Whats Next for Microsoft and Nokia?

Todays announcement – major mobile manufacturer sells off its assets to an even larger tech company – is one Ive been anticipating for a few months now. Its just that, honestly, I expected the manufacturer in question to be BlackBerry.

In retrospect, though, Microsofts €5.4bn acquisition of Nokia shouldnt have come as much of a surprise. After all, the two companies have been strategically partnered since February 2011, when the manufacturer agreed to exclusively produce smartphones running the Windows Phone OS.

That deal meant Nokia was “entirely reliant on Microsofts software for its mobile future”, argues Victor Basta, managing director of Magister Advisors – and made todays acquisition inevitable.

“Nokia’s value has eroded progressively since, making the actual deal to acquire the mobile business even more attractive for Microsoft,” says Basta.

The 7.1bn dollar question is what lies ahead for each company. Will Microsoft be able to turn around the fortunes of Nokias struggling and boost the popularity of Windows Phone in the process? How will Nokia operate without its flagship mobile business?

Unfortunately, we dont have a crystal ball here at Mobile Marketing Towers. Instead, we can provide you with the context around the deal and leave you to make up your own mind. 

What the deal means for Microsoft

“We’re the number three smartphone player,” said Microsoft CEO Steve Ballmer in an interview with AllThingsD following the announcement. “We have a long way to go and we have a lot we want to do.” 

Its a pleasantly realistic take on Microsofts current position in the mobile landscape. Its last big push – the introduction of Windows Phone 8, its Surface tablets and the touchscreen-friendly Windows 8 OS – didnt quite make the dent it was hoping for.

However, Windows Phone seems to be starting to find its audience. According to Kantar figures published yesterday, the OS holds a 8.2 per cent market share in the top five European markets, and has even taken the number two spot in Mexico, with a 11.6 per cent share.

According to Microsoft, meanwhile, sales of Nokia Windows Phone devices have grown 78 per cent year-on-year, and now hold a share of 10 per cent or more in nine markets. By 2018, it expects to be shipping 1.7bn smartphones, giving it a global market share of 15 per cent, and annual revenue of $45bn.

That still puts it far behind Android and iOS, however, as Analysys Mason principal analyst Ronan de Renesse points out: “The acquisition will have a limited impact on the smartphone market in the short-to-medium term. Nokia and Microsoft have been working hand-in-hand on the Lumia device range for two and a half years and we don’t expect the acquisition to fundamentally change the Lumia team and its product roadmap for the next 12 months.”

On the other hand, the acquisition seemingly marks the beginning of a new direction for Microsoft, if only symbolically. CEO Steve Ballmer announced last month that he would be leaving within the year. The first clues lay in the internal email announcing his retirement, to clear the way for “our transformation to a devices and services company focused on empowering customers in the activities they value most. We need a CEO who will be here longer term for this new direction.”

The deal also seems to make good business sense for Microsoft. In its strategic rationale, the company revealed that under the existing partnership, it was receiving less than $10 gross margin for each Windows Phone unit sold by Nokia; after the acquisition, it will earn more than $40 per unit.

From an outside perspective, it also looks like Microsoft got a pretty good deal. Look at the $1bn Facebook paid for Instagram last April, for which it got a start-up consisting of 13 employees, with a single product – or Microsofts own purchase of Skype for $8.5bn in 2011.

“The sale of Nokia’s mobile unit to Microsoft for a trivial sum of €3.79bn is great news for Microsoft shareholders,” says Ajay Bhalla, professor of global innovation at Cass Business School. “It is not yet clear how Nokia’s board arrived at this valuation, but this appears to be a great bargain for Ballmer.

Not only will Microsoft get access to Nokia’s impressive intellectual assets for small change, it will also get access to its well-established infrastructure and competencies in emerging markets – where it continues to retain an impressive market share. Nokia has also poured billions into its handset business and has been showing signs of genuine turnaround.”

Bringing the hardware side of its smartphone business in-house puts Microsoft in a similar position to Apple – something Google also seems to be aiming for since its acquisition of Motorola, which has finally borne fruit with the launch of the Moto X.

“I think the main challenge for Microsoft now is is building a single customer experience, and thus customer loyalty, across its devices and properties, including desktop, mobile, Xbox and Bing,” says Forrester principal analyst Thomas Husson. “In the long run, integration is going to be key.”

This is particularly true in emerging markets, where Nokia devices are still extremely popular and where smartphone adoption is yet to truly take off – meaning habits might be easier to break. Devices coming with Bing preinstalled as the default search engine, for example, could help push Microsofts market share in other areas.

If Microsoft is able to properly leverage the Nokia brand – which is the second most coveted brand in Nigeria, Brazil, India and Saudi Arabia, according to research from Upstream and YouGov – developing markets look like its biggest opportunity.

What the deal means for Nokia

“This brings another chapter in Nokias history to an end, having once dominated the mobile devices business with a global market share of over 40 per cent,” says Ben Wood, chief of research at CCS Insight. “This move should be positive for both companies, but what exactly it means for the New Nokia is less clear.”

Its perhaps easy to forget in all the speculation about Microsofts future following the acquisition that Nokia will continue to exist, albeit in a very different form. Devices & Services, the business thats being sold off, accounted for just under half (47.8 per cent, to be precise) of Nokias total revenues in Q2, 2013.

That leaves Siemens Networks (which brought in 48.9 per cent of revenues) and Here (four per cent) as well as its patent portfolio. It doesnt add up to “an organisation with compelling logic,” according to CCSs Wood.

But its worth noting that this deal isnt the only way that things could have gone. Ballmer told AllThingsD that Microsoft had considered a variety of possibilities during the negotiation period, which means its probably particularly worth focusing on the exact terms that the two companies finally settled on.

The key seems to be Here, the mapping and location-based services business, which Ballmer acknowledges was something of a sticking point in negotiations. In the final reckoning, Microsoft has ended up “an innovation partner and customer of Here”, as Ballmer puts it. In practice, that means Microsoft is becoming a strategic licensee, as well as paying separately for a four-year license, with Nokia granted the right to use its patents in Here services.

It might only be providing a small amount of Nokias revenues for now, but the mapping business is clearly important to the company. When the company unveiled its rather comprehensive Here Connected Driving solution last week, we raised an eyebrow, and suggested that maybe it “pointed the way forward for Nokia, as its handset business struggles … it seems to be a market Nokia is well-placed to tap”. 

My incredible prescience – and smugness – aside, this seems to be at the heart of Nokias decision.

Its easy to accept the story of this acquisition as out-of-touch mobile company needs bailing out, and in all honesty, had it been BlackBerry, I might have well been saying just that. But by jettisoning the parts of the business which were struggling, Nokia is giving itself a chance at a brighter future. Its just that in this case, that future lies outside of mobile handsets.