The press has been awash in the last week with speculation over the Microsoft and Nokia deal. The reality is that this is a deal that has been almost two years in the making and not something new. What everyone is trying to work out now, is will this save Microsoft, the Nokia phone business and Windows Phone.
Partners in failure
Back in 2010, ex Microsoft executive Stephen Elop took over as Nokia CEO. It wasn’t long before he issued his “burning platform” memo which described Nokia as on the path to oblivion. At the time, virtually every experienced analyst, business journalist and technology journalist viewed this as preparing Nokia for sale to Microsoft.
While that didn’t happen immediately, Elop did announce a deal with Microsoft to be their lead partner on Windows Phone. As part of that deal, Microsoft paid US$1bn to persuade Nokia to depreciate the Symbian platform and thereby removed a smartphone OS competitor.
At CIC, our view was that this was two failing businesses trying to prop each other up. There was no sign that this would rescue either and no evidence it was going to stop Nokia shareholders from drowning.
Since 2011, that view has proven correct. Although Nokia has released a lot of new Windows Phone handsets, the take-up has been marginal. The only bright spot has been that the demise of the Blackberry brand has meant that the Windows Phone market is now third behind iPhone and Android.
At the same time, Microsoft has stumbled from crisis to crisis with the Windows Phone OS. It failed to properly align versions with the desktop, failed to build the huge app store it promised and failed to make any meaningful inroads into the smartphone market.
The net result is that the deal has failed to deliver shareholder value to Nokia and Microsoft has proven it really doesn’t understand the smartphone market.
Microsoft losing the post PC battle
Given how poorly the partnership arrangement has worked, many people are questioning why Microsoft would want to acquire the Nokia phone division. The answer is simple, Microsoft is preparing itself for a post Ballmer and post PC world.
This is a world of services and devices. Platforms are the bridge, but it has taken Microsoft too long to understand that the OS alone is not enough to win. As a result, Microsoft has found itself a bit player as first its consumer market and secondly its business users have begun to defect.
The breadth of choice, style and functionality available from Apple and Android devices is significant. They are attractive to users, priced from low-end commodity to high-end premium market and are massively outselling Microsoft’s traditional platforms.
Microsoft has tried to fix this itself. Microsoft Surface was supposed to be the saviour of the Windows on tablet market but instead has turned out to be a huge flop. Delivered late, with software problems and at a price that was unrealistic, Microsoft has been left with warehouses full of unwanted product.
With Windows Phone failing to grab a real share of the smartphone market and Surface becoming the latest high profile embarrassment Microsoft was left with two choices: Get out of the market and admit defeat or take drastic action to fix the problem. The latter is what they’ve chosen to do and to achieve that they have finally agreed this long awaited acquisition.
So what does this acquisition mean?
The headline cost of acquiring Nokia has been put at US$7.2bn. This consists of US$5bn for the handset division and US$2.17 for a 10-year licence to use Nokia’s patents. In reality, Microsoft had already given Nokia a US$1bn advance back in 2011 so the real price is US$8.2bn, a number that overvalues the Nokia phone business when you think in terms of engineering and manufacturing. So why pay that much?
The first thing to look at is the Nokia patent library. This is huge and very significant. It extends beyond the handsets into standards and a lot of patents that other handset vendors have to licence. Nokia has been probably the biggest player in the Java market when it comes to mobility and holds a lot of software patents here as well.
Although Microsoft has a lot of patents of its own, it has been buying up patent libraries over recent years to bolster its position in cross-licensing negotiations. As part of this deal, Microsoft has NOT purchased the Nokia patent library but has acquired a 10-year licence to utilise any of the patents contained within it. While not the best deal, we would have liked to see Microsoft acquire those patents, it does mean that Microsoft has access to the key patents to developing new devices.
The second part of the acquisition is the engineering resources that Microsoft has acquired. Although Microsoft has built its own reference platforms in the past, it still lacks the highly specialised engineering resources that Nokia owns. The acquisition will give it access to research on different device classes, device designs, touch screen technologies and the intricacies of how to combine CPU and memory inside the devices.
This latter point is critical to Microsoft. Despite the work it has done to slim down its OS, it still contains a lot of bloat and is heavy on CPU and memory. Nokia’s engineering teams can now sit cheek by jowl with Microsoft’s software teams and finally create a slick, fast and responsive OS that does not require huge computing resources.
This will not be a quick fix. Rewriting an OS takes time and Microsoft cannot risk trying to do something on the fly that will impact the brand any more than recent problems with updates have done. It will also take time for the two teams to be merged together. If anything happens within six months it would be surprising. We are almost certainly looking at a year.
The last, and to many, the biggest gain is the handset and device business. While the Nokia Lumia phablet is not expected to ship until September/October, it has completed the engineering cycle for it. In a post PC world, Microsoft now becomes the fourth company, after Apple, Blackberry and HP, to own the entire chain from manufacturing to OS and through to applications. Google still relies solely on OEMs for devices although it must now be considering its next move.
Smartphones and tablets are not everything. Nokia made its money by delivering devices that catered for users from basic handsets to smartphones. While it is no longer a trendsetter at the top end of the market, the explosion in growth at the bottom end through the Asha brand has been spectacular. Microsoft will certainly see this as an opportunity to expand that brand and use it to then trade users up to more fully featured Windows Phones.
Now that it owns everything, Microsoft has no excuse for not getting a smooth story sorted out. Phones and tablets should now be on the same schedule for OS release. The app store will become a single point of call for phone, tablet and desktop apps. Developers will be able to and should be encouraged to target multiple platforms easily. Like other software vendors, Microsoft has been encouraging developers to make their software run on multiple devices. What is still missing is a strong breadth and depth of UI and UX education for developers.
For Microsoft’s own applications, it can now look at how it will create a smooth home to business delivery. Skype from Xbox One to the enterprise is already there but Office is not. Now is the time for Microsoft to look at which assets are key and which are not.
The successor to SkyDrive, once Microsoft complies with the recent court ruling and does the renaming, will become essential here. Microsoft has a bigger opportunity than Apple iCloud and Google cloud by making SkyDrive the default storage option for consumers using phone, tablet, Xbox One, laptop and desktop.
The OEM challenge
One of the perceived risks for Microsoft in buying Nokia is what it will mean for Microsoft OEM phone partners. The honest answer is come back in a year and we’ll take a look.
On the face of it, Microsoft competing against you doesn’t sound like a promising thing. However, Microsoft has built its entire business around learning how to create an ecosystem that fills in gaps and even competes with it. Attend a major Microsoft show and there are competitor databases, management suites, developer tools and a host of other things that directly compete with Microsoft products.
The same is true of the some of the current limited hardware Microsoft makes. Xbox was never designed to compete with partners but keyboards, mice and other peripherals do compete and Microsoft has designed some nice stuff.
There are two risks here for Microsoft from its OEM partners. The first is that they will either slow their pace of innovation or stop making devices. Both of these are very unlikely outcomes given the potential size of the market.
The second and more damaging risk would be an anti-trust lawsuit. This has always been a challenge for Microsoft and is one of the reasons it has never properly integrated its internal teams. If this deal does result in a significant number of OEMs ceasing or scaling back production, I would expect to see lawyers jump in.
It is highly unlikely that Microsoft has not already considered this and sought legal opinion because the costs and impact on the business would be high.
Job losses and costs
Even before this announcement, Microsoft was entering a major restructuring exercise that it admitted would lead to job losses. With the acquisition, it has suddenly gained 32,000 new employees worldwide. It will take several months to start thinning out the additional workforce and potentially years before it is completed.
The result of this is that Microsoft may not show any significant profit from this acquisition for up to two years. With a major change in CEO happening in that time and shareholders already restless about the rate of return, Microsoft will find itself under real pressure to cut costs quickly, deeply and without serious risk to the business.
The Elop Question
Even before the deal with Nokia was announced, the bookmakers had listed Stephen Elop as their favourite to become the next Microsoft CEO. As part of this acquisition, Elop now re-joins Microsoft as head of an expanded Devices division where he will report directly to Ballmer. Is this about grooming him for the top spot? Possibly.
What isn’t clear is whether Elop really is the person Microsoft needs to save them. He was unspectacular in his previous stint at Microsoft. During his time at Nokia, he has failed to turn the business around and apart from the revenue from the acquisition, has not delivered significant value to the business.
It is also unclear as to whether someone versed in devices or someone with more of a background in cloud and emerging markets is the right solution for Microsoft. We won’t really know the answer to any of this for at least six months. By then, we will be able to see what Elop has achieved at Microsoft and how quickly he has managed the integration of the two businesses under his control.
If all goes smoothly, he could well put himself in the right place at the right time. However, Elop has more than just Ballmer and some shareholders to convince of his candidacy. Microsoft has announced that the successor to Ballmer will be chosen by a committee which means that Elop will have to go through whatever process they deem necessary and to do that he needs to be on the short list. At least by being in-house, Elop can make his case by delivering a viable and believable devices strategy.
On the surface, this is a far better deal for Microsoft than the possible acquisition of Blackberry, something that several commentators have advocated. Yes, the price seems a little high and they failed to acquire the Nokia patent library but they are at least getting a working company and one that already works with them.
It also offers a solution to the critics who believe that a failed smartphone and tablet strategy is the beginning of the end for Microsoft. Provided Microsoft can avoid an anti-trust case, the success of this move is down to how well it manages the integration of the two businesses.
Ultimately the big question is “is this a good deal for customers?” In essence I believe it is. Nokia has always had high engineering standards and arguably part of its problem has been the over engineering of its products. As part of a single entity, the Windows Phone OS and physical phone teams are now one and the same. This should lead to more tightly aligned products with fewer opportunities for error.
With a single division focused on devices, Microsoft finally has a chance to deliver that seamless phone to tablet to desktop story it has been talking about for a decade. If this happens, Microsoft will be back in the game and that has to be good for customers.