How Free is Free?

The great thing about selling software is that the incremental cost is very small - typically the cost of production and packaging.

If the software is delivered via download, even that cost goes away, and the incremental cost per unit shipped can be arbitrarily close to zero.

The exception is if the software includes any licensed technologies - then there can be a per-unit cost for licensing.

"So what's this got to do with telecom," you ask? Well, Skype has claimed that its marginal cost per user is less than US$0.01. But Skype licenses the Global IP Sound VoiceEngine product, and it's not free: Global IP Sound's 3Q04 results include in their highlights "First royalties from Skype Technologies S.A."

Also in their 3Q04 results, Global IP Sound notes that "Deployed software reached more than 26 million endpoints (measured by downloads and shipments)." Doing a pencil-and-paper interpolation from a chart in a Skype Journal post, it looks to me like Skype had about 21M downloads as of the end of 3Q04. Since this is the first quarter in which Global IP Sound realized revenue from Skype, let's assume every Skype download up to the end of 3Q04 generated revenue for GIPS in 3Q04.

Let's also assume that the Skype marginal cost per user is as much as US$0.01, and 100% of that marginal cost is the license for GIPS VoiceEngine. The royalties from Skype to GIPS would therefore have been around US$210k, or about KSEK 1,610 at current exchange rates (I don't know what the exchange rates were in 3Q04, but that's a level of precision way beyond this analysis anyway).

Now, Global IP Sound's total revenues reported for 3Q04 were KSEK 7,639. Which means that since Skype didn't contribute more than KSEK 1,610, other GIPS customers contributed about KSEK 6,000.

But if total deployed software reached 26M endpoints, and 21M of those endpoints were Skype, then the other 5M shipments generated KSEK 6000 for GIPS, or an average of SEK 1.20 per endpoint - over 15 times the upper limit on the revenue per endpoint that GIPS could be getting from Skype.

So either:

• Skype has a tremendously favorable licensing contract with GIPS (possibly getting a very good price in exchange for the publicity Global IPSound is getting out of being associated with Skype, and the potential business they can get licensing their products to other customers who want to make products that interwork with Skype) - in which case other GIPS customers could be getting pretty upset; or,
• Skype's marginal cost per customer isn't really less than $0.01.

Perhaps that's another reason why Skype is moving into retail - not only is the viral marketing growth potentially slowing, but giving away a non-free product can cut into one's margins...