and rivalry also supported the acquisition decision. The entire idea of adding another powerhouse to eBay’s portfolio arose from the idea of reciprocal synergies. In Skype’s case, eBay envisioned closely integrating VoIP as part of the auction process, so knowledge sharing would be required. In addition, multiple companies were considering acquiring Skype, a three-year-old innovator that was seemingly young enough to be integrated easily, so a partnership would likely have been thwarted. Internal development was also a weaker method than acquisition, as eBay believed it would be too costly and time-intensive to develop capabilities that mirrored Skype’s existing technology and to build a competitive customer base. The market seemed to agree with

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eBay’s decision, as its stock price jumped by 2.4 percent on the day of the acquisition announcement (Exhibit 1). Although on the surface, acquiring Skype seemed to be a rational decision, further analyses showed that eBay poorly assessed the sources of value that Skype would generate post-acquisition. As a result, the reality of the acquisition did not match the expectations that eBay original had for the purchase. At the time, eBay believed it needed VoIP technology, cross-selling opportunities, international expansion, and innovative people. eBay sought VoIP technology as a resource, as it could potentially increase trust between eBay customers with an integrated Skype platform providing the option for buyers and sellers to discuss products and for buyers to communicate during bidding wars (eBay, 2008). Had eBay conducted in-depth market research, however, they would have realized that their customers actually preferred anonymity and did not wish to intimately communicate with each other using Skype’s asset (Silverman, 2014). As for the process, VoIP technology was never well integrated into eBay’s website. eBay had intentions to leverage cross-selling opportunities and international expansion as capabilities. In regards to cross-selling opportunities, eBay believed it could convert Skype’s users through the network effect of having more customers. As a fully integrated third leg, Skype could even allow users to wire money to each other through PayPal (eBay Inc., 2005). No unusual growth of either party was recorded following Skype’s acquisition, so this asset never materialized (Statista, 2014). Meg Whitman also never formulated a synergy strategy to utilize the business units’ services in combination (Mance, 2013). In addition, eBay needed international expansion as a capability, and Skype seemed to perfectly satisfy this need considering its growing popularity and product adoption around the world. Despite Skype’s international users showing potential to be a strong asset, Skype’s existing international user base proved to have limited reasons or incentives to use eBay considering
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eBay primarily served the domestic U.S. market. Thus, eBay never successfully captured Skype’s global customer base. Finally, eBay wanted innovative manpower as a component of culture since eBay itself lacked people who were capable of developing and integrating Skype’s VoIP technology. Likewise, business-minded eBay envisioned adding value to entrepreneurial Skype by providing guidance to a rapidly expanding Internet company. In reality, eBay and Skype continued to operate very separately. In fact, when they tried to work together, they often clashed for many reasons—one being the aforementioned business-minded versus entrepreneurial difference. This point was not to be underestimated, as change strategy expert Dr. Jerry Want argued that culture is a significant contributor to merger failures in the current age of radical change (2003). All things considered, although it seemed that acquiring Skype could have more or less fulfilled eBay’s needs on the surface, further analyses demonstrated that the sources of value that Skype could actually offer did not meet eBay’s expectations. According to former Skype CEO from 2008 to 2010, Josh Silverman, this was because the above needs were repackaged for public relations purposes (2014). In actuality, Meg Whitman had passed up the chance to acquire Google and was not willing to make the same mistake again. Thus, eBay leadership was hopeful and eager to buy the next big thing, and when they saw Skype as a potential target, they were rash in their decisionmaking, choosing to gloss over comprehensive due diligence and market research in favor of an optimistic vision. According to a Harvard Business Review article, high-quality due diligence should be more than verifying data—acquirers should also “put the broader, strategic rationale for their acquisitions under the microscope…acting as a counterweight to the excitement that builds when managers begin to pursue a target” (Cullinan et al., 2004). Josh Silverman also believed that the rationales eBay articulated in press releases clearly did not make sense. Using the press releases’ justification that VoIP will allow eBay sellers and buyers to communicate better and thus boosting
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sales, he instead explained in a personal interview (2014) “most sales on eBay are made through power-sellers who do not have the time to call each individual potential buyer. This would have meant hundreds if not thousands of calls,” which was clearly not feasible. Once eBay realized

that its reasons for buying Skype were inconsequential, eBay decided to divest the company. In particular, few relational rents were realized under a difficult environment for execution and culture clash among other issues. Limited synergies and relational rents materialized after the acquisition. There turned out to be few co-specialized assets and complementary resources and capabilities, as eBay and Skype operated in different industries of e-commerce and telecommunications, respectively. The only way they could have created value is if each company’s users adopted the other’s service, but as discussed earlier, the users had no motivation to do so. Since Skype continued to operate out of Europe, it was especially difficult to govern and share knowledge across borders (Skype Fast Facts, 2008). Additionally, the environment for execution was tough. Though Skype was growing rapidly and gaining 150,000 users per day, the high costs and high risk that eBay incurred from the acquisition did not justify the cost of the purchase. The acquisition price of $2.5 billion was especially significant, considering Skype was not yet profitable. Moreover, eBay was not able to control Skype very well since it was still operating out of Europe and not carefully managed or integrated. Furthermore, as eBay attempted to impose its bureaucratic structure and processes on Skype, it slowed down the process of developing Skype’s videoconferencing additions. In fact, eBay’s leadership discontinued attempts to integrate Skype into the eBay company structure one year in (Ignatius, 2011). Another contributing factor was the culture clash between the two companies. eBay was and still is a profit-driven company, especially relative to the innovative technology industry. eBay has historically achieved approximately 20 to 25 percent profit margins, so Skype operating at a net loss,
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even with high revenue growth, was weighing down eBay’s financials (Yahoo! Finance, 2014). Skype likely did not understand this mentality, as it cared more about its products and growing its user base. Most Skype employees were entrepreneurial and came from an engineering background, making it difficult for them to understand the bureaucracy that was eBay (Mance, 2013). On top of it all, there was also a national culture clash. Skype was a company with Estonian roots operating out of Luxembourg at this point, whereas eBay embraced Silicon Valley and American values. From the first day, the culture clashes damaged the relationship between eBay and Skype. eBay realized these issues more formally through a year-long review of Skype in 2008, when it replaced Skype’s founders with eBay and Shopping.com executive Josh Silverman. eBay was against the idea of eBay being a “broader Internet portal, like Yahoo! Inc. and Google Inc.” and only wanted to hold onto acquisitions that could help “create an unparalleled e-commerce engine” (eBay Inc., 2005). In addition, eBay did not want to retain an unprofitable venture. Therefore, instead of allowing Skype to operate independently under its ownership, eBay CEO John Donahoe admitted that Skype would be “an enormously successful way to connect people, but not through commerce” and rightfully decided to divest Skype (Ignatius, 2011). eBay had three choices: spin-off, selloff or buyout, and liquidation. Liquidation was not an option, as Skype still had much unrealized potential and would likely not be valuable sold in pieces, seeing as how it did not hold onto that many assets and resources. In April 2009, eBay announced that it would plan to divest Skype and began preparing it for an IPO scheduled for 2010 (eBay Inc., 2009). CEO of eBay Inc., John Donahoe, admitted that eBay was seeking both immediate and longterm value in potentially high valuations of Skype (eBay Inc., 2009). eBay was able to frame the spinoff in a positive light in terms of potential capital raised and successfully avoid negative press at first. However, at the time Skype’s founders were suing the company for how it handled the patented resources during their own tenure (Mance, 2013). These legal issues, as well as the intrinsic difficulty
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of valuing innovative technology firms and overall market uncertainty, reduced Skype’s estimated valuation to—in eBay’s opinion—a measly $2 billion (eBay Inc., 2009). While eBay continued to submit IPO filings for Skype, Donahoe also announced that eBay would be considering acquisition offers as well. A selloff made sense for Skype, as it could generate more value with better management and potentially even add value to a different parent firm. Though the low valuation likely made a negative impact on Skype’s offers, eBay was willing to consider any bid that offered more short-term value than a $2 billion IPO (eBay Inc., 2014). A group of technology investors led by private equity firm, Silver Lake Partners, offered to buy a majority stake in Skype at a valuation of $2.75 billion in 2009. eBay Inc., desperate to get Skype off its hands in exchange for money, agreed to the terms, though it retained a 30 percent stake in Skype (eBay Inc., 2009). eBay issued optimistic press releases and company announcements, using its minority stake as a signaling effect to illustrate that it still believed in Skype

Transformation under Silver Lake Partners As a private equity firm and financial acquirer, Silver Lake Partners focused on leveraged buyouts and growth capital investments in mature technology companies. When Silver Lake acquired a 70 percent stake in Skype for $1.9 billion of Skype’s total $2.75 billion valuation, it made the largest equity investment in its history at $940 million (Vance, 2011). Financial acquirers (e.g. Silver Lake) and strategic buyers (e.g. eBay) typically treat and evaluate targets differently. While both look to buy targets with long-term revenue and profit potential at good prices, they have dissimilar motivations. For instance, strategic buyers usually seek to integrate company operations and ultimately achieve revenue and cost synergies. On the other hand, financial buyers base their investment decisions purely on future company potential since there is no possibility for integration. Moreover, financial buyers do not face as many limitations and can thus take larger risks than
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strategic acquirers who have to satisfy shareholders and deal with public and press reactions (Aiello and Watkins, 2000). However, Skype employees complained that Silver Lake was too ruthless and money-driven without a care for Skype employees (Yeeguy, 2011). Though Silver Lake was not able to offer Skype integration potential or cross-selling opportunities, it added value to Skype from 2009 to 2011. In addition, Silver Lake focused on improving Skype’s product development cycle, giving Skype the room to grow again, and resolving aforementioned intellectual property issues. As a financial acquirer, Silver Lake allowed Skype to focus on the long-term instead of shortterm synergies, which was the case for Skype under eBay. Silver Lake swiftly recruited a new management team, including new CEO Tony Bates. They more aggressively pursued the strategic partnerships that Skype established with Verizon during its time at eBay, adding Samsung and Panasonic to the list (Silverman, 2014). This proved to current and potential public investors that Skype could coexist with telecom giants and circumvent competition from mobile providers. Furthermore, although Skype released the videoconferencing application it is famous for today during its years at eBay, Skype’s process of pushing out product updates and new product lines decelerated significantly under eBay’s bureaucratic leadership (Vance, 2011). As such, Skype risked becoming an outdated platform in light of increasing competition from the “third generation of VoIP technology” led by players such as Google Voice (Das, 2008). Under Silver Lake’s two-year ownership, Skype launched several new products including Skype Mobile and Skype Connect. More precisely, Silver Lake dramatically reduced Skype’s product release cycle from six months to one month (Yeeguy, 2011). Silver Lake also successfully unlocked Skype’s value by resolving the patent litigation issues, which arose when eBay acquired Skype without sorting out its licensing issues or develop a strategy to rewrite the code. Specifically, Skype licensed core technologies from Joltid, which was a company controlled by Skype’s founders, and thus Skype’s founders only shared the intellectual property with
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Skype because they owned both companies (Silverman, 2014). As a result of being replaced Silverman as the top Skype executive, the Skype founders sued eBay for misusing the license it had bought from Skype (Silverman, 2014). Because this issue continued without resolution by the time eBay began filing for Skype’s IPO, Skype was unable to achieve an accurate valuation without owning its core technology. Under Silver Lake’s leadership, however, litigation issues were made a priority and quickly resolved, transforming Skype to a liquid investment as Silver Lake continued to submit IPO filings. After only a year under Silver Lake, Skype became much more attractive and received considerable acquisition offers, even though it was still operating at a net loss of $7 million (Kim, 2011). In May 2011, Microsoft announced that it would be acquiring Skype for a whopping $8.5 billion (Skype, 2011). This was $5.75 billion more than Silver Lake had paid for Skype only twenty months earlier, resulting in an approximately 80 percent internal rate of return (IRR) in only eighteen months. For reference, the standard in the private equity industry is about 20 percent (Harris, 2012). The deal sent shockwaves around the technology industry because of the deal size and speed at which Silver Lake was able to generate enormous returns. Skype employees “celebrated the huge potential of the Microsoft deal,” though Silver Lake was planning on firing more employees in order to maximize profits (Yeeguy, 2011). While Silver Lake undoubtedly added value to Skype, it was unclear if it added $5.75 billion worth of value; multiple factors contributed to their fortuitous situation. For one, Silver Lake was able to purchase Skype from eBay at a discount through stronger due diligence and negotiation. According to corporate development experts Aiello and Watkins, financial buyers have a superior ability to screen, plan, negotiate, and execute (2000). Though this was crucial in enabling Silver Lake to achieve its results, it was still highly unusual for a financial buyer to achieve an 80 percent return in less than two years. Another theory argued that Silver Lake did not create any value—rather, it
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unlocked value by settling the founder disputes and litigation issues. This made it possible for Skype to go public and ultimately gave Silver Lake more leverage when negotiating the Microsoft acquisition. Furthermore, Microsoft may have been caught in a bidding war, attempting to prevent Facebook and Google from acquiring Skype (Bright, 2011). Microsoft strived to stay relevant in the face of immense competition from younger technology firms such as Facebook and Google who were already in the social market, a wave that Microsoft missed and thus was willing to overpay for. Through an interview with former CEO Josh Silverman who spent minimal time overseeing Skype under Silver Lake, it seemed that Silver Lake had not added $5.75 billion. Rather, Silver Lake had negotiated well in the purchase and “was willing to take the risk of buying Skype given the issues the company was facing,” and Microsoft had overpaid (Silverman, 2014).

Microsoft’s Current Ownership of Skype Technology giant Microsoft finalized its $8.5 billion acquisition of both Silver Lake and eBay’s stakes in Skype on May 10, 2011. Microsoft paid a sum worth 32.2x EV/EBITDA—much higher than the average industry multiple of about 7x (SDC Platinum, 2014). Microsoft used cash from overseas, allowing it to receive some tax benefits, but not enough to explain the huge premium paid. While many analysts and investors were shocked that Microsoft overpaid by approximately $5 billion more than Skype’s valuation—reflected by the 1.9% drop in share price—both Silver Lake and eBay profited from this deal (Yahoo! Finance, 2011). eBay in particular announced to its investors that it was able to make an easy $1.4 billion off Silver Lake’s work (eBay Inc., 2014). Though Microsoft was a well-respected global brand, it was deemed to be increasingly irrelevant as it faced limited growth and minimal differentiation in the mature, highly concentrated software industry. Realizing rapid growth in the IP communications space, Microsoft felt it needed to find a way in as a means of staying competitive and relevant in the wake of changing consumer
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demands towards increasing connectivity among electronic platforms (Clemons, 2011). Specifically, Microsoft sought to take advantage of Skype’s unique combination of peer-to-peer VoIP technology as well as its large brand-aware user base to become a key player in the technology sector by crossselling and bringing together all of Microsoft’s business units through the integration of Skype across all existing Microsoft products and platforms (Exhibit 2). Microsoft first had to consider whether to ally or acquire Skype in order to utilize its resources and potential synergies. Though Microsoft sought both hard and soft resources, Microsoft was specifically hopefully of taking hold of the patent-protected VoIP technology and code more so than the people since it already had many engineers. Despite this hard resource being relatively redundant since Microsoft already had Lync—a VoIP communication and instant messaging tool, Microsoft believed that Skype’s peer-to-peer component made it easier to make video calls, and its features were easily adaptable across all products with minor changes. Furthermore, Microsoft wanted reciprocal synergies, which Skype would be able to provide. Whereas Microsoft wanted the intellectual property and user base as well as tacit knowledge sharing, Skype could gain brand credibility through Microsoft’s partnerships, broad customer reach, and—most importantly, what eBay could never have offered—tacit knowledge from Microsoft’s superior technical abilities. Over time, the synergies would become increasingly reciprocal in nature, as Microsoft could utilize Skype in order to diversify its products and carve out a unique position in the market. For instance, under Microsoft’s guidance, Skype recently developed Skype Translator, a tool that can translate between languages during Skype calls. In this case, Microsoft brought ten years of experimentation in Microsoft Research, while Skype provided the platform that Microsoft could use to demonstrate its innovativeness (Arce, 2014). Therefore, Microsoft rightfully decided to acquire Skype in order to access its hard resources and reciprocal synergies.

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In consequence, when rumors of Facebook’s, Google’s, and Cisco’s interest in Skype circulated, Microsoft insisted on a “no shop” negotiation process, meaning that Skype could only negotiate with Microsoft on their deal (Rosoff, 2011). In a sense, Microsoft desperately escalated its commitment to buying Skype by ordering this negotiation method, but in the end negotiations ended up going smoothly and Microsoft positioned itself to get out of third place in the IP communications sector. In order for Microsoft to consider Skype so seriously, Skype had to offer Microsoft more than just a way to compete better in the IP communications industry. In particular, Microsoft had a few specific resource, capability, and culture needs that Skype could potentially fulfill. For example, Microsoft wanted Skype’s VoIP technology as a resource to serve as a linkage between Microsoft’s existing products (Rosoff, 2011). The tool could be integrated across all of Microsoft products and fulfill its need for increased connectivity. Skype was able to deliver on this front, as Microsoft easily manipulated its peer-to-peer VoIP code to be rolled out across its different electronic platforms. While eBay had also looked to use Skype’s VoIP technology, Microsoft had a better and more easily controllable plan to integrate the technology into its existing platforms. Skype in particular had complementarities with Microsoft’s Lync. Skype’s high-quality VoIP innovations made more sense in conjunction with Lync, rather than an online auction website. Plus, in Microsoft’s eyes, Skype’s VoIP technology was exactly what allowed it to stay relevant in the wake of changing industry trends and norms. Microsoft also sought a company with a considerable customer base for more cross selling opportunities, given it had always been one of Microsoft’s strongest capabilities and core competencies. Growing its user base is key since the player with the highest market share in a concentrated market wins (Rosoff, 2011). In March 2011, Skype easily satisfied this need with over 600 million registered users (Wauters, 2011) and 30 million active online users (Skype, 2011).
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Microsoft CEO Steve Ballmer has always emphasized the need for Skype to be working on all platforms, not only Windows, in order to provide value as a communications software (Wingfield, 2012). However, Microsoft likely did not pay a $5 billion premium just to access a new customer base. Based on the deal terms, this meant Microsoft paid over $1,000 for each Skype user. Meanwhile, each Skype user was only worth an annual profit of $30 based on the assumption that Skype’s income came from subscriptions and call charges (Bright, 2011). The large discrepancy suggests that Microsoft saw other sources of value in Skype. However, Microsoft was somewhat able to find a use for Skype’s established user base. Since Microsoft already had an established hold on the business-to-business market with its existing software products—especially the ubiquitous Microsoft Office applications—it now aspired to shift towards a business-to-consumer model. The corporation already used Lync, but it was again meant for businesses instead of consumers. Skype provided Microsoft a chance to offer a product and therefore get in touch with many consumers. Although Microsoft’s processes were to be adopted given its scale and demonstrated success, Skype’s model aligned perfectly with Microsoft’s intended switch to a more consumer-facing setup. Lastly, Skype could provide Microsoft with more opportunities for partnerships and client relationships. CEO Steve Ballmer wanted to expand Microsoft’s current relationships with other major technology, particularly those in the mobile phone industry due to widespread growth in mobile applications (Gross, 2011). Thanks to eBay and Silver Lake, Skype already had strategic partnerships with several major mobile phone carriers, including Samsung Electronics, Verizon Wireless, and Hutchison 3G UK (Capital IQ). These relationships may have helped when Microsoft released the Windows Phone. Potential risks included moderate integration complexity and some market uncertainty. On the first front, Microsoft ended up integrating Skype slowly, waiting for years to realize synergies and
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only this past summer combining the two teams (Krater, 2014). There may also have been a potentially uneven give-and-take relationship—with Microsoft selfishly having more to gain—and questionable ability to transfer knowledge and retain employees. But their overlapping technologies and thus easily combined software were able to somewhat balance out the integrative complexity (Bright, 2011). In addition, Skype was still not profitable at this point in time, so Microsoft was unsure if VoIP communication market could be commoditized. Clearly, it desired to more aggressively monetize Skype’s “freemium” business model while retaining its customer base. Skype was also facing increasing competition and saturation of the market with relatively new players like Google Voice and Apple’s FaceTime. On top of that, there was always the added typical uncertainty of the technology industry as a whole. On the other hand, Microsoft’s acquisition matrix overall looked better than eBay’s since it was able to exercise more control over Skype than eBay did. Microsoft requested that Skype add a new headquarters location in Redmond, Washington, to increase contact, knowledge sharing, and influence (Microsoft, 2013). The corporation was also able to fully control Skype’s intellectual property and tailor it to Microsoft’s code. Nevertheless, Microsoft still believed Skype to have growth potential, though it was costly and risky. Microsoft still faced many challenges similar to eBay’s. All in all, Microsoft’s dependence on long-term revenue synergies—rather than short-run cost synergies—truly led Microsoft to justify the high premium. This allowed Microsoft to avoid an illogical decision like the HP-Compaq acquisition that focused on cost synergies rather than existing customer bases and products. While Microsoft is still integrating Skype into the rest of its ecosystem, it has been able to meet several goals for the integration. First, Microsoft wanted to merge Skype’s peer-to-peer VoIP technology with its existing VoIP offerings. Early on, Skype’s code was adjusted to bolster Lync’s capabilities. Additionally,
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Skype has, to date, been integrated into XBox Live, Messenger, Outlook, and Office. Microsoft had not bothered adding Skype to the Windows Phone, preferring customers to call each other using the cell phone plan minutes instead of Skype. Besides, Windows Phone has not proven to be particularly successful so far. Next, Microsoft sought to realize revenue streams by finding ways to make Skype profitable on its own. Conversation Ads were launched recently to increase Skype’s average revenue per user by displaying advertisements on the side of the free video calls. More importantly, it wanted to launch new, innovative products. As mentioned earlier, a strong differentiating factor between Microsoft and eBay was Microsoft’s extensive research on Skype Translator, according to former Skype employee Kelly Krater. Since “Microsoft had been developing a language translating software for a long time,” they needed an international communications platform to debut it on, and “Skype was the perfect brand to go forward with this new technology because of its widespread consumer base throughout the entire world” (Krater, 2014). Skype Translator was just announced to the public in 2014 after many years of innovation, research, and development, and is expected to revolutionize the industry next year (Arce, 2014). In spite of these goals, Skype’s added value to Microsoft still remained in its simple integration into current product offerings. Finally, Microsoft wanted to integrate both firms’ people and cultures in order to ensure knowledge transfer and collaborate on new ideas together. Due to the aforementioned slow speed of integration, the two companies only just reorganized more than three years after the acquisition took place, due to Microsoft’s bureaucratic structure and processes. Even today, “there still exists a lack of communication between Skype and Microsoft’s other business units,” as Microsoft business units tend to be siloed and complex enough within themselves (Krater, 2014). Along these lines, McKinsey specialist Oliver Engert explained that revenue synergies take approximately four or five years to realize, so Microsoft is likely still integrating Skype (2014). Only
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time will tell how successful Microsoft’s integration of Skype will be, but for now it seems like it at least makes more sense than eBay’s.

Key Takeaways In conclusion, Microsoft has been more successful in handling Skype than eBay due to a clearer vision for integration into its existing business. Both wanted to incorporate Skype into the company ecosystem, but only Microsoft already had the technological knowledge and expertise in this field through Lync, XBox Live, and Microsoft Messenger. Microsoft clearly wanted a larger customer base and a way to reach out to consumers instead of businesses. On the other hand, eBay’s judgment was clouded in that it did not want to miss out on another “Google opportunity”. As a result of this rash decision, eBay failed to understand what both its and Skype’s users wanted when eBay rushed through the process of conducting market research to see if their own customers would even appreciate the integration. In addition, eBay did not have much to offer Skype except the loose promise of cross selling and growing the user base. Meanwhile, Microsoft had a clearer plan for how it could add value to Skype by giving Skype the large-scale technology infrastructure that it needed, platforms such as Lync, and over ten years of research for Skype Translator. Microsoft and Skype shared co-specialized assets since they were in similar industries. Still, the give-and-take relationship between Microsoft and Skype were a bit uneven, hence the lack of knowledge sharing and overall feeling that Skype employees are separate from the rest of Microsoft. If Microsoft continues to improve this relationship going forward with the reorganization this summer, they can transfer more knowledge between each other and therefore create more revenue synergies. Of course, eBay received a much better financial deal than Microsoft did since eBay profited from Microsoft’s overpayment. Skype’s apparent $8.5 billion value to Microsoft is very dependent on its ability to realize revenue synergies. According to Stern Professors Damodaran, “If Skype can
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deliver revenue growth over 35% and pre-tax operating margin over 30%, then the deal is worth its price,” though he notes this is highly unlikely (2011). These potential revenue synergies are dependent on ability to transfer knowledge and address the market uncertainty due to increasing competition from Apple, Facebook, Google, and mobile applications. Conversely, a financial acquirer, Silver Lake was able to focus on Skype instead of how Skype would fit into the bigger picture. Though financial acquirers cannot offer reciprocal synergies to targets like Skype, they can offer them the freedom to innovate and release products, which is key to a company like Skype. In general, acquirers should always conduct due diligence and market research before assuming integration and synergies, even under the time pressure of a bidding process. The escalation of commitment and willingness to pay to foreclose competitors can push potential bidders to go through with the acquisition, but determining a walk-away price and standing by it is a crucial part of due diligence (Cullinan et al, 2004). Shared values are very important, as Skype pushed back on eBay’s profit-driven mindset; this may even prove to be a problem for Microsoft as it seeks to monetize Skype in the future.

Further Research Going forward, it may prove useful to investigate eBay’s and Microsoft’s other acquisitions to determine whether Skype was an extreme case for either companies. For instance, evaluating how eBay conducted due diligence on PayPal could prove to be useful in adding recommendations to eBay’s corporate development strategy as a whole. On the other hand, Microsoft has made a few unexpected and difficult to justify decisions, so looking into why, for example, Microsoft chose and integrated Nokia among other companies could add perspective to our Microsoft analysis.

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Exhibits Exhibit 1

(Yahoo! Finance, 2014) Exhibit 2

(Bryce, 2011)

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eBay Inc. (2014, March 3). Statement by eBay Inc.: EBay Inc. Reiterates "The Truth About Skype" Retrieved October 12, 2014. Engert, O. (2014, November 24). Lessons on Mergers and Acquisitions. Lecture conducted from University of Pennsylvania, Philadelphia, PA. Friedman, L. (2010, October 20). Apple introduces FaceTime for Mac. Macworld. Gobry, P. (2011, April 8). EXPLAINER: What Is The Freemium Business Model? Retrieved October 11, 2014. Gross, D. (2011, May 10). Five things Microsoft may do with Skype. Retrieved November 10, 2014. Harris, R., & Jenkinson, T. (2012). Private equity performance what do we know? Cambridge, Mass.: National Bureau of Economic Research. Hsiao, A. (2009). How did eBay start?: A brief history of eBay. About. com. Retrieved October 11, 2014. Ignatius, A. (2011, March 1). How eBay Developed a Culture of Experimentation. Retrieved November 29, 2014. Lerman, S. (2014). IBISWorld Industry Report 45411a. E-Commerce & Online Auctions in the US. Retrieved November 8, 2014 from IBISWorld database. Kahn, S. (2014). IBISWorld Industry Report 51711e. VoIP in the US. Retrieved November 12, 2014 from IBISWorld database. Kim, R. (2011). Microsoft Makes $8.5 Billion Skype Buy Official. Retrieved November 30, 2014. Mance, H. (2013, August 28). Skype’s First Decade Reflects a Trail of Missed Opportunities. Financial Times. Retrieved November 8, 2014. Microsoft. (2013). 2013 Annual Report of Microsoft. Porterfield, J. (2013). Niklas Zennstrom and Skype. The Rosen Publishing Group. Rosoff, M. (2011, May 12). Microsoft Insider: Here's Why We Bought Skype. Business Insider.
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SDC Platnium (2014). Complete Financials/Multiples Report on Microsoft-Skype Deal. Retrieved November 9, 2014 from SDC Platinum Database. Silver Lake. (n.d.). Silver Lake - Overview. Retrieved November 11, 2014. Silverman, J. (2014, November 12). Former CEO of Skype. (A. Kassim-Lakha & K. Yao, Interviewers). Skype. (2011, May 10). Microsoft to Acquire Skype. Retrieved October 11, 2014. Statista. (2014). Skype: Annual revenue from 2006 to 2010 | Statista. Retrieved November 17, 2014. Vance, A. (2011, May 11). Silver Lake Partners Wins $2.9 Billion Skype Payday. Retrieved October 16, 2014. Wang, J. (2003). When worlds collide: Culture clash: Corporate culture – illuminating the black hole. Journal of Business Strategy, 24(4), 14-21. Wauters, R. (2011, May 10). Done Deal! Big Deal. Smart Deal? Microsoft Buys Skype For $8.5 Billion In Cash. TechCrunch. Retrieved November 29. Wingfield, N. (2012, May 28). $8.5 Billion Deal for Calling Service Presents a Puzzle. Retrieved October 10, 2014. Yahoo! Finance. (2014). EBAY Historical Prices. Retrieved October 23, 2014. Yahoo! Finance. Microsoft Corporation (MSFT). Retrived November 9, 2014. Yeeguy. (2011, June 24). How employees get screwed in private equity deals. Retrieved November 30, 2014.

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