The Microsoft–Nokia Deal: The Real Battle Will Be In Proprietary Services

A recent IDC quarterly report on mobile phones estimates that 237.9 million smartphones shipped worldwide during the last quarter. The market was dominated by Samsung, with 30% share, followed by Apple’s 13% share. LG came in a distant third with 5.1% share, closely followed by Lenovo’s 4.7% share. Finnish phone maker Nokia did not even make it on the leader board.

Microsoft to Act as Nokia’s Savior
But that may soon change. In a big announcement yesterday, after several months of will they, or won’t they, Microsoft finally announced their plans to acquire Nokia’s (NYSE:NOK) handset business for a whopping $7.2 billion. The all-cash deal values Nokia’s phone business at $5 billion and the company’s patents at $2.2 billion. Nokia and Microsoft have been working together since 2011 when Nokia agreed to get rid of the Symbian OS in their phones in favor of Microsoft’s Windows Phone.

Nokia has been of significant importance to Microsoft with their Windows Phone success. An IDC report estimates that Microsoft’s Windows Phone operating system was the fastest-growing phone OS, reporting 78% growth over the year. Android-based phones account for 79% of the market, followed by iOS’s 13% share. Windows Phone came in a distant third with a 4% market share. Nokia contributed 82% of all Windows Phone shipments in the quarter.

With the buy-out, Microsoft will aim at getting a big jump in the mobile segment. Microsoft has been bothered by the lackluster performance of their products and the growing dominance of Google and Apple within the segment. Analysts believe that the acquisition may also help decide the future of Microsoft’s leadership. Earlier last month, Steve Ballmer announced plans to step down from the position of the CEO within a year. Nokia is led by Microsoft alumni, Stephen Elop, who could be a potential successor for the technology giant. For Nokia, the deal means that they can focus themselves on their telecommunications, NSN, and mapping businesses.

Nokia’s Financials

Nokia’s Q2 revenues fell 25% over the year to $7.46 billion, missing the market’s target of $8.49 billion. The company did, however, manage to report a break even quarter compared to the market’s projected loss of $0.03 per share.

By segment, revenues from devices and services segment fell 32% to $3.57 billion, with sales from smartphones falling 25% to $1.52 billion and from mobile phones falling 39% to $1.84 billion. Nokia Siemens Network Segment revenues fell 17% to $3.64 billion, and revenues from the mapping segment, HERE, fell 18% to $0.31 billion.

Earlier this quarter, Nokia announced plans to buy the remaining share from Siemens for their NSN joint venture in hopes of strengthening its smartphone offerings. Nokia was also enhancing HERE’s offerings by releasing a new in-car navigation system, HERE Auto. HERE helps users plan trips using their smartphones, access fuel prices, get navigation details, and even find parking lots. The app comes with a companion mobile app that allows users to sync routes, save favorite places, and routes from both Android and Windows Phone devices. It lets drivers find where they left their cars and is able to access a vehicle’s sensors to provide information on fuel levels and tire pressure, and it can manage the car’s air conditioning system.

Nokia’s Failed Smartphone Attempts

Meanwhile, Nokia continued to push sales of its Lumia phones in attempts to establish a stronger position in the smartphone market. It recently announced a tie-up with AT&T that will enable the network provider to offer Lumia 925 for $99.99 starting this month.

The company’s smartphones are also being pushed into the emerging markets like that of India, where Nokia released the Lumia 925 at a hefty price tag of more than $500. Other Lumia models such as 625 were also released in the country. Finally, Nokia also lowered the prices of other Lumia models 520 and 620 by 30% to 40% in India to help attract more buyers.

The Windows 8–based Lumia smartphones from Nokia have received positive reviews since their launch. But it appears that they may be too little, too late. During the quarter, Nokia sold 7.4 million Lumia smartphones, which is a tiny number compared to the overall 71 million smartphones sold by Samsung and 31 million sold by Apple.

Nokia’s Success in Feature Phones
Nokia may have struggled to establish itself in the smartphone market, but it remains strong within the feature phone segment. IDC’s report estimated Nokia to be the second largest mobile phone seller, with 14% market share, a distant second from Samsung’s 26% market share. The feature phone market was led by Samsung. Nokia sold 53.7 million feature phones, which included 4.3 million Asha full-touch phones.

To further strengthen its position, the company continues to release new feature phones. Last week, it released a high-end feature phone, Nokia 515, which boasts of features like a 5-megapixel camera, LED flash, Corning’s scratch-resistant Gorilla Glass, aluminum-coated chassis 11 millimeters thick, 256MB internal storage, 32GB microSD support, Bluetooth 3.0, HD Voice, and USB tethering. The phone is priced at $150 and is expected to be available soon in Russia, Germany, Switzerland, and Poland. Analysts are concerned about the high price tag for the phone, which may hamper sales.

In nearly 150 years of its existence, Nokia has continuously reorganized itself. After beginning operations as a paper mill, until a few years ago Nokia was the leader in phone sales, with more than 67% of the market. Today, that market share has fallen significantly. Following the announcement of the acquisition, Nokia’s stock is trading at 52-week highs of $5.12 with a market capitalization of $19 billion. It is still a far cry from the good old days when the company boasted of a market capitalization of more than $200 billion. 

As for Microsoft, the mobile computing trend is unmistakable, the company’s weakness in that segment is proven, and acquiring Nokia at this juncture looks like a reasonable move to take a shot at the #3 position in the smartphone market behind Android and iOS. Nokia’s still-significant feature phone market share perhaps offers an opportunity to play in the low-end upgrade game. The price points will need significant adjustments to be competitive.

And the real battle will be played, I believe, in proprietary apps and services that will differentiate the brands in an increasingly commoditized hardware/OS game.

That battle has hardly started.