Microsoft had no choice. After years of getting trounced in the mobile market by rival tech titans Apple and Google, the Redmond, Wash.-based software giant needed to make a bold move if it wanted to mount a serious smart phone challenge. Microsoft’s $7.2 billion deal to buy Nokia’s mobile phone business and license its patents is certainly an aggressive move — one that signals a new direction for the software giant — but given Apple and Google’s dominance of the smart phone market, Microsoft’s Nokia gambit may be too little, too late.
In many ways, Microsoft’s purchase of Nokia represents a tacit acknowledgement of failure. Despite pouring billions of dollars into mobile software and gadgets like the ill-fated Surface tablet device, Microsoft has not been able to find a formula to compete successfully with Cupertino and Mountain View. The deal is also a belated acknowledgment of the market’s structural shift away from desktop computing and toward Internet-enabled mobile devices.
Microsoft’s Nokia deal is a Hail Mary pass. And like all Hail Mary passes, it carries more than a whiff of desperation. The question now is whether the combination of Microsoft and Nokia can achieve what neither company could accomplish on its own — a credible challenge to Apple and Google (not to mention Samsung) in the booming smart phone market. On Tuesday, investors expressed their skepticism about the deal, pushing Microsoft shares down nearly 5%.
By gobbling up Nokia’s device business, Microsoft is signing on to the integrated software and hardware model employed by Apple with stunningly successful results. (As my colleague Harry McCracken noted, Nokia already sells close to nine out of ten Windows-based phones.) That logic was also endorsed to a limited degree by Google two years ago, when the tech giant announced a deal to buy Motorola’s mobile phone business and patent portfolio for $12.5 billion. To be clear, Google is nowhere near fully buying into that model. The majority of Android phones are still manufactured by external device makers like Samsung and HTC, but Google’s Motorola purchase made clear that it wanted to produce its own hardware at scale.
“Integration of hardware and software will help Microsoft offer competitive alternatives to Google and Apple,” Microsoft said in a document outlining the strategic rationale for the Nokia purchase (embedded below). “We will continue to support iPhone and Android/Galaxy phones with our services. But we cannot risk having Google or Apple foreclose app innovation, integration, distribution, or economics. We need a first-rate Microsoft phone experience for users.”
It’s somewhat startling that Microsoft is making such a declaration in late 2013, many years into the smart phone revolution. But the company’s candid acknowledgement of the risks posed by Google and Apple — and the need for “a first-rate Microsoft phone experience” — underscores just how late Microsoft has been to the smart phone party. And it’s not just hardware. Microsoft completely missed the boat on one of the essential ingredients for building smart phone market share: the creation of a robust app ecosystem. Both Apple and Google now offer hundreds of thousands of mobile apps through their online markets. These software programs have worked wonders to propel Apple and Google to their positions of dominance.
Last month, Google unveiled the new Moto X, the first phone it has designed and produced entirely in-house. By buying Nokia, Microsoft is in some ways following in Google’s footsteps — more than two years later. “The latest acquisition announcement by Microsoft has many similarities with Google’s purchase of Motorola Mobility,” says Darren Hayes, a professor at Pace University’s Seidenberg School of Computer Science and Information Systems. “The move is a positive one but also very necessary given Microsoft’s poor performance in gaining a foothold in the smart device market.”
The latest U.S. mobile device and software market numbers underscore the uphill battle Microsoft faces. Microsoft’s mobile software accounts for a minuscule 2% of the market, compared with a combined 92% share for Apple’s iOS and Google’s Android operating system, according to data released last month by research firm Nielsen. On the device side, Apple accounts for 40% of the market, while Samsung, HTC, Motorola, and LG devices running Android account for a combined 48% of the market. Nokia devices are only used by 1.2% of U.S. smart phone owners — a stomach-churning plunge from the pre-iPhone days when Nokia accounted for 40% of the market.
These market share numbers illustrate the conundrum Microsoft faced as it contemplated the Nokia purchase. Microsoft realized that it needed a bold, transformative move in order to compete with Apple and Google. Clearly, an acquisition made sense, but which company to gobble up? Although there had been rumblings in recent years that Microsoft might make a play for BlackBerry (formerly known as Research in Motion), that prospect dimmed as BlackBerry’s market share plummeted in the midst of the Canadian phone maker’s own travails.
For the last three years, Microsoft has been working intensively with Nokia on devices that run the Windows mobile operating system, so a tie-up with the Finnish tech giant made sense. (Just days before the deal was announced, AllThingsD’s Kara Swisher presciently guessed that Microsoft might buy Nokia “to solidify its phone efforts.” She described such a move as a “whoa-nelly one, but not completely out in left field, either.”) As it turns out, Microsoft’s deal for Nokia had been percolating for months, dating back to a February meeting at the Mobile World Congress in Barcelona between Nokia’s then-chairman Risto Siilasmaa and Microsoft CEO Steve Ballmer, according to Swisher’s AllThingsD colleague Ina Fried.
Given Apple and Google’s command of the smart phone market, it’s not surprising that some industry analysts are skeptical of Microsoft’s ability to compete, even after the Nokia purchase. “Winners in the smart phone market are already declared,” Trip Chowdhry, managing director at Global Equities Research, wrote flatly in a note to clients. “Ninety-five percent of the market is going to remain with Google Android and Apple. There is no third player. Microsoft, Blackberry, etc. will play in the ‘Others’ category, which is the remaining 5% of the smart phone market.” Chowdhry added: “Had Microsoft acquired Nokia in 2005, we would have thought that to be ground breaking, not in 2013, when the smart phone industry is already well-defined.”
Chowdhry may be overly pessimistic by declaring “Game Over” before Microsoft has even had a chance to integrate Nokia into its business, but there’s no doubt that Microsoft faces an immense task. As my colleague Harry McCracken observed, tech mergers don’t have a great track record, especially tie-ups between companies already operating from a position of weakness. “In other words,” McCracken wrote, ”If the deal ends up looking even modestly successful, it’ll have beaten the historic odds.”