Almost exactly three years ago, just before the Windows 7 beta made its public debut, I asked Should Microsoft get into the PC hardware business? Now I’m hearing the same question again—but this time it’s not about PCs. It’s about phones.
The smartphone category is growing at breathtaking speed and shows no signs of easing soon. Unfortunately for Microsoft, its share has eroded as the market has grown. For now at least, Apple and Google account for more than 80% of the market, according to just-released numbers from NPD. Microsoft has a credible contender to the iPhone and Android in Windows Phone 7, especially after its Mango update arrives this fall. But its market share remains microscopic nearly a year after it was launched.
So how does Windows Phone grow? The old-fashioned way.
For the Windows Phone business, Microsoft uses the same partner model it has refined over three decades with PC OEMs. Microsoft supplies the operating system software, and OEMs design and build their own devices on which to run that code. Those partner relationships bring in the bulk of Microsoft’s revenue, and even small changes can have tremendous consequences. Outsiders often underestimate just how powerful those relationships are, and how difficult (and dangerous) it is to change them.
That’s why it was a big deal when Microsoft and Nokia entered into a “collaboration agreement” earlier this year. The jointly developed “portfolio of new Nokia devices” should begin to appear later this year and accelerate through 2012.
If Microsoft wanted to begin manufacturing its own brand of phones, it could buy Nokia. In the wake of Google-Motorola, some analysts think that’s going to happen. I disagree.
The current Nokia-Microsoft deal is the nearly perfect test of whether Microsoft can evolve its business model without disturbing those sensitive partner relationships. When the deal was announced six months ago, some Microsoft partners, like HTC and Samsung, had to be nervous about Nokia’s special arrangement. Ironically, Google solved that problem for Microsoft with its acquisition of Motorola. Now, Microsoft looks like the one that has been sensitive to its partners by not becoming a direct competitor.
The Nokia deal has all sorts of advantages for Microsoft, not the least of which is Nokia’s vast worldwide reach and established billing networks worldwide. Back in April, in an interview at the MIX conference, Windows Phone General Manager Matt Bencke told me that the number-one benefit of the Nokia deal is that it will allow the Windows Phone platform to scale faster: “Nokia ships more phones than the top three PC OEMs all put together,” he noted. “They have supply chain and manufacturing in place in all major [geographic regions] and they have operator billing worldwide.”
Those are formidable advantages. And make no mistake about it: Nokia is huge. Its share of the smartphone market is larger than any competitor—five times larger than Motorola, for which Google is about to pay $12.5 billion. (See this New York Times infographic for a superb illustration of just how Nokia compares to its competitors.)
In addition, the partnership combines a truly enviable collection of patents. According to my colleague Mary Jo Foley, Microsoft is kicking in “payments measured in the billions of dollars” to Nokia, which in turn is making “substantial payments” to license Microsoft’s patents. ZDNet’s Larry Dignan notes, correctly, “It’s safe to say Nokia comes out ahead on the payment side of the equation.”
The cross-licensing essentially makes each company about as lawsuit-proof as you can get in our current, patent-crazed world.
Given the depth of that relationship, what could possibly motivate Microsoft to buy Nokia? What else would they get except the management headache of running a very large company and anger from their existing partners? Nothing.
Google is willing to risk alienating its Android partners. But that is a calculated risk for Google. It needs Motorola’s patents to defend the Android operating system that its partners get for free. Microsoft doesn’t need to buy the patents, nor can it afford to take a similar risk with its partners by buying Nokia.