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Skype Beyond the Hype

The peer-to-peer masters at Skype are offering free Internet calling and plan to make a killing at it.

My transatlantic call with my little sister at Smith College in Northampton, MA, starts with her recurring complaint about the campus food. This week, it seems, there’s a shortage of fresh fruit. Normally, as the long-distance seconds tick by, I’d be tempted to ask her about more serious issues. But this time I’m happy to listen: our hour-long call, placed over the Internet from my computer in Riga, Latvia, to her computer in Northampton, is using a free program called Skype and is costing us nothing.

When I start up Skype to call my sister, the software links my PC with the computers of other Skype users who also happen to be online. In this case, one of them is my sister, 6,500 kilometers away. Our voices are broken into digital packets that hopscotch from computer to computer until they reach their destinations, where they’re reassembled into astonishingly clear audio.

The peer-to-peer strategy used by Skype is very similar to that of the Internet file-sharing systems, such as the original Napster, that have become the bane of the music industry. Indeed, the creators of Skype-Niklas Zennstrm of Sweden, Janus Friis of Denmark, and a set of expert programmers in Estonia and elsewhere-are largely the same team that unleashed Kazaa, the music-sharing program perhaps most loved by music swappers and most reviled by music corporations. So it’s only natural that Zennstrm and Friis, who have given away more than 10 million copies of their new software to users in more than 170 countries since launching Luxembourg-based Skype Technologies in August 2003, would be anointed by some as Davids aiming their high-tech slingshot at the Goliaths of the telecom world.

But in reality, the two entrepreneurs and their programmers are hardly radicals out to destroy the telephone as an instrument of profit. Despite their nonconformist markings, they’re simply ambitious businessmen intent on changing the economics of making a phone call. Other companies such as Net2Phone have been routing calls over the Internet for years (see “The Internet Phone Booth”), but most such services still depend on centralized computer servers to direct calls and track usage and must charge accordingly. Skype’s leaders, on the other hand, believe they can afford to give away their software and let users call each other free, confident that customers will pay for the additional services they plan to introduce, such as voice mail. And there is another reason for their generosity: they have no complicated infrastructure to build and maintain. They simply use the Internet.

So far Skype has about 4.5 million registered users, but its ability to expand its base of customers indefinitely simply by handing out more copies of its software has many in the information technology and investment communities watching it closely. In March, Skype raised $18.8 million in venture funding from investors such as Silicon Valley’s Draper Fisher Jurvetson and Geneva, Switzerland-based Index Ventures. German electronics giant Siemens says it will launch a line of cordless phones in September that incorporate Skype’s software, and wireless Microsoft Pocket PC personal digital assistants can now run a stripped-down version of the software that turns them into mobile Skype phones. Both developments untether Skype users from their PCs.

No one expects that free peer-to-peer telephone service will eat into traditional calling as rapidly as software like Kazaa has deflated the retail music business. For one thing, most current Internet calling technology still requires users to buy and install special modems and adaptors. But Internet telephony will catch on “quicker than most people realize,” predicts Randolph May, senior fellow and director of communications policy studies at the Progress and Freedom Foundation, a Washington, DC, think tank focused on the digital revolution. Indeed, once consumers have experienced the surprising sound quality of Internet voice calls, not to mention the pleasure of getting no bills-or very low ones-they may find that old-fashioned dial tone harder to listen to.

Ear-to-Ear Computing

A few days after the call with my sister, I’m sitting in a small set of offices in a renovated Soviet-era factory in Tallinn, the capital of Estonia. I’m visiting Ahti Heinla and Jaan Tallinn, a cheery and startlingly tall pair of programmers who helped Zennstrm and Friis by doing much of the coding behind Kazaa and were called in again to help complete Skype. Heinla’s personal office is hardly a dot-com wonderland of multigigahertz processors and fancy flat-screen displays: it contains just one standard desktop computer.

“I’m thinking about buying a laptop,” Tallinn says with a capricious smile. Heinla doesn’t have a laptop yet either, but he does say he bought his first home computer a few months ago. He didn’t even have a cell phone until two years ago-shockingly late in this Baltic state where cell phones are next to ubiquitous. These guys firmly oppose investing in unnecessary equipment. “We’re into technology, but we’re not gear freaks,” Heinla asserts.

The aversion to buying your own hardware when you can use someone else’s is at the core of Skype’s strategy. Both Zennstrm and Friis had been working for a Swedish telecom company when they decided in 1999 to break free and try something more daring. They settled on creating a peer-to-peer file-sharing network, turning to the Estonian programming team to come up with a system that would allow users to find files such as MP3 songs on one another’s computers, even if no single machine contained a master list of the files’ locations. In other words, Zennstrm and Friis wanted to let users exchange music but didn’t want to maintain a centralized server to manage the network.

Within months, the Estonian programmers had found an approach that fit the bill, and their system, Kazaa, turned into a major smash: the free software has been downloaded more than 300 million times. But it also led to legal headaches for Zennstrm and Friis, as music publishers tried to fight back with piracy lawsuits. The pair eventually sold Kazaa in 2002 for an undisclosed sum. Their next big career move was logical. They wanted to create a service that would also be peer-to-peer but this time find an area of unquestionable legality. Their choice: Internet telephony.

Zennstrm says he had already “learned how telephone companies work, and that in their business model it’s extremely costly to acquire customers, and secondly very costly to operate each customer in terms of the billing system, customer service, and network.” Recruiting members into a peer-to-peer network and sending calls through members’ computers, he and Friis realized, would mean they wouldn’t have to build their own network, or even a billing system, since the calls themselves would be free.

Skype might operate much like Kazaa, but there is a twist. “Kazaa was a much simpler technology than Skype,” says Zennstrm. “With Kazaa, you’re not usually searching for something that is unique. You’re searching for things that are usually duplicated”-like a popular Madonna song owned by hundreds of people on the network. With Skype, however, “you need to find a unique person. If you want to make a call to me, for instance, then you need to find me and not someone who’s similar to me.” This time around, there would have to be a master list-and the trick would be creating it without resorting to an expensive infrastructure of centralized computers.

Outsource Everything

Skype’s solution is dubbed Global Index. This bit of software tells computers in the peer-to-peer network how to communicate with hubs known as “supernodes” in order to find the locations of people being called. With Kazaa, similar supernodes-which are simply PCs randomly selected from among the most powerful computers that happen to be online at a given moment-play a crucial role in relaying file requests. But with the Skype technology, the supernodes can also talk to each other and collectively store a complete, up-to-date directory of every Skype user online. Calls move seamlessly from computer to computer even as supernodes go online and offline without notice. By clever use of software, Skype can outsource the entire business of running a telephone network to its own users.

Skype’s base of users is still tiny compared to the market for traditional phone service. So far, subscribers can use the network only to call each other. And the software doesn’t come with the kind of service and support guarantees that many users, especially in the business world, expect. But Skype may not need business customers in order to thrive. If average users get hooked on the free calls, they may not mind paying for the premium services-including voice mail and the ability to call conventional phones-that Zennstrm hopes to roll out later this year. And while those services may force Skype to adapt the way its system works, its costs will likely remain lower than those of its competitors.

Meanwhile, don’t expect traditional telephones to disappear. The shift toward Internet telephony will more likely resemble the transition from fax to e-mail as the preferred way to send text quickly, Zennstrm predicts. “You still have the fax machine, but you’re not using it as much as you used to,” he says. In fact, he sees a practical benefit in Skype for the existing telecom industry, if consumers interested in making calls over the Internet flock to high-bandwidth cable and DSL services. “There is a huge broadband market potential for telecoms to go after, which will work well with our offering.”

Free phone calls, high-flying startups, soaring demand for telecom capacity-the promises might sound a bit familiar. But Skype may be the company that finally delivers on the hype.

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