Rome-Bruxelles, 20 September 2011

European Commission Directorate for Competition Mergers Registry J- 70 1059 Bruxelles - Belgium by e-mail: [email protected]

Observations relating to the case COMP/M.6281 — Microsoft/Skype (C 268/12 Official Journal of the European Union 10.9.2011)

Need to impose interoperability of combined Skype/Microsoft services

in the market of IP-to-IP voice and videotelephony services

Dear Sirs,

We are writing to you on behalf of Messagenet S.p.A. ( www.messagenet.it ), a fully-licensed fixed- line and VoIP telephone operator based in Italy. Messagenet, part of the COMM2000 group, is a leading Italian company in the development and on-line commercialization of Internet fax and SMS messaging as well as VoIP services, with more than 376,000 registered users, one million faxes managed per month and more than 88,000 VoIP telephone numbers assigned (January 2010).

We are strongly concerned about various anticompetitive effects deriving from the proposed merger operation at stake, in particular with regard to the strengthening of the dominant position of Skype in the IP-to-IP services market and, namely, on the markets of IP-to-IP voice and video- telephony services (hereinafter together: the “Relevant Markets”).

Other markets affected by the present operation are these of “Presence” and Instant Messaging (although they are not examined by the present letter).

As it will be explained below, the main issue derives from the lack of interoperability of Skype IP-to- IP services with other similar services offered by third parties communications operators, which may become crucial for competition on such markets, especially with the strengthening of Skype’s position in combination with Microsoft.

Specific remedies deemed to address this problem are therefore required in order to clear the merge.

Messagenet S.p.A. Messaggistica e Telecomunicazioni Sede legale e operativa: Via Giacomo Leopardi, 9 – 20123 Milano (MI) P.Iva 13004930155 – Reg. Imp. MI 23010/2000 - REA 1605496 Tel +39 02 48102000 – Fax +39 02 48026819

1. INTRODUCTION

Despite the fact that Skype generally claims to just provide users with software, it is clearly a provider of electronic communication services 1. A list of the communication services provided by Skype is available at the IPO Document (hereinafter: “IPO Doc”) filed with the US financial authorities in August 2010 2 (“Our Products”, pp. 141 and ff.). In addition, despite the fact the Skype claims to just rely on the connectivity and infrastructures of other operators, it is clear that some of its services are not purely software-based but they need some infrastructures and related control (at least data base of ID and super-nodes) in order to work properly (see IPO Doc, “ Peer-to-Peer Architecture ” p. 151).

Furthermore, it should be noted that Skype also offers PSTN to VoIP and VoIP to PSTN services in the EU without the necessary UE authorizations and safeguards that other VoIP providers abide to (for example the identification of the user for law enforcement and national security, privacy regulations), thus competing unfairly.3

2. THE RELEVANT MARKETS

As it will be explained below, the services comprised by the Relevant Market, i.e. video-telephony and IP-to-IP voice may not be substituted with other services, due to their technical features as well the different needs of the users which it are aimed to satisfy, and therefore constitutes specific relevant market.

The Relevant Markets have global dimension, although only their effects on the EU market are considered in the present letter.

(a) IP-to-IP voice services

IP-to-IP voice service market consists of voice over IP services from terminal-to-terminal (including PC, smartphones and other devices identified by IP addresses). Such services are based upon broadband access services and allow the end users of a VoIP service provider (or more VoIP services providers, if their networks are interconnected and services are interoperable) to talk to each other, usually at no charge utilizing VoIP/IP end to end.

This market is different from both traditional voice services over PSTN (including IP to PSTN and PSTN to IP) and from voice services partially over IP for the following reasons: 4

1 Although the qualification of some of these services as falling within the definition of the European Electronic Communications Framework for regulatory purposes may be controversial, it is stressed that the definition of the markets in this case is made for antitrust purposes, by applying the antitrust criteria of products substitutability and consumers demand. 2 http://www.sec.gov/Archives/edgar/data/1498209/000119312510182561/ds1.htm#rom83085_3a 3 See for example the recent actions against Skype taken by Italy’s Ministry of Telecommunications and AGCOM leading to the shut down of Italian Skype-in Numbers. 4 For the sake of clarity, the VOIP technology does not constitute a reason of market differentiation.

Messagenet S.p.A. Messaggistica e Telecomunicazioni Sede legale e operativa: Via Giacomo Leopardi, 9 – 20123 Milano (MI) pag. 2 P.Iva 13004930155 – Reg. Imp. MI 23010/2000 - REA 1605496 Tel +39 02 48102000 – Fax +39 02 48026819

- Voice quality is substantially higher than PSTN, IP to PSTN and PSTN to IP (because the PSTN does not support HD voice) - the end users are identified by ID and the terminal point is identified by IP addresses, rather than geographic E164 numbering ; therefore, nomadic use is possible; - the availability of users is marked by the “presence” function; - the service is normally offered for free, while remuneration derives from other sources (advertising, sale of “fringes”); remuneration may also partially consists in subsidies deriving from services in other markets (voice PATS); - the service is normally not regulated (this is the case in the EU, since Skype services are currently not regulated under the European Electronic Communication Framework, unlike traditional PATS voice). IP-to-IP voice services are frequently marketed together with traditional PATS services (in the case of Skype, the PSTN-like products are known as Skype-in (PSTN to IP) and Skype-out (IP to PSTN),which of course do not have high quality voice), however this is not a bundle in commercial terms, since users are not obliged to buy a subscription for all services. The PSTN-like services of Skype are normally bought by Internet users to replace traditional phone services. In other words, Skype-in and Skype-out services are substitute for traditional PATS voice services, not for pure VOIP services.

(b) Video telephony services

Video telephony services are based upon broadband access services and allow end users to video-communicate among each other by their PCs (or similar devices) integrated with webcams. Like IP-to-IP voice, the terminal point of the end customer is identified via IP addresses and allows nomadic usage. 5 Voice quality is higher than PSTN. The features mentioned above for the IP-to-IP voice services apply, mutatis mutandis , also for the video telephony. It must be stressed, however, that videotelephony is by definition “IP-to-IP”, there I no need to distinguish it by similar products using geographic numbers.

These services satisfy a demand of communication different from traditional or pure voice services.

Skype is by far the largest provider of video telephony services on the world market. In addition, also Microsoft is engaged in the provision of such services.

(c) Structure of the relevant markets

These markets are featured by:

5 Video telephony via PSTN or dedicated lines is marginal and limited to the corporate market.

Messagenet S.p.A. Messaggistica e Telecomunicazioni Sede legale e operativa: Via Giacomo Leopardi, 9 – 20123 Milano (MI) pag. 3 P.Iva 13004930155 – Reg. Imp. MI 23010/2000 - REA 1605496 Tel +39 02 48102000 – Fax +39 02 48026819

- growing scale and scope economies as also confirmed by the IPO Doc, as well as increasing marginal returns which grant a very high value to the marginal client / traffic;6

- large sunk costs and high fixed costs and are subject to a continuous technological development;

- strong network effects (as also confirmed by the IPO Doc), which may be easily transformed into network externalities (or diseconomies), just by denying interoperability of the dominant services with those provided by smaller operators;

- In addition, the convergence process and the substantial network effects affect, just to name some, the access to fixed and mobile telephony networks, contents and DRM systems, possibly jeopardizing the competitiveness of the mentioned market in favour of the former

In markets with the above features of high sunk costs, companies are more prone to adopt exclusionary practices in order to maximize the (incremental) margins.

3. THE DOMINANT POSITION OF SKYPE IN THE RELEVANT MARKETS Skype is the dominant operator in the EU and in the world markets for IP-to-IP voice and video telephony services, with more than 663 million registered users on global level, more than 98% of whom use a free version of the product, and about 9 million users buy paid Skype services with additional functions 7. According to the IPO Doc (p. 93), in June 2010 Skype had 560 Million registered users, 124 of which were active users (and 8,1 were paying), growing quickly.

Also Microsoft provides IP-to-IP voice and video telephony services. As a matter of fact, in April 2005 Microsoft launched " MSN Video Conversation "8 and several new releases of the service have been marketed since then.

On the other side, companies like Google, VOIP Bastard, Apple Facetime ecc. are marginal in the IP-to-IP voice and video call segments. Google has concentrated mostly on a different market (the management of calls incoming from the PSTN) and in the US only.

Messagenet does not own official data about the market shares of Skype vis-à-vis the other competitors. However, the absolute figures of Skype’s business lead to conclude that no-one can come close to and, in particular, the growth of Skype is dramatic.

6 See also the IPO Doc statements quoted in footnote 10 . 7 Source: interview of industry analyst Mike Moe, president of NextUp Research, on USA today, May 10, 2011; http://content.usatoday.com/communities/technologylive/post/2011/05/q38a-analyst- on-how-microsoft-skype-deal-affects-consumers/1 . 8 Within the MSN Messenger 7.0, offering free full-screen video calling over the internet, with synchronised audio and video.

Messagenet S.p.A. Messaggistica e Telecomunicazioni Sede legale e operativa: Via Giacomo Leopardi, 9 – 20123 Milano (MI) pag. 4 P.Iva 13004930155 – Reg. Imp. MI 23010/2000 - REA 1605496 Tel +39 02 48102000 – Fax +39 02 48026819

All major metrics point in this direction:

• In addition to the absolute figures mentioned above, the charts published by Skype show that the above figures are growing very rapidly. For example, from the three months ended June 30, 2009 to the three months ended June 30, 2010, our connected user base grew by 36% to 124 million average monthly connected users. 9

• The externalities effect reinforces such trend: consumers who wish to use this service tend to choose Skype on the basis that it is much more likely to find others on Skype too. 10 This is a self-reinforcing position as long and Skype does note interoperate with other VoIP providers.

• The same holds true considering the number of users who can be reached (online, via the presence function) at any time with Skype, currently over 30 million and rising very fast. Again, we do not believe that any competitors come close.

Source: http://skypenumerology.blogspot.com/ .(post of April 3, 2011)

9 IPO Doc, p. 134. 10 This is recognised by Skype in the IPO Doc (pp. 134 and 135): “ Strong network effects. We and our users benefit from network effects. Skype becomes more valuable as more people use Skype, thereby creating an incentive for existing users to encourage new users to join. As more users join and become accessible for Skype communications, users’ engagement levels increase. With a larger user base and increased user engagement, we are well positioned to attract commercial partnerships, as we have done successfully with mobile network operators, desktop and laptop computer manufacturers and leading global TV manufacturers. New features and partnerships in turn broaden Skype’s usefulness, attracting more users. This results in viral marketing and lower marketing expense for Skype ”. …… “ Our registered, connected and paying users have grown over time, which we believe is primarily attributable to the network effects of our users, our strong global brand and our differentiated technology and product offering ”.

Messagenet S.p.A. Messaggistica e Telecomunicazioni Sede legale e operativa: Via Giacomo Leopardi, 9 – 20123 Milano (MI) pag. 5 P.Iva 13004930155 – Reg. Imp. MI 23010/2000 - REA 1605496 Tel +39 02 48102000 – Fax +39 02 48026819

The number of minutes of voice and videocalls on Skype’s platform dwarfs that of competitors: it has now reached 200 Billion minutes per year.

Source: http://skypenumerology.blogspot.com/ (post of March 15, 2011)

Evidence of the dominance of Skype in the Relevant Markets may be derived by the share of Skype-to-Skype calls for the long distance traffic, amounting to 54 billion minutes (of total 406) in 2010 11 but with dramatic increases as shown below:

11 Source: http://www.telegeography.com/press/press-releases/2010/01/19/international-phone-traffic- growth-slows-while-skype-accelerates/index.html

Messagenet S.p.A. Messaggistica e Telecomunicazioni Sede legale e operativa: Via Giacomo Leopardi, 9 – 20123 Milano (MI) pag. 6 P.Iva 13004930155 – Reg. Imp. MI 23010/2000 - REA 1605496 Tel +39 02 48102000 – Fax +39 02 48026819

Source: http://skypenumerology.blogspot.com/ (post of January 7, 2011)

Because of its VoIP market dominance Skype is being incorporated successfully with mobile network operators, desktop and laptop computer manufacturers and leading global TV manufacturers. 12

4. THE DOMINANT POSITION OF MICROSOFT

Microsoft is dominant in various markets: PCs Operating Systems; Office Automation software (Office); corporate email server (Exchange); LAN server. The dominance in the PCs Operating System market, recognized by the European Commission with its antitrust decision of 2004, is particularly relevant for the present case.

5. THE LACK OF INTEROPERABILITY OF SKYPE’S SERVICES, AND ITS IMPACT ON COMPETITION

Small new-entrants companies, including Messagenet, find it difficult to compete with Skype in the Relevant Markets in the absence of interoperability with Skype, because potential customers prefer to choose Skype in order to reach the overwhelming majority of individuals who are Skype users (network externalities, as mentioned above). This is true even if we offer lower rates for the paid-in PSTN services, and have introduced some innovations for which we have filed for patents.

Skype protects this dominance by basing its service on secret and closed IP standards as opposed to open standards such as the one used by our company, Google, and others, making it impossible for competing providers to interoperate with Skype 13 .

12 IPO Doc, p. 134.

Messagenet S.p.A. Messaggistica e Telecomunicazioni Sede legale e operativa: Via Giacomo Leopardi, 9 – 20123 Milano (MI) pag. 7 P.Iva 13004930155 – Reg. Imp. MI 23010/2000 - REA 1605496 Tel +39 02 48102000 – Fax +39 02 48026819

VoIP providers who had tried to use Skype’s software to interoperate (Fring for instance) by circumventing the secrecy of the standards have been successfully sued by Skype, with the result of being ordered to stop using the software to interoperate. In May 2011 Messagenet wrote to Skype to ask for interoperability also for IP-to-IP voice and videotelephony services (see letter in attachment), however we received no answer.

Skype decides which hardware and software manufactures are allowed to have the means to incorporate Skype functionality in their products.

6. WHY THE PRESENT OPERATION WILL STRENGHTEN THE DOMINANT POSITION OF SKYPE AND HARM COMPETITION AND CONSUMERS’ INTERESTS Both Microsoft’s Operating System business and Skype’s VoIP business are characterized by strong network effects, whereby as each business grows it is harder and harder for competitors to enter and / or compete in each of the two markets.

The merger of the two companies would strengthen, in particular, Skype’s dominant position in the Relevant Markets because of the following reasons: - Skype services will likely extended or available, by default, to the massive customer base of Microsoft in the markets where the latter is dominant, and also for MSN and X-box; Microsoft will be able to leverage its dominant position, in particular in the Operating System market, by giving the possibility to pre-install Skype in all PCs; - Microsoft has already publicly announced that it will integrate Skype in Office (including Exchange), the X-BOX gaming console, its smartphone OS, ecc; 14 - Due to the combination with the above resources of Microsoft, the network externalities and the lack of interoperability of Skype services will become more and more critical. The first effects of the proposed merger will be an even more rigid approach to interoperability of Skype services so to exclude competitors from the market. As a matter of fact, on May 2011, Skype has terminated its partnership with Digium, which allowed Asterisk (the open- source telephony system), to be integrated with the Skype service. By this way, Skype has been effectively killing “Skype for Asterisk”, which integrated the VOIP service with the open-source telephony platform. Of course, Skype incentive to refuse interoperability of

13 From the Skype IPO document: “ Protection of our source code is very important to us. We protect our source code as a trade secret and as a copyrighted work. We distribute our products in object code, which is a form of computer software that is executed by computers and does not reveal the structure or logic of the programming performed by humans. Our agreements with our customers prohibit reverse engineering of the object code to get access to the source code. ” 14 See for instance http://www.engadget.com/2011/06/19/webos-skype-integration-revealed-in-screenshots/ ; and also http://www.engadget.com/2011/08/25/microsoft-front-facing-cameras-skype-integration-coming- with-m/

Messagenet S.p.A. Messaggistica e Telecomunicazioni Sede legale e operativa: Via Giacomo Leopardi, 9 – 20123 Milano (MI) pag. 8 P.Iva 13004930155 – Reg. Imp. MI 23010/2000 - REA 1605496 Tel +39 02 48102000 – Fax +39 02 48026819

Skype VoIP and video telephony services will be increased by the possibility of getting access to an even wider market thanks to Microsoft resources and Microsoft dominant position on the Operating System for PC client.

In addition, it would be very difficult to ensure that third party VOIP services providers will have the same opportunity that the Microsoft business division will have in integrating Skype services in Microsoft’s products and services, since:

• at a technical level, this would require equal access to oftner sensitive technical details on Microsoft’s products and services, equal access to APIs, equal access to hardware accelerators (for VoIP voice and video coding, echo suppression and battery saving);

• at a business level, this would entail monitoring the bundling of Skype’s services with other Microsoft offerings in a manner that would damage other VoIP competitors (Microsoft has an history of uncompetitive bundling practices).

7. THE REMEDIES WHICH SHOULD BE IMPOSED BY THE EUROPEAN COMMISSION IN ORDER TO CLEAR THE MERGE

In order to avoid the reinforcement of the dominant position of Skype in the Relevant Markets, and the related foreclosing consequences, the merge should be authorized only upon the following conditions: - Skype/Microsoft should be obliged to make interoperate their IP-to-IP voice and videotelephony and presence services, by disclose to competitors the interfaces required for their products to be able to 'talk' with the ubiquitous Skype software, including HD voice functions; - Skype/Microsoft should provide all information and APIs needed by VoIP service and software providers to developed and distribute their own VoIP applications and services on Microsoft’s products and services on an equal basis ad it will do internally with the integration of Skype with its own products and services, ad it has already announced publicly; - anticompetitive bundling of Skype into the Microsoft OS should be prohibited in any case; - to the extent possible, it should re-affirmed the need for the Skype’s services, combined with Microsoft, to comply with EU Regulatory Framework for electronic communications services. *****

We remain at your disposal for any further information, and we are available to meet with you in Brussels to further explain our position.

Messagenet S.p.A. Messaggistica e Telecomunicazioni Sede legale e operativa: Via Giacomo Leopardi, 9 – 20123 Milano (MI) pag. 9 P.Iva 13004930155 – Reg. Imp. MI 23010/2000 - REA 1605496 Tel +39 02 48102000 – Fax +39 02 48026819

Please contact our representative in Brussels Mr. XXXXXXXXXXXXX XXXXXXXXXXXXXXXXXX XXXXXXXX XXXXXXXXXXXXXXX

The content of the present communication and the attachment are confidential.

Kind regards,

Andrea Misa Galli Amministratore Delegato

MESSAGENET S.P.A.

XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX

Messagenet S.p.A. Messaggistica e Telecomunicazioni Sede legale e operativa: Via Giacomo Leopardi, 9 – 20123 Milano (MI) pag. P.Iva 13004930155 – Reg. Imp. MI 23010/2000 - REA 1605496 10 Tel +39 02 48102000 – Fax +39 02 48026819