Sunday, February 13, 2011

Nokia & Microsoft, The Real Story

View of the Nokia corporate headquarters in Ke...
The recently announced strategic alliance between Microsoft & Nokia has been getting a lot of press, much of it negative. Some of that negative feedback has come in the form of a drop in their stock price, nearly 14% on Friday. All this negativity has Nokia CEO Stephen Elop on the defensive. I'm going to answer a couple of questions in this entry. The first one is, why did Nokia do this?

There are likely a number of reasons. The following two graphics will shed some light on one of the major ones.  The first one looks relatively good for Nokia.  Their market share has declined slightly over the past four years, but they are still the largest single player.  Notice how tiny Apple's share is even now, though it has been growing steadily.

The next graphic looks at margins (profit) rather than sales volumes. 

Here's where we begin to see the problem.  Notice how Nokia's profits have been shrinking steadily while Apple's have been growing? Basically what this says is that Nokia has been increasingly forced to compete based on price; and competing on price is almost never a good thing.  Particularly if this isn't the way you've been used to operating in the past. 

There are very few companies out there that like to compete on price. It's much more desirable to differentiate yourself in some other way and keep your margins high. Competing on price can lead to a downward death spiral. This is particularly true in situations where you have plenty of competitors who are smaller and more agile than you are. In the best possible outcome you are the last one standing and your margins are razor thin. You might be able to move back up market at that point but you're going to have a very hard slog. In short this isn't a fight that Nokia wants, win or lose.

So, what can they do? They've clearly failed to generate any excitement in the smart phone space where Apple, RIM & various Android based variants currently rule supreme.  They could join the Android bandwagon, but differentiation in that space is going to be very difficult.  There are plenty of companies out there making Android phones already and most of the opportunity for customization & differentiation lies with the carriers. All of which brings us to Microsoft. Microsoft hasn't had much luck selling any of their various smart phone OS's. Windows Phone 7 hasn't changed that picture much if any so far as I can tell. Still, Microsoft is a major player with significant corporate cachet.  It's easy to see why Nokia was willing to make this deal.  

Of course, that isn't the story they are telling. Nokia CEO Elop is blaming Android and claiming that Nokia is doing this to keep the smart phone market place from becoming a two horse race.  The following is quoted from this article

Wary of that development, Nokia instead decided to back Microsoft and its emerging Windows Phone operating system to make the mobile market more of a “three-horse race,” explained Elop. Because of its heft, Nokia’s decision to support Windows Phone “creates a different dynamic,” said Elop — namely, an environment where Windows Phone, which debuted just a few months ago, is a “challenger” to the forces of Google and Apple.

Apparently RIM doesn't even factor into this race according to Elop. I'm only being a bit sarcastic when I say that such an oversight may help explain why Nokia is in this mess in the first place. Their management is either very much out of touch or incapable of telling a credible story when some spin is needed. I suppose both of those statements could be true. Nokia would have no interest in making this a three horse race if they were one of the two (or really three) front runners right now.

The second question is, who has more to lose in this deal? The answer here is clearly Nokia.  Microsoft would love to see Windows phone 7 take off but given how small a part of their revenues the smart phone space is it isn't going to be the end of the world if Nokia falls flat on their faces. Don't get me wrong, Microsoft could benefit significantly given the changes that we're seeing in how people interact with the Internet but at the end of the day Microsoft still makes their money by selling applications and non phone operating systems and they have plenty of other initiatives in motion that are likely to help them maintain market share. This is a gamble that Microsoft would like to win, but it isn't life or death for them.  Nokia has much more to lose.

On the money front, I suspect that the dollars going back and forth are going to be roughly equal. The point of this deal isn't for Microsoft or Nokia to make money off of the other.  The point is to take a bigger slice of the smart phone pie and share in the profits.

Image at top via Wikipedia

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