Why Skype’s Peer-to-Peer Voice over IP Is Revolutionary

The Customer Revolution Continues: End Users' Adoption of Skype Could Challenge the Global Telecommunications Industry

February 5, 2004

Skype offers a compelling combination of voice over IP telephone service and presence awareness, leveraging peer-to-peer networking. The result is a killer app--an application that makes it advantageous for households and businesses around the world to upgrade to broadband. Skype’s impact on telecommunications companies will be profound. It challenges the notion that users should pay for phone calls by the minute.


Voice over IP (VOIP) has come of age! Our own small business needed to replace its entire phone system in early 2004, and our quick research revealed that we’d be much better off moving to VOIP than replacing our internal phone system or signing up with some phone company’s centrex system. We’ve purchased 3Com’s affordable SuperStack 3 NBX Networked Telephony Solution for use in our office, homes, and from our traveling PCs. We now have combined VPN, WiFi, and VOIP capabilities for less than the cost of replacing a standard small business PBX. We’re just taking an evolutionary step: Our phone system in the office works like a regular phone switch; it only uses VOIP when we access it from our homes or computers via VPN. But there are more subversive implications of the VOIP wave. What happens when you combine VOIP with peer-to-peer networking?

Skype’s P2P IP Telephony Takes Off

While we had heard of Skype, we just thought it was another neat technology to keep in our peripheral vision until we recently noticed the following “heads up.” In a letter to Mark Anderson, publisher of the Strategic News Service, dated September 24, 2003, Beau Vrolyk, managing director of Warburg Pincus, wrote:

Peer-2-Peer may have just found its killer app. Of course in their last act (Kazaa) this team caused a minor disruption to the Recording Industry. This time they have chosen an area in which the author of the content (you doing a voice call) owns it, the network is in place and already sold at a flat rate, and all that one needs is the connection directory service that Skype so gracefully provides…As you look at the Skype client you discover that it does a number of fun things. In addition to call logging, you can call someone back with a simple double-click on their name, you can call friends by their "name" rather than a ten digit phone number, you can see pictures of those you intend to call or who are calling you, and you can have multiple "personalities" with different "names" for when you’re in different moods, the list is quite extensive. Note that many of these features have existed for years on the various instant messenger services and still don’t exist in any phone system of which I’m aware. Did I mention that it is fully integrated with text messaging from one’s unified "friends" list, that you can sort your call log, or that you can set your status as "away" or "busy"? My conclusion is that this overlay network has more and superior features than a wire-line phone system today, costs nothing incrementally over what you’ve already spent on your PC, and is the largest threat to traditional telephone wire-line service to date.

What’s Skype? Skype is free software that you download from the Internet. Once installed on your PC, you can make free phone calls from your PC to any other Skype user. (Use a headset for decent sound quality and to avoid annoying your family or roommates.) Skype combines Internet telephony with presence awareness and a directory service. You can add your friends and family to your Skype directory and see when they’re online. (See Illustration 1.) Today, you can only call other Skype users. Soon, according to Skype’s Web site, you’ll be able to call non-Skype users as well.

Please download PDF to see the illustration.
Illustration 1. Skype combines free VOIP telephony from your computer with presence awareness. It’s popular among college students and broadband users around the world.

Others apparently share Mr. Vrolyk’s enthusiasm. Fortune made Skype the cover story of its February 9, 2004 issue. Author Daniel Roth points out that “Skype has been downloaded more than six million times in six months, it is regularly used in more than 170 countries--and it has spread by word of mouth alone”[1]. Apart from Skype’s obvious appeal, ease of use, and viral marketing, it’s Skype’s approach to infrastructure investment that makes its peer-to-peer architecture so economical. Anyone with broadband connectivity and a PC can not only access Skype, but her PC also participates in the distributed hosting for the directory software, analog-to-digital conversion, data compression, and packet routing. This means that there is no need for the company to invest in network hardware and disk farms to run its VOIP service--a service that Skype’s architect, Kaido Karuer, claims can scale to support 6 billion users.

That’s one reason why Skype can offer free phone calls with no monthly service or access charge, while telecommunications and cable companies and pure-play VOIP players like Vonage, Net2Phone, and 8x8 require users to pay a monthly fee for their services. Set-up and support costs are negligible as well. There’s no additional truck to roll to get consumers up and running. (The truck already rolled to set up your network.) There are no customer acquisition costs. According to Roth, “it costs Vonage almost $400 to add a new customer. It costs Skype one-tenth of a cent.”

What else does Skype’s P2P architecture enable? You can use it even if your PC is behind a firewall. According to Skype, “most voice over IP applications don’t work from behind firewalls and NAT (Network Address Translation) devices. Nearly all broadband users are behind a NAT or firewall and so they cannot use VOIP applications. Skype is not a typical VOIP application--it’s P2P telephony! Because of its advanced design, Skype works behind nearly any firewall and NAT.”

Limits to the Technology: PC-to-PC Telephony?

The first and most logical objection to claims that Skype will have a revolutionary impact on the global telecommunications landscape is the current constraint that you need a PC to access the VOIP service. That was my original assumption as well. But as a new user of VOIP service from my home, office, and PC, I realize two things: First, I can still make and receive phone calls via my mobile phone and route them through my VOIP system with its follow-me roaming and voice mail capabilities. (Both of these are services that Skype will be offering as paid add-ons to its free phone service.) Second, it won’t be long before the next generation of mobile phones are WiFi enabled. At that point, we’ll have seamless end-to-end VOIP connectivity even for mobile users--anywhere that sufficient bandwidth exists. (Here’s one data point: There’s a new chipset from Agere that combines VOIP and WiFi that’s already being tested in NTT’s mobile phones in Japan.) And WiFi hotspots are bubbling up exponentially, especially in pockets of the world that have otherwise low density of phone service and Internet service (e.g., in Africa, India, and China).

Friends in High Places

In his Fortune article, Roth cites a speech given by Michael Powell, chairman of the FCC, at the University of California, San Diego on December 9, 2003. In this speech, Powell declared, “I knew it was over when I downloaded Skype…when the inventors of Kazaa are distributing for free a little program that you can use to talk to anybody else, and the quality is fantastic, and it’s free--it’s over. The world will change now inevitably.”

Does that statement make Powell a friend of Skype against the lobby power of the telecommunications interests that long have exerted influence over the FCC? Powell has been quite outspoken in favor of giving free rein to VOIP technology, not favoring either the telecommunications or the cable companies. Powell’s statements to date seem to imply that he’s eager to shake up the U.S. telecommunications industry by letting consumers’ interests rule.

Another example of Powell’s “power to the people” stance was that after four years of delaying tactics on the part of the U.S. mobile phone service suppliers, the FCC finally enforced the order to permit mobile phone users to keep their phone numbers when they switch carriers. As a result, on November 24, 2003, the United States became one of the world’s later adopters of phone number portability[2].

Will Skype Succeed?

Skype’s business model is the now-classic “give the basic service away for free and charge for added-value services” net-centric business model. Skype adds the following two important ingredients to this basic paradigm ...


1) “Catch Us If You Can,” by Daniel Roth. Fortune, February 9, 2004, p. 74.

2) In my book, The Customer Revolution , I cited phone number portability regulations in Asia and Europe as a good example of what happens when customers agitate and regulators take the customers’ side over that of big business.

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