Microsoft + Nokia’s Mobile Business – The Road Ahead
By Kaleena Rivas, Madhavi Rao, Andrew Rivas, Amar Memon, Antonio Pérez Malpica
Since their introduction in 1979, mobile phones have been constantly evolving and becoming an integral part of our daily lives. From the first generation of devices based on cellular networks to the introduction of digital technologies like GSM and SMS and all the way to ultra-fast third and fourth generation (4G) networks, mobile phones have become more powerful, have increased their capabilities and have turned into essential devices for consumers around the world.
According to the International Data Corporation (IDC), in September of 2010 Nokia (Symbian OS) had 40.1% of the worldwide smartphone market share followed by BlackBerry (17.9%), Android (16.3%), and Windows Phone (6.8%). The IDC predicts that by the end of 2011, Android will become the leading OS system with 39.5% of worldwide market share due to their popular royalty-free business model, their partnerships with key global mobile carriers and the popularity of its applications (most of which are free). In order to increase its market share in the smartphone industry, Microsoft must deal with the strategic issue of proving the value of its Windows Phone 7 OS to their ecosystem partners and customers particularly in emerging markets where most of the growth is expected to occur.
Smartphones (phones with computing capabilities) became popular in the early 2000s with the business community, but it was not until 2007 when they were introduced to mainstream consumers with the release of Apple's iPhone which started the “consumerization” of mobile devices. While some smartphone manufacturers such as Apple and BlackBerry have proprietary operating systems, others use a third party developed software like Microsoft’s Windows OS or open source OS options such as Android developed by Google. The mobile industry has also a broad value chain with multiple parties involved: OS developers, phone manufacturers (OEMs), network operators and service providers. While there has been some recent consolidation across the mobile value chain (HP’s acquisition of Palm OS), there isn't a single company that provides all of these components and services which forces an inherent interdependency in the ecosystem.
Most of the future smartphone demand is expected to come from Emerging Markets, and primarily from the BRIC countries. Although many mobile users in these markets will remain on less sophisticated devices, on second-generation mobile networks and on prepaid agreements due to price-sensitivity, mobile devices and contracts are becoming cheaper and more accessible to low-income consumers. Smartphones in these markets are replacing PCs and evolving into vital communication lifelines for these consumers by providing convenient access to the internet, overcoming the lack of local infrastructure and by allowing them to quickly have access to latest technologies and service offerings.
China is leading the BRIC countries on smartphone adoption, the percentages of Chinese consumers planning to buy smartphones for the top, middle and low-income brackets are 15%, 10% and 8%, respectively (“PCs are passé”, 2011). Smartphones are also expected to be the most purchased device in India and Russia and the second most purchased in Brazil. It is important to note though, that the long-term sustainability of this growth will depend on the local government’s policies (aimed at long term sustainability instead of short term gains), infrastructure investment and incentives to domestic demand, innovation, fair local and foreign competition and overall development. For example, Brazil and China are still protecting local ecosystem players which could limit their growth in the long run.
New entrants in the emerging market smartphone industry have big barriers to overcome as Apple has built a loyal customer base and Android has saturated the market with their free product. Windows has a slight sense of familiarity and brand recognition with people who use its PC at home. However, OEM partners look at licensing fees as additional costs which translate into less profit per unit sold, making their future far more uncertain. Unless Windows can produce a product that consumers in these markets perceive as superior to Apple or Android’s products, they are only going to gain a small percentage of market share and become a niche market player.
Nokia & Microsoft Pre-alliance
Several mobile industry ecosystem partners have struggled in this industry due to the dynamic nature of the business and the new business models introduced by companies like Google, which have eroded gross margins. For example, before entering the strategic alliance with Microsoft, Nokia was facing several challenges and it was losing significant market share after dominating the mobile industry a few years back. A key contributing factor of this trend was Nokia’s organizational structure, significant overhead and slowness to react to consumer trends.
While Nokia had presence in over 150 countries, most strategic and executive decisions were still made at the corporate level in Finland. The company was focused on producing products suitable for the global market but did not always correctly anticipate local trends. For example, Indian consumers became very interested in cell phones that allowed the user to use dual SIM cards. Nokia’s competitors began offering phones with this capability, but Nokia was slow to respond. According to one former Nokia senior executive: “The Indian team was screaming for dual SIM phones, but either they did not scream loud enough or they weren’t heard.” (Goyal and Jaiswal). From a dominant Indian market share of 59% in 2005, Nokia fell to 33% of the cell phone market in 2010.
Microsoft was not doing any better. After the failure of the 6.5 version of their Windows Phone OS, Microsoft had to overhaul its approach to compete to Google’s superior and cheaper offering. While Microsoft was able to stop losing market share with the release of Windows Phone 7, this platform is still licensed to their OEM partners through a royalty model, is offered only through a subset of the key global carriers and does not have offer many applications. A key strength that Microsoft had is their global subsidiaries and development teams and how they were using their brand recognition to hire local, talented individuals in these markets. For example, the Microsoft India Development Center was able to recruit the top engineering graduates from India’s premier universities to develop software used in multiple Microsoft products. Over the last five years, the Microsoft India Development Center has been awarded over 270 patents, which has elevated the subsidiary to strategic status amongst Microsoft’s international subsidiaries.
Nokia & Microsoft Alliance Details
On February 11th, 2011 Nokia and Microsoft entered into a strategic partnership in the mobile business. By leveraging each other’s assets and core competencies in the mobile ecosystem, both companies expect to create value for consumers and partners (Figure 1). Under this partnership, Nokia will adopt Microsoft’s Windows Phone starting in 2012 as their smartphone operating system (slowly phasing out the Symbian OS), Bing as their search engine, adCenter for their advertisement and Microsoft tools for application development. Nokia will also contribute with expertise in hardware design, language support and broad billing capabilities and will provide Nokia Maps and their content and application store which will be integrated with Microsoft’s Map and Marketplace services respectively.
Figure 1 – Nokia and Microsoft mobile partnership value chain and capabilities
The expected benefits of this partnership can be summarized across the following audiences:
Both companies will be able to increase their competitive chances against industry leaders (RIM, Apple & Google) and new entrants (HP) while increasing their leverage with their mobile value chain partners – device manufacturers, applications developers, services providers and network operators. Furthermore, it is expected that they will be able to leverage their brand portfolio (Windows, Office, Bing, Xbox, NAVTEQ and Nokia) to create marketing synergies and eventually, reduce costs.
By replacing its outdated Symbian OS platform with Windows Phone 7 in their smartphone offerings, Nokia will be able to significantly cut their R&D costs, restructure their organization and access key Microsoft’s assets (search, global advertisement, productivity, development, cloud and marketplace). Furthermore, Nokia will have the right to modify Microsoft’s OS, will receive financial assistance (estimated in the hundreds of millions of dollars) to alleviate the costs and risks associated with the transition and could generate incremental revenue from search and advertisement referral agreements. Last, Nokia will get access to Microsoft’s marketing infrastructure in the US which could allow them to regain market share in this important market.
Once the transition is implemented, Microsoft will gain access to Nokia’s global presence and distribution channels, will benefit from Nokia’s hardware expertise for future versions of the OS, and will receive incremental revenue from WP7 royalties. Strategically, this partnership will allow Microsoft to regain much needed global market share (at both top and bottom ends of the market), to reduce the pace of the Google platform expansion and to access additional geographies where Nokia has local capabilities and partners. Lastly, the integration of Nokia’s intellectual property (Navteq) with Microsoft’s products and the increase in developer adoption could benefit the development of future products.
Customers will benefit from the partnership by having access to an additional strong alternative to the established leaders in smartphone market (Blackberry, Android & Apple). They will also gain access to Microsoft’s productivity offerings (Office, Business Communications, Sharepoint and Exchange ActiveSync) through additional platforms and devices enabling more services for them (IM, VoIP, etc.). Lastly, they will benefit from the integration of the device, OS, services, applications and support, which will reduce costs and improve their overall experience.
The success of this partnership is not guaranteed and it will face many obstacles. First, the length of the transition (2 years) is an eternity in the mobile industry and both companies’ futures in the mobile business could be in jeopardy if the partnership does not work. In the short term, going exclusively with WP7 could cause Nokia phone sales to plummet as traditional Nokia fans adopt other platforms. Therefore, it is in the interest of both companies expedite the transition as much as possible in order to increase their chances of success.
Second, both companies need to develop fully integrated products, that are accessible to emerging market consumers, that generate profits and that are easy to support in a multi-platform portfolio offering (Nokia has the right to continue to support other platforms including Symbian and MeeGo).
Third, this deal gives Nokia favored status and the right to modify the OS as they see fit. Microsoft needs to avoid alienating other OEM partners of their existing WP7 ecosystem (HTC, Samsung, LG) due to the specific HW requirements (buttons, chipset, etc.) that they have imposed on them and that they are now waiving for Nokia. In order to create a level playing field, Microsoft will have to increase the flexibility of their requirements for their existing OEM partners, allowing for enough differentiation among them while making sure interoperability and features are not affected.
Fourth, Nokia’s new CEO (former Microsoft’s employee) has experienced an increase in criticism from shareholders is facing low morale from Nokia employees due to the planned layoffs and re-structuring and still has the daunting task of repairing damaged relationships with Symbian developers who will now have to migrate to the Windows platform in order to remain in Nokia’s ecosystem.
Last, market saturation is high and it could be even more in two years. Both companies need to be able to produce devices that can compete on price on both ends of the market. For example: the iPhone is still relatively cheap to emerging market customers used to paying $500 for a BlackBerry or an Android based device. Considering the price sensitivity of the emerging markets, this could be a formidable challenge.
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This report was a group project for the Global Strategy class of Thunderbird School of Global Management Professor Nathan Washburn, Ph.D.