With the opening of its offices this past June in Bahrain, Skype, the Internet phone service software company, finally got its feet on the ground in the region. But aside from the hospitality it received from its host Gulf state, the company has found that for the most part it isn’t welcome by the region’s governments. Its voice-over-internet-protocol (VoIP) software is banned in the United Arab Emirates (UAE), Oman and Kuwait — all three Gulf countries have restricted the downloading of Skype’s software within their borders. Other Arab countries took harsher stances against Skype over the summer, including Egypt, which has blocked access to the software service, and Lebanon began enforcing a ban against the software that was first announced in 1999.

Amid such a hostile regulatory environment, head of the company’s Middle East and Africa office, Rouzbeh Pasha, is upbeat, describing the region as a "dynamic market." But his rosy assessment has more to do with the software’s popularity among the region’s expatriate workforce. Skype’s financial reports do not break out performance geographically, its global numbers are impressive — the company, which reported 2009 revenue of US$718 million, said it has roughly 124 million users around the world, who made 95 billion minutes’ of calls in 2009. According to Telegeography, an analytical firm, Skype captured 13% of the world’s long-distance calls last year.

"Skype is focused on continuing to build a growing and profitable business," Pasha says. "With the recent launch of the Arabic language version of Skype’s website at skype.com, we are making Skype accessible to even more people." The way Skype will be able to do that is to gain official acceptance, despite regional political and economic interests moving to protect state-owned telecom monopolies. To add to the challenge, competition is intensifying, as Google enters the Internet phone market with Google Voice. But a potential partnership with Facebook could extend its reach, and help it overcome regional roadblocks.

The Community Effect

Skype has had often-unexpected success. For example, since its launch, Skype has spawned a cottage industry of online language education in the Middle East. A number of Arabic teachers advertise real-time conversations over Skype with people around the world looking to learn the language. Though an unintended development, it is indicative of the software’s prospects in the region, where analysts expect some of the world’s fastest growth to occur. Google says there are an estimated 56 million Internet users in the Arab world today, a 228% increase from 2004. Step by step, they are becoming a profitable audience. Online advertising in the Middle East is currently a US$54 million business, which is expected to increase to US$266 million in the next five years, according to a recent study by the Dubai Press Club.

The market in the Arab world showing the greatest potential, and Skype’s main target, is the UAE, where expatriates comprise 80% of the country’s 4.8 million residents. As a result, the country experiences significantly higher-than-average international call patterns. And unlike other countries in the region, the majority of the UAE’s expatriates can afford access to a computer and a good Internet connection. According to an August report by the country’s Telecommunications and Regulations Authority (TRA), 66% of all households in the UAE have Internet access. More importantly, 87% of those connections are high-speed broadband, critical for uninterrupted and clear Internet phone connections, compared with 12% broadband Internet penetration in the region as a whole.

Within that market, there is a distinction between social classes that have affected its development, experts say. "The expat community is polarized into two groups, which have completely different settings: Executives and workers," says Alberto Pamias, a managing partner at Delta Partners, a telecoms consultancy. "In the former group, computer penetration is very high. But they have less price sensitivity because their companies often pay for the phone lines. While in the latter group, who are mainly South Asian workers, computer penetration is low and price sensitivity is very high. VoIP traffic is captured in Internet cafes and settings of this kind."

The difference in costs of making an international phone call through a state-owned telecom monopoly and Internet software is wide. Due to its expatriate population, most international calls made from the Middle East are to India, Pakistan, Bangladesh and Sri Lanka. Among the region’s traditional operators, the cheapest average rate for a call to South Asia is with Saudi Telecom Company, at 36 cents a minute; Bahrain Telecommunications Company charges 90 cents a minute. For the same call, Skype charges less than half a cent per minute. (Video chats between Skype users are free.)

Skype can offer such a low rate because its service is essentially just software, without the costs of building and maintaining telecom infrastructure that a traditional phone company has. With its mobile phone application, the customer pays a termination fee to a mobile operator, part of which the software company receives. "Skype’s business model is not based that much on the margins per call or connection basis, but rather on the ‘community effect’ and the different ways to monetize such a community, like advertising or e-commerce," Pamias says. "The Middle Eastern community is not as big as other markets but disposable incomes are significantly higher."

Not Welcome Here

Skype’s Pasha asserts, "Skype is not a telecommunications operator and should not be treated as such." The region’s telecom operators disagree. Having enjoyed captive markets as a result of their state-sanctioned monopolies, these operators see Skype as a threat, and have worked with regulatory bodies to block the software. In the UAE, for instance, an online user cannot even see Skype’s homepage; instead, web browsers are redirected to a TRA cautionary page, just like when someone attempts to view pornography.

In Egypt, the National Telecommunication Regulatory Authority (NTRA) banned access to Skype in March. Up to that point, VoIP was tolerated on mobile Internet telephones, until the NTRA noticed a drop in international mobile call volumes. The country’s three mobile operators (Mobinil, Etisalat Egypt and Vodafone Egypt), which offer Internet access for computers via USB and mobile modems, are not allowed to provide Skype on mobile phones. The service is, however, still available from Internet service providers, as stipulated under a national law from 2003. In practice, international calls have to pass through the state-controlled fixed-line network.

The UAE has banned access to Skype’s service since 2006. But after the country’s legislative body criticized the TRA for the telecom sector’s lack of competition, the regulator announced in March that it would allow VoIP, albeit only through the two existing telecom providers, Etisalat and du. "The door is open for the VoIP providers, but they have to conclude a partnership with any of the existing licensees in the country," a TRA official told Dow Jones after the announcement.

Skype has tried to tackle the ban by seeking talks with regional governments. But aside from its welcome in Bahrain, it has been a slow and fruitless effort. At a media summit in Abu Dhabi in March, Skype’s chief executive, Josh Silverman, said the UAE’s ban on its service is "short-sighted" for a country that wants to be an international hub. "When a government acts to protect a legacy of a profit pool, it’s usually not in the interest of the economy or the people," he told the audience. Skype reportedly formed a group to lobby the Egyptian government as well, to little avail.

In the meantime, Middle Eastern residents who want VoIP have sought ways around the restrictions. In the UAE, for instance, computers and mobile devices with Skype already installed can access the service from within the country, through a proxy Internet server, which bypasses the local provider. Also, residents travelling outside the Middle East download the software freely. Consumers in the UAE were also quick to discover that they could make Skype calls with their iPhones because the application is available from Apple in the UAE. (Tech researchers at IDC reported that 31,526 iPhones were sold in the UAE last year.) In response, the TRA sternly announced: "If a third party application, such as Skype, is available for download from iTunes or any other website, it does not mean that it’s legal to use. Furthermore, the licensees have the right to block the illegal traffic of the application." If anyone should think that the UAE sees it as an offence not worth punishing, three men in Dubai were arrested in September for offering VoIP calls for a fee.

Profitable Partnerships

In what seemed like a warning to consumers, Mohammed Omran, Etisalat’s chairman, told Arabian Business magazine in May that if Skype were allowed in the UAE, it would result in higher prices for local fixed-line calls. For most operators, international calls are a high-margin revenue stream. Across the Middle East, the stream has already begun to dry by partial liberalization of the market, and increased price competition. But Skype argues that VoIP could help Middle Eastern telecom operators raise their average revenue per user (ARPU). Ovum, a technology advisory company, upholds Skype’s argument. "Attempting to block mobile VoIP is not a viable long-term strategy for mobile operators," it stated in a May report. "Implemented well, VoIP can attract new users," and that could mean entering into partnerships.

Among the first telecom operators to let Skype use its mobile network was Hong Kong-based Hutchison Whampoa. Hutchison’s network — called 3 — covers Hong Kong, Australia and seven countries in Europe. According to its latest annual report, mobile revenue in 2009 was roughly US$4 billion, up from US$3.3 billion in 2008. The group’s registered 3G customer base grew 29% over 2009, to approximately 25.9 million at the end of the year and is currently nearly 27 million. Helping that growth are the partnerships it has forged in the U.S. and China, enabling it to offer Skype applications on a number of mobile devices in those countries. But the response from Middle Eastern operators has been guarded. In the UAE this year, Etisalat and du announced they would offer their own VoIP service, rather than addressing partnerships with Skype.

Without VoIP partnerships, traditional telecoms have a lot to lose, according to a report by London-based Juniper Research. The firm forecasts that mobile phone VoIP traffic will double each year between 2010 and 2015. Also, it expects mobile VoIP traffic on 3G and 4G networks to rise from 15 billion minutes in 2010 to 470.6 billion minutes by 2015. In particular, mobile VoIP traffic will rise in developed markets, thanks to the increasing ubiquity of 3G networks. "Wi-Fi mobile VoIP is potentially the most damaging of all VoIP traffic as it bypasses the mobile networks altogether," stated Anthony Cox, an analyst at Juniper, in the report. "We forecast that mobile VoIP over Wi-Fi will cost operators US$5 billion globally by 2015."

Can’t Control the Tides?

As telecom regulators in the Middle East aim to protect monopolies, their immediate response seems to be to threaten companies and users with restrictions, even as Internet-based communication finds new ways of integrating with web services. "Blocking VoIP is like trying to control the tides," said Steven Hartley, principal analyst at Ovum, in a statement accompanying its May report. "Most mobile operators today have attempted different means of hindering the use of VoIP, or are cautiously monitoring usage. At best, they offer special VoIP tariffs to avoid regulator attention, but these are not viable for end users."

The newest target seems to be Google Voice, the VoIP service that the search engine launched in North America. It is a similar product to Skype, as it enables consumers to place Internet calls through a computer or mobile phone. It works in tandem with its free Gmail service. Google says no Middle Eastern version is available, but regionalized products will be released over time. Analysts reckon the ban on Skype would apply to Google’s VoIP product too. Access to Google’s site featuring Google Voice has alreadty been restricted in the UAE. When contacted, Google representatives in the Middle East declined to comment.

Skype, unlike rivals also offers video conferencing. According to Skype, it represented 34% of its total call volume. A beta Skype edition allows five persons to be online simultaneously. Furthering its reach into corporate VoIP, the company announced a strategic partnership in September with corporate telephone maker Avaya. While the partnership is focused on U.S.-based businesses, Skype has also joined with television manufacturers to have its software included in their products. Internet-enabled TVs from LG and Panasonic, equipped with Skype for video chat in high definition, are available in the Middle East, and marketed for conference rooms and living rooms alike.

There is speculation about a potential partnership between Skype and social media giant Facebook. Recent reports suggest Facebook’s platform could merge with Skype’s VoIP client. If that happens, Skype would have access to Facebook’s 15 million registered users in the Middle East and North Africa, providing another buffer of vocal users to make it even more difficult for governments to slap restrictions on their service. A strategy of becoming too big to avoid may be the way for VoIP to find its place in the region, suggests Pamias of Delta Partners. "It is a question of leveraging a big community and [figuring out] how to monetize it," he says.