Nokia-Microsoft's marriage: a marginal future

Nokia-Microsoft's marriage: a marginal future

Summary: There is no conceivable end to the Microsoft Nokia deal other than a full merger of the companies.If this deal had happened ten years ago, then that statement would be unarguably right.

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TOPICS: Emerging Tech
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There is no conceivable end to the Microsoft Nokia deal other than a full merger of the companies.

If this deal had happened ten years ago, then that statement would be unarguably right. There are plenty of signs that it will happen, a probability only strengthened by Microsoft's Chris Weber taking over as head of Nokia US.

Bad as that might be for Nokia and its people, the reality could be far worse.

The two companies are almost inextricably bound together now, in something very like a shotgun marriage. Although polygamy is common in the relationships between software and hardware companies, few handset makers will fancy a role as deputy wife with Mrs Nokia in charge of the household's hardware. And while Nokia is technically free to see other people, Microsoft can be an enormously jealous husband, especially when it comes to seeing the missus wearing anything other than the family jewels.

So it is easy to say that in two years or sooner, Nokia will become Microsoft's portable hardware division. That would seem to give Redmond, at least in its own eyes, the ability to compete with Apple head-on – and Apple sets a very strong example of what you can do when one company has absolute control over everything in its product range. If Steve Jobs stays out of the picture, the equation seems even more compelling.

Let's look a year down the line at the companies as they celebrate their first anniversary. Nokia will have changed: some of its best people will have left for good, taking their expertise onto the market or into start-ups. Some senior software people will have moved to the US: it's that or move Microsoft's Windows Phone team to Finland. Both companies have plenty of experience of trying to run large R&D efforts across time zones, and thus plenty of reasons not to do it. There will be little or no work on software, let alone alternative platforms, within Nokia. Regardless of how sensible that would be, Elop's in charge and Ballmer wouldn't like it.

Nokia's fortunes are now those of Windows Phone 7.

Microsoft, however, will be much the same. All it needs from this deal is a compliant wife who can work miracles in the kitchen. Provided it can resist meddling, Microsoft will get some great handsets out of this, an unparalleled worldwide distribution network and a huge potential presence in the developing world that, at the moment, is hard to call. The talk of optimising Nokia's hardware design to run WP7 is misguided. There's not much to be done that wouldn't be expensively pointless, at least until Nokia can start to emulate Apple's notoriously effective and market-shaping deals with component suppliers.

Looks good for Microsoft, less so for Nokia, If this was all the game had to offer, the rapid assimilation of the plucky Finns would be a given. Yet there's another factor. The problem with that scenario is that it's got a major downside for Microsoft.

Assuming that the Nokified WP7 won't sweep all before it in the space of twelve months, the project still won't be turning in very much cash. Apple only works because it makes enormous margins — of the order of twice Nokia's — and can thus throw reality-bending amounts of cash at R&D, marketing and supply line management in maintaining the Apple brand. Nokia can't rebuild its brand on the back of someone else's software. Further, Nokia's margin will now be split with Redmond, whereas Apple keeps the lot.

That picture is painful for Nokia, as it spells the end of so much of the company's expensive R&D habits, but it's doubly so for Microsoft. All of Microsoft's money comes from the insanely profitable Windows and Office franchises — insanely profitable, but declining. They're roughly the same as Apple's, but heading in the wrong direction.

The game is played in the margins, and Microsoft is under huge pressure from investors to keep those up. (Investors including one Stephen A Elop, listed as seventh biggest individual Microsoft shareholder, although he demurs - see below). Absorbing a large hardware company dependent on the cut-throat mobile market will hit the books a lot harder than having a Arms-length relationship which just delivers software profits. Microsoft's recent and expensive experience with gaming underlines that logic: while the Xbox franchise may look healthy, that's purely on the Xbox Live billion-dollar, 60 percent margin business. The consoles themselves are basically break-even. Not a model that looks tempting from the other side of the Baltic.

If Windows Phone 7 doesn't deliver the numbers, then cutting loose the devastated hulk of Nokia will be much easier than having to soak up the pain internally. And if it does make money, it will be for Microsoft alone. The investment needed for Nokia to survive in anything like its current form will be unavailable; Microsoft remains free to discard the deal if Windows Phone 7 is a winner and pick up with a lower-cost, far Eastern partner.

The Microsoft-Nokia deal may indeed be a marriage, but it's one of praying mantises.

(note: edited to correct spelling, and to note Elop's disagreement with the shareholder listing)

Topic: Emerging Tech

Rupert Goodwins

About Rupert Goodwins

Rupert started off as a nerdy lad expecting to be an electronics engineer, but having tried it for a while discovered that journalism was more fun. He ended up on PC Magazine in the early '90s, before that evolved into ZDNet UK - and Rupert evolved with them into an online journalist.

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8 comments
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  • "can thus throw reality-bending amounts of cash at R&D..."

    Nokia's research budget far exceeds that of Apple.

    Also a merger between the two firms is inconcievable, if only for the size of Nokia. If a merger happened there would be far more Nokia staff than Microsoft.

    "The consoles themselves are basically break-even. Not a model that looks tempting from the other side of the Baltic."

    This is to gain a market foothold, the Xbox couldn't compete if it priced at cost. The model IS tempting, and its success is judged by division profits. Sony uses a similar pricing strategy for its Playstation range.

    "If Windows Phone 7 doesn't deliver the numbers, then cutting loose the devastated hulk of Nokia will be much easier than having to soak up the pain internally. And if it does make money, it will be for Microsoft alone... Microsoft remains free to discard the deal if Windows Phone 7 is a winner and pick up with a lower-cost, far Eastern partner"

    Why? Any unit sales will get profits for Microsoft and Nokia. Why would Microsoft want to loose Nokia as a hardware partner when it still gives them licensing fees? What "far eastern" partner is going to offer Microsoft the same opportunities Nokia does?
    Closie-773af
  • > Elap's in charge and Ballmer wouldn't like it.

    Elop ;-)

    > Stephen A Elop, seventh biggest individual Microsoft shareholder).

    I don't think so. For starters, both Sinofsky (as of Jan 2011) and probably Ozzie (as of Nov 2009) hold more shares but they are not listed by Daily Finance. At MWC, Elop said:

    "About me being the 7th largest shareholder in Microsoft: that is not true. That would be a substantial amount of money that I don't have... when I moved from Microsoft from Nokia, I was legally prohibited from selling my shares. As soon as that lifted, I began selling. But when our discussions began, I had to stop selling again -- the laws are very clear. As soon as the legal restrictions lift, of course I'll sell those shares. I have been given an equity position in Nokia" but that won't be disclosed until later in the year for some financial and legal reasons."
    http://www.engadget.com/2011/02/13/live-from-an-evening-with-nokia-at-mwc-2011/

    Given that Elop was only at Microsoft somewhat briefly (2008-10), it sounds a bit unlikely that he'd have a bigger shareholding than all but a handful of roughly 90,000 current staff.

    > All of Microsoft's money comes from the insanely profitable Windows
    > and Office franchises — insanely profitable, but declining.

    They might decline in the future, but they are not declining at the moment.
    Jack Schofield
  • Apple has a very small R&D budget, considering, but then it makes hardly any products. The point I was making was that it's all part of the brand management strategy, and Nokia doesn't do that (and won't be able to, now).

    As for ElOp (ahem); well, he doesn't deny being the seventh biggest individual shareholder - if you want to be really paranoid! And the Windows/Office margins are declining. Revenues are up (as you'd expect at this stage in the various product cycles), but margins are not - and margins are what matters here.
    rupert.goodwins@...
  • Closie - the basic point is that for Nokia to carry on being Nokia, it has to make more money than it can by being a Windows licensee. MS will want Nokia for as long as it IS Nokia. After a while, that will change - and then MS will get better deals elsewhere, having kick-started WP7 (which was having a rocky start). Think of Nokia as the first stage of a Saturn V rocket. Gets you going, but you don't take it with you.
    rupert.goodwins@...
  • @Rupert
    A good analysis, particularly you rpoint about the margins. It seems extraordinary that Nokia has surrendered so much while MS has given so little. The Navteq map technology they use is their prize asset. There is no mention if this will now be available to all WP7 handset manufacturers. If so then Nokia have commoditized one of their best assets. I've commented elsewhere on the spinelessness of Nokia effectively giving up on MeeGo - if it is good enough to be a possible future but it is nearly ready now then why orphan it?! I know it is not just Elop and that previous management at Nokia should have shaken things up so that they had more output from their massive R&D spend but they've done well with MeeGo in a short time - consider how out of date WP7 will be by the time it is on Nokia phones with the slow reaction times of MS from the past. Just devastated after developing with Qt and knowing what it is capable of.

    People also forget where Apple were in 1996 - on the ropes. Luckily they didn't surrender and see where they are now. They had the intelligence to back their own technology and sell it even though they had failed with their own attempt at building a new OS. Nokia could have done the same with MeeGo - pushing into new markets like home entertainment and lifestyle web devices but because they are receiving "billlions" from MS they will sideline it until it is too late and they are shadow of what they were. It is going to end badly for them.
    bam-alam
  • @Rupert Goodwins
    > As for ElOp (ahem); well, he doesn't deny being the seventh biggest
    > individual shareholder - if you want to be really paranoid!

    Yes, he does deny it, as in "that is not true".

    > And the Windows/Office margins are declining. Revenues are up
    > (as you'd expect at this stage in the various product cycles), but margins
    > are not - and margins are what matters here.

    A weak and unsupported assertion. Margins are down in the last quarter, but not by an unusual amount. (On a corporate basis, June 02 and Sep 06 were lower.) Let's see your five-year numbers, please! ;-)
    Jack Schofield
  • I don't know why this whole Elop having stocks in Microsoft is a big deal or shocking either.

    Elop worked at Microsoft for a considerable number of years, before moving over to Nokia. While at Nokia he has not been able to sell his Microsoft shares due to insider trading laws.

    Also he isn't the 7th biggest shareholder, he is the 7th biggest publicly disclosed stockholder. There are many more private stockholders with much more substantial investments in the company.

    > "the basic point is that for Nokia to carry on being Nokia, it has to make more money than it can by being a Windows licensee"

    Why will Nokia make less as a Windows licensee? Sure it adds cost (around $8 per unit), but it also adds value to the consumer. Nokia sales have suffered recently due to bad software, $8 per unit to increase sales significantly is worthwhile.

    More importantly, what alternative strategy would you have had Nokia choose? Continue developing Symbian? Becoming yet another Android phone manufacturer (with the disadvantage of being a latecomer)? License stock WP7 (with no differentiation to competition)?

    I really don't see any other feasible strategy for Nokia.

    Also your assertion that Microsoft will "ditch" Nokia seems a bit unfounded. As long as Nokia is successful into the future, it will be a strong partner to Microsoft. Microsoft needs partners that can build great hardware into the future for WP7 to be successful, and that's what Nokia offers. The need for great hardware to support Microsoft's platform won't disappear in the future.
    Closie-773af
  • I was at the press conference quoted by Engadget above. He didn't deny being the seventh largest *individual* shareholder, he denied being the seventh largest shareholder. There is a 800 fold difference between those things.
    Simon Rockman