• by Mark Walsh  @markfwal, August 9, 2010

Skype's filing today for a $100 million <IPO highlights the company's reliance on the freemium model to build a huge user base and start to make money. It counts on a small proportion of users accessing its paid services to subsidize the vast majority of customers who use only the free Internet-based calling service Skype is best known for.

Skype's premium services include allowing users to place calls to, and receive calls from, traditional landline and mobile phones instead of just those using Skype's software. This program also charges for SMS messages, receiving voicemail and Wi-Fi access.

In the second quarter, these services were only 7% of Skype's 124 million "connected" users, or the average number of users who logged in over the last three months. If you count the 560 million total registered users Skype reports in its prospectus, only 8.1 million -- or about 1.5% -- are paying customers.

Even so, the Luxembourg-based company has managed to become profitable. Skype posted a profit of $13.1 million for the first six months of 2010 on revenue of $406.2 million. Revenue was up 25% from the year-earlier period, while profit was down about 40% from $22.5 million a year ago.

So how does Skype make any money at all with this approach? Its peer-to-peer technology means it doesn't have to build or maintain its own network infrastructure, keeping costs low. "As a result, we can add new users and provide them with a wide range of products at minimal incremental cost to us, allowing us to offer many of our products for free," states the Skype filing.

Still, it looks like the company isn't content to rely entirely on signing up an ever-expanding number of consumers to maintain growth.

"Historically, a substantial majority of our revenue has come from our consumer users," the prospectus states. "As we seek to develop new communications services products and expand our Skype for Business offerings, we expect our net revenues attributable to our consumer users to decrease as a percentage of total net revenues and our revenues from business users to increase both in absolute terms and as a percentage of total net revenues."

Further, Skype expects its business will increasingly shift from the PC to mobile devices: "As we seek to implement our strategy of expanding the use of Skype products across a broader spectrum of platforms, such as mobile devices, television and websites, we expect that our net revenues will, over time, be derived less from desktop users of Skype than has historically been the case."

Expanding into the enterprise market, though will require Skype overcoming corporate concerns about the security of its peer-to-peer system for business communications. In the "Risk Factors' section of its filing, the company acknowledges that, "managers of some large networks in businesses and large institutions may refuse to allow the use of our products due to concerns over security or bandwidth usage or for other reasons."

The passage continues, "The perception that our software is unsafe could hamper its adoption, and any actual security breach could damage our reputation and expose us to a risk of loss or litigation and possible liability."

What about relying on advertising as a revenue model? Skype doesn't stake much on success there. The company states that the current version of its software doesn't allow it to deliver standard-sized ads to users. "Furthermore, even if certain versions of the Skype software client were able to deliver advertisements, we may face difficulty in successfully implementing advertising on certain platforms, such as mobile devices," the filing states. It goes on to express concern over the possibility of alienating its user base with advertising.

Skype may also not be so high on social media as a marketing vehicle after a partnership with MySpace turned out to be a bust. In explaining how the number of registered and connected users may be inflated for various reasons, the company disclosed that as of June 30, its total of registered users included 20 million who joined through MySpace.

"Such registration occurred automatically as part of the MySpace registration process, and as a result, the number of our registered users may overstate the number of users who actively decided to create a Skype account," according to the prospectus. "We believe that users that have registered through MySpace are infrequent users of Skype products." No wonder Skype wants to go after the business market more heavily.