TCS Daily

Skyping the Hype

By Meelis Kitsing - October 20, 2005 12:00 AM

"Supermodels not wanted. We want your brain." This ad, in English, appeared in Estonian newspapers in 1999. At the time, the advertisement seemed ironic in a country where the biggest international breakthroughs had been achieved by skin-and-bones supermodels, such as Carmen Kass. Now the anti-supermodels irony is history. The result of the brains attracted by the ad -- the peer-to-peer (P2P) Voice over Internet Protocol (VoIP) venture called Skype -- was sold to eBay in September for $2.6 billion.

The ad was placed by Niklas Zennstrom and Janus Friis, a Swede and a Dane, who later became known as the founders of Kazaa (a P2P filesharing program) and Skype. It seems to be about the only commercial message Zennstrom and Friis had to pay for. Despite their efforts to remain geeks, the Swedish-Danish tandem and the Estonian programmers behind Kazaa and Skype became supermodels in their own right. They were on the front page of the New York Times as early as 2002. When their new program, Skype, was still in its beta version, Fortune magazine ran a feature story, the lead of which opened with a scene in the trendy bohemian bar Noku in the Old Town of Tallinn. Now Skype is becoming a household name, with magazines ranging from the Economist to Vanity Fair fawning over the venture -- which has yet to make a profit and had a turnover of $7 million last year and expects to earn $60 million this year.

Despite the media frenzy, Skype should not be dismissed as hype. Skype users swear by the superb quality of the experience. A recent conversation with a Stanford-educated Indian computer engineer who frequently makes calls to India via Skype confirmed the excellence of service. Prior to using the service, he doubted the quality, based on a number of technical problems he foresaw as hampering the technology's potential. To his surprise, he discovered that Skype actually provided better quality than experienced in regular phone calls to India.

Unlike many other VoIP service providers, Skype (like the file-sharing program Kazaa) relies entirely on peer-to-peer (P2P) technology. P2P technology creates important technological advantages compared to the traditional server-client model. The Skype directory is entirely decentralized and distributed among network nodes. This in turn implies that Skype can increase its scale rapidly without added investments for expensive and centralized infrastructure.

For instance, the Skype team's previous undertaking, Kazaa, has often been called the new Napster. However, the Napster comparison completely misses an important technological difference. While Napster utilized client-server structure for some tasks, Kazaa relied entirely on P2P technology. Naturally, the technological difference translates into crucial legal and economic implications. In the case of Kazaa, it has been more difficult to hold the distributors of file-sharing program responsible for illegal downloading of files. Due to the use of server-client structure by Napster, documentation of its direct involvement in illegal file-sharing was easier.

This technological aspect explains why P2P VoIP is economically superior to server-client VoIP as well as to traditional telephony. Economic superiority has a tremendous effect on the competitive rivalry in the telecom market. Skype has a lower cost structure, thereby enabling lower prices in comparison with non-P2P VoIP and traditional phone services. It is also easier to scale Skype's subscribers, because Skype does not need to invest in additional infrastructure for accommodating new users - a necessary investment for non-P2P centralized VoIP service providers and, obviously, traditional telephony companies. Hence, Skype is not growing rapidly because of hype but rather, due to its technological and thus economic superiority. The quality of this disruptive technology has created hype - not other way around.

Most interesting is the origin of this superior technology. It did not emerge in the high-tech clusters of Silicon Valley or Boston's Route 128. Skype's management and marketing office is in London. The company is registered in Luxembourg. However, all the programming and product development is carried out in Tallinn, Estonia.

Furthermore, Skype's programmers were not in any way backed by the government. Quite the opposite, it received relatively little attention before skyrocketing to international fame; the local "technology gurus" and politicos with technological leanings were busy searching for the "Estonian Nokia." Just half a year ago, many local IT and telecom analysts were still underestimating the role Skype might play in changing the traditional telecom landscape. And then overnight, millions of dollars poured into the country and Skype has become a part of eBay.

Loose networks of computer programmers and small companies in libertarian and bohemian environments are behind such success. Estonia's reforms in the 1990s created an open environment for Internet diffusion and related technologies in Estonia. A recent report out of the World Economic Forum on the competitiveness of countries ranked Estonia as 20th in the world -- far ahead of any other new EU member states and also ahead of many "old" EU members. The country has consistently placed in the top ten of various rankings on economic freedom during the last years.

The conventional account of Estonia's success in entering the information age overnight, despite its initial backwardness, has overemphasized the role of direct government intervention, and has perhaps given attention to some large companies while ignoring a vast number of small technology companies. Certainly, due credit must be given to politicians for opening the market and carrying out rapid liberalization after the collapse of the Soviet Union. In this sense, the government has contributed to this achievement by not interfering much in the market during the last decade. Technology entrepreneurs and creative destruction took care of the rest.

Nevertheless, technological successes have led to attempts by politicos to capitalize on the achievement by showing themselves as true heroes. Such a posteriori rationalization and this self-congratulating attitude has created some unnecessary public sector financed pet projects. The shortcomings of direct government intervention are well demonstrated by the sorry saga of the national gene project, where public sector money was poured in and politicians dominated the supervisory board. Despite many years of hype and political backing, the gene project has nothing to show for the taxpayers' money spent so far.

Hence, the difference between the bohemian, non-hierarchical culture of Skype and the government-backed gene project could not be more telling. The success of Skype and the failure of the gene project can be understood in the context of research by Richard Florida, who emphasizes the importance of "creative classes" for the emergence of new technology enterprises. Technology, talent and tolerance, what Florida calls the 3Ts, are mutually self-enforcing and their combination is vital for entrepreneurship. In other words, Florida identifies the linkages and positive externalities of technological, economic, and artistic and cultural creativity. Indeed, the story of Skype demonstrates that bohemian clubs have better chances for contributing to the emergence of a new technology venture than does government intervention.


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