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Millions of internet users who use Skype could be forced to find other ways to make phone calls after parent company eBay said it did not own the underlying technology that powers the service, prompting fears of a shutdown.

Why are there firms? A more flexible way to manage transactions would be through a system of specific contracts detailing what each individual should produce, to whom it should be delivered and what he should be paid. It would also be more efficient: a traditional firm makes some group of individuals the owners and a separate group of individuals the workers. The firm is saddled with the problem of motivating workers when the profits from their efforts go to the owners.

The problem of course is that most of these contracts would be far too complicated to spell out and enforce. And without an airtight contract, disputes occur. Because disputes are inefficient, the disputants almost always find some settlement which supplants the terms of the contract. Knowing all of this in advance, the contracts would usually turn out to be worthless. The strategy of bringing spurious objections to existing contracts in order to trigger renegotiation at more favorable terms is called holdup. The holdup problem is considered by some economic theorists to be the fundamental friction that shapes most of economic organization.

Case in point, Skype and eBay. eBay (NASDAQ:EBAY) acquired the Skype brand and much of the software from the founders, JoltId, but did not take full ownership of the core technology, instead entering a licensing agreement which grants Skype exclusive use. Since that time, Skype has become increasingly popular and a strong source of revenue for eBay. Now eBay is being held up. JoltId claims that eBay has violated the licensing agreement, citing a few obscure and relatively minor details in the contract. Litigation is pending.

Not coincidentally, eBay has publicly stated its intention to spinoff Skype and take it public, a sale that would bring a huge infusion of capital to eBay at a time when it is reinventing its core business. That sale is in turn being held up because Skype is worthless without the license from JoltId. This puts JoltId in an excellent bargaining position to renegotiate for a better share of those spoils. (On the other hand, had Skype not done as well as it did, JoltId would not have such a large share of the downside.)

Whatever were the long-run total expected payments eBay was going to make to JoltId in return for exclusive use of the technology, it should have paid that much to own the technology outright, become an integrated firm, and avoided the holdup problem.

And don’t worry. You got your Skype. Hold up may change the terms of trade, but it is in neither party’s interest to destroy a valuable asset.


Source: Skype's Hold Up Problem