By Jessi Hempel
August 11, 2010

The video chat service is mostly free, for now. But if Skype just tiptoes into the advertising business, its returns could be massive.

Apart from Google (GOOG), Skype may be the largest consumer site on the web without a banner ad. So when the company filed its prospectus with the SEC Monday in preparation for an initial public offering, I noted with interest that advertising was called out as one of its strategies for making money.

Sure, it was more of an aside than some of the others highlighted — like pushing paid products and cultivating business users. As most of web 2.0’s largest companies have discovered, advertising alone is not enough to sustain most businesses on the social web. But it’s not hard to image that the company could increase revenues — which totaled $406.1 million in the first half of the year — by 25%, simply by monetizing the current site. Assuming a conservative $800 million in revenues, that’s a $200 million opportunity.

Consider Skype’s potential take from banner ads alone. According to the prospectus, Skype has 124 million registered users who log on via the site’s front page at least once each month. If it were to introduce a homepage banner ad, commanding the $8-$10 per thousand impressions (CPMs) served that YouTube is rumored to get, back-of-the-napkin math suggests it would instantly come in to a new revenue stream of $12-$15 million annually. Sure, many of Skype’s users might be outside the United States where CPMs will be lower. But then again, most of those registered users will land on the homepage more than once during a visit, and many will return multiple times in a month.

There’s more opportunity in the 40% of Skype-to-Skype minutes that are videochats. During the first half of 2010, that was 61 billion minutes. Right now, those chats happen against a white background. In adding ads, Skype will likely fall into the trap that most user-generated content sites do — it’s hard to put banner ads against content that advertisers can’t control. But it’s not impossible. “Every impression has a price for some advertisers,” says one CEO of a large ad network. At such scale, even slim CPMs could still deliver meaningful revenue.

Opportunity in the unknown

The real advertising play for Skype comes in new formats, many of which don’t yet exist. Tom Bedecarre, CEO of the digital advertising agency AKQA, sees huge potential in branding on the site, pointing out that lengthy video calls allow advertisers deeper engagement opportunities. That creates potential for creativity at scale. Then there are new ways to add Skype capabilities to other types of businesses. “Imagine a telephone feature in an ad to immediately call a toll free number and buy something,” says Bedecarre. “I’d love to put our clients on Skype.”

Skype is thinking about that, too. In July, it launched Click & Call Advertising. Participating advertisers pay to have a phone number highlighted with a blue “free call” button anywhere online that the number appears. Search for a local car repair business, for example, and when the business appears in your search results, you will have the opportunity to call from your computer — for free — with the click of a mouse.

These types of highly targeted advertisements often resonate well with consumers because they are useful. If advertisers find news ways of giving people things they value, they’ll be able to cash in. Several advertising executives and investment bankers agreed that this type of advertising along with other new formats could be much more lucrative than any of the traditional banners for Skype, easily surpassing $150 million over the course of a year.

Building up a legitimate advertising business will be important for the company if it wants to preserve its freemium model in which a small percentage of the users — 6% in Skype’s case — pay for the services while most use it for free. As web 2.0 companies come of age, some have abandoned this model because they weren’t able to build up strong enough revenue streams to support free users. Most notable, white-label social networking site Ning began requiring all of its users to pay a monthly fee this summer.  Skype’s users have gotten accustomed to free calls. With competition heating up from traditional telecom companies as well as the Internet giants like Google and Facebook, Skype doesn’t want to disappoint them.

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