Capital Ideas Blog

Why the Microsoft-Nokia deal might work

By Pradeep K. Chintagunta

From: Blog

This post originally appeared on the Kilts Center Faculty Blog.

In the movie Disclosure, based on the famous novel of the same name by Michael Crichton, Bob Garvin, the character played by veteran actor Donald Sutherland notes: “The Chinese say, ‘May you live in interesting times.’ Well, this has been the most interesting merger since my second marriage.”

Microsoft’s recent acquisition of Nokia’s Devices & Services business has generated much talk in the press with both companies clearly going through “interesting times.”

The deal, coming on the heels of BlackBerry’s apparent failure, makes some prima facie sense given Nokia’s struggles in the smartphone market and Microsoft’s limited success with the Windows phone software.

Nokia will get access to Microsoft’s deep pockets and marketing muscle, and Microsoft will be able to move forward on its “hardware-software” strategy (Xbox and videogames; Surface and tablets; and now Nokia and cellphones) of better integrating devices with its software core. 

The cellphone industry has come a long way in the past 10 years. As a contrast, here is an excerpt from a Wall Street Journal article from 2002 (Facing Big Threat From Microsoft, Nokia Moves to Share Its Software).

“By 1998, Nokia had become the biggest mobile-phone supplier in the world. Bill Gates, chairman of Microsoft, approached Jorma Ollila (the then CEO of Nokia) to ask whether the two companies could work together to develop advanced phone software. Mr. Ollila spurned Mr. Gates's overtures, because he feared that Microsoft would eventually siphon off most of the profits generated by the mobile-phone industry. Instead, Mr. Ollila got together with executives from Britain's Psion PLC, a maker of hand-held computers, and rival phone maker Telefon AB L.M. Ericsson of Sweden. They met at a country house near the town of Nokia, the Finnish company's birthplace, a two-hour drive north of Helsinki. In June 1998, the three companies -- later joined by Motorola -- pooled their software resources into a joint venture, called Symbian, aiming to lock Microsoft out of the mobile-phone market. It didn't work. Microsoft responded by teaming up with one of the few major mobile-phone makers outside the joint venture -- Samsung Electronics Co. of South Korea. In June 2000, the two companies began to develop a version of Microsoft's Windows PC software for mobile phones. They dubbed it Stinger.”

In 2002 Nokia had a 36% share of the worldwide device market and Motorola had 15%.

Fast-forward 10 years and the cellphone universe looks very different. First, what the customer wants from a device has changed dramatically. The cellphone today is very closely integrated with all aspects of an individual’s life—right from playing the role of a secretary, to enhancing productivity on the job, to providing a platform for social interactions, to keeping track of health and wealth, to taking pictures, to replacing the watch, to providing entertainment, to even being a mirror on the go. The smartphone has been able to successfully span both professional and personal domains—no easy feat!

Second, firms have been working furiously to incorporate all the functionality that consumers have begun to expect, and more. Companies that have not consistently kept up with these demands—including Nokia and BlackBerry—have suffered.

Back in 2002, Mr. Ollila, when asked whether the mobile-phone industry was becoming more like the PC business, responded, “I don't think the argument is a valid one.” He did, however, recognize the importance of software; today’s operating systems combined with the myriad available application software seem to attest to this insight.

Third, and as a consequence, the players in the device market are very different. In 2002 Samsung had a 7% share of the market and Apple was not even on the horizon. Today, as software and device players, Google, Samsung, and Apple are leading the way.

Into this world steps the Microsoft-Nokia combine. What are some of the success factors for it going forward? The first thing it needs to ensure is that it can cover the “entry ticket” needs that consumers are looking for—a beautiful design, ease of use, and availability of applications.

Clearly, Nokia has demonstrated the ability to make beautiful devices—witness the luminous Lumia line. Ease-of-use has traditionally not been a Microsoft strength given its primary focus on the business market; but there certainly exists recognition for a need to achieve this. In terms of application availability, the company needs to draw on its lessons from the Xbox; videogame consoles are the canonical example of the importance of indirect network effects.

Even if the new combine can do this, it still needs a “hook” or a key differentiator that will draw consumers to its devices. Prior to the acquisition, Nokia’s attempts at differentiation appear to be along the lines of “amping up” the phone’s features.

An example of this is the Lumia 1020 with a 41-megapixel camera. This phone’s camera sensor far outdoes other phones; not only that, it exceeds the specifications of most standalone digital cameras as well. This is certainly a “wow” factor but appeals most to those for whom taking pictures and videos is a key activity with the smartphone.

From the productivity perspective, a key benefit of Windows devices is MS Office. Along these lines, more tightly integrating the phone with the desktop and enabling seamless remote access and operation of business machines and processes might rekindle interest for these devices in the corporate sector.

A third possibility is to leverage the one Microsoft franchise that has high customer equity—the Xbox. If Microsoft wants to go after the consumer market with its Surface tablets and Nokia phones, one way to do it is via tight integration with the Xbox game console as an enabler, accessory (e.g., controller), and a standalone device in the Xbox “family.”

Videogames represent a segment that is Microsoft-specific; Apple, Google and Samsung are not direct players in the console business (although all their devices are platforms for playing games). It is also an area where Microsoft has high brand equity. A creative way of “tethering” these strengths may be an effective way of differentiating itself.

Having said that, the other lesson that the company needs to take away from the devices market is the unforgiving nature of the product life cycle (see my earlier post on this topic) and the need for constant innovation in the quest for providing additional consumer benefits.

As Flint Lockwood (voiced by Bill Hader) in the movie Cloudy with a Chance of Meatballs tells the character played by Neil Patrick Harris: “Come on, Steve. We've got a diem to carpe!”

Hopefully, Microsoft’s CEO Steve Ballmer heeds this call.


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