Microsoft and Nokia: A Strategic Blunder

on September 3, 2013

There’s an old military adage, “Reinforce success; never reinforce failure.” By purchasing Nokia’s device business for about $5 billion, Microsoft has just reinforced failure in a big way. It has been three years since Microsoft attempted to reboot its mobile business with Windows Phone 7, two and a half years since the company struck a broad partnership with Nokia, and a year since the introduction of Windows Phone 8 and the Surface tablet. Microsoft has next to nothing to show for any of these efforts.

Microsoft can easily afford the purchase price; it has the money lying around under the cushions of various couches around the world. The issue is one of strategic focus. At a time when Microsoft should be turning its attention to its successful core businesses to build for the future, it is redoubling  its efforts in an area where it is struggling, at best.

Microsoft financials chartAt a time when it should be thinking about the strategic direction of  a new CEO, Steve Ballmer in his remaining months and his now probable successor, Nokia CEO Stephen Elop, who will become a Microsoft executive vice president, will instead be devoting a lot of time and effort to integrating Nokia. The money-losing device business had about $15 billion in revenues last year, which would make it Microsoft’s fourth largest division (see chart.) But its 32,000 employees will increase Microsoft’s worldwide employment by nearly a third. A Finnish hardware unit and Microsoft, the quintessential software company have cultures that likely will resist easy integration.

The challenges for Nokiasoft are overwhelming. I thought for a long time that there was room for a third platform in mobile phones and that Windows Phone might well be it. But Microsoft, even with the Nokia partnership, has yet to rise above minuscule market share in the U.S. or worldwide. The implosion of BlackBerry was the best opportunity for Microsoft to grab share, but it has failed to do so. Microsoft must struggle to carve out a niche in what has become an iOS-Android world, or maybe an Apple-Google-Samsung world if Samsung and Google part company.

Missing apps. Furthermore, Windows Phone, now with more Nokia, still has the same old problem: The lack of an adequate app ecosystem. In software, Microsoft doesn’t get anything from Nokia that Windows phone didn’t already have (Nokia’s strongest mobile software asset, its maps business, is not part of the deal.) After three years, Windows Phone still lacks such table stakes apps as native YouTube and Instagram clients. Maybe a Herculean effort by Microsoft management could change this, but such an effort means other, probably more important things, are not going to be done.

The outlook in tablets is even bleaker. Windows RT, the version developed specifically for tablets, is a resounding flop and Windows 8 on tablets hasn’t faired much better.  Nokia reportedly has a Windows RT tablet ready to launch this fall; unless it is a lot better than the Surface or the Surface’s planned successor, it would just split a tiny market.

The iPhone has turned mobile phones, even business phones, into an overwhelmingly consumer business. This means the Nokia acquisition has plunged Microsoft far deeper into an area it really should be abandoning, Microsoft simply is not very good as a consumer company. And it is hard to see what Nokia, headed by a man whose greatest managerial success came as head of the Microsoft Business division, brings.

The Xbox problem. Xbox is Microsoft’s one consumer bright spot, but the chart above shows its fundamental weakness. Even putting aside the enormous sunk cost of Xbox and the fumbled launch of the Xbox One, the Entertainment & Devices segment is too small, especially in profit share, to make much of a difference. With little prospect for explosive growth in the game console-cum-set top box market, Xbox is not going to save Microsoft.

With whatever energy Microsoft management has left after coping the the challenges of the Nokia acquisition, the company should focus on what it does well, and that is to sell business software. That is a market that has been changing,  but here Microsoft has been adapting, converting its traditional sale of permanent software licenses into software-as-a-service and platform-as-a-service offering.

Windows sales will shrink with the PC market, but they aren’t going away and will remain highly profitable; a 50% operating margin for the Windows division in a crummy year is impressive. The urgent need is for Microsoft to develop a replacement for Windows 7 that businesses might want to buy–something with the under-the-hood improvements of Windows 8 but without either of its unloved user interfaces.

Reinforce success. The business software operations also deserve reinforcement. The big part of the tech commentariat that knows little or nothing about business software consistently underestimates the importance and staying  power of Office (I agree that Office is finished in consumer markets, but that was never its real business anyway.) Back-office tools such as Exchange, SharePoint, and SQL Server remain mighty money-makers and the Microsoft Dynamics suite of resource planning, customer relationship management, and accounting tools is growing nicely.

Web services, particularly those that serve business rather than those that are directly consumer-facing,  are another area of strength. While behind Google in many areas, Microsoft is well ahead of Apple, which often seems as clueless about Web services as it is savvy about devices. Azure, another service little-known to those who do not follow enterprise software, has made impressive gains the the platform-as-a-service business, though Microsoft should stop hurting itself by branding the product as Windows Azure. Windows has had a great run as a brand, but it is time to move on.

In the constantly mutating tech world, Microsoft cannot afford for its top management to take its eyes off these successful operations. But I fear that it will be hard to give these operations, which I think represent Microsoft’s best chances for future success, the attention they deserve while management is deeply distracted by the enormous challenges of Nokia. The $7 billion investment (including a patent licensing deal) was not a huge amount of money, but its ultimate cost to Microsoft could be a lot higher.