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Nokia (NYSE: NOK ) yesterday filed a 273-page annual report that includes some details about the expected risks and possible benefits of its recent decision to adopt Microsoft's (Nasdaq: MSFT ) Windows Phone 7 as its primary smartphone platform. It's an all-or-nothing bet, and Nokia could easily be screwed if only one of 69 domino pieces falls. And if it wasn't clear so far, Windows Phone 7 will also depend on Nokia, as Microsoft's commitment is unlikely to encourage any other companies to compete with Nokia. Competing against Nokia with a WP7 phone would be business suicide.
Investor communications and reports have to include cautionary statements. However, any investor reading Nokia's cautionary notes surrounding the Microsoft deal and its decision to drop Symbian and MeeGo in favor of Windows Phone 7 is depressing, a virtual plea to shareholders to drop Nokia shares now. In 12 pages of scary risks, we counted 69 explicit and key risk factors and reasons why the partnership with Microsoft could fail and why Nokia could go down the drain. As an investor, you need to have a lot of faith in Nokia CEO Stephen Elop's move to go with Microsoft, as well as confidence in his buddy Steve Ballmer, CEO of Microsoft.
The most dramatic aspect of these risk factors is that many of them are not in Nokia's power to influence but instead depend very much on Microsoft and Windows Phone 7, which Nokia even describes as an unproven platform. I cannot quite remember any other time in IT history when a market leader dumped its own assets and bet the farm on something new -- and succeeded with such a strategy. Windows Phone 7 may be backed by Microsoft, but the fact is that we haven't even seen proof that Microsoft can update its phones without a hiccup. Here's a taste of Nokia’s risk factors:
- "In choosing to adopt Windows Phone as our primary smartphone platform, we may forgo more competitive alternatives achieving greater and faster acceptance in the smartphone market. If we fail to finalize our partnership with Microsoft or the benefits of that partnership do not materialize as expected, we will have limited our options and more competitive alternatives may not be available to us in a timely manner, or at all."
- "The Windows Phone platform is a very recent, largely unproven addition to the market focused solely on high-end smartphones with currently very low adoption and consumer awareness relative to the Android and Apple platforms, and the proposed Microsoft partnership may not succeed in developing it into a sufficiently broad competitive smartphone platform."
- "The Microsoft partnership may not achieve in a timely manner the necessary scale, product breadth, geographical reach, and localization to be sufficiently competitive in the smartphone market."
- "We do not currently have tablets in our mobile product portfolio, which may result in our inability to compete effectively in that market segment in the future or forgoing that potential growth opportunity in the mobile market."
Of course, Nokia also notes the upsides of the deal and mentions that it will drop Symbian over time but expects to still sell about 150 million more Symbian phones in the years to come. It is hopeful that it can transition 200 million current Nokia users to a Windows smartphone. This year and next are expected to be transitional years for Nokia: "During this transition, we believe that our Devices & Services business will be subject to significant risks and uncertainties," Nokia states. "Those uncertainties, among others, include consumer demand for our Symbian devices and potential market share losses as competitors endeavor to capitalize on our platform and product transition. Therefore, we believe that it is not appropriate to provide annual targets for 2011 at the present time."
However, Nokia bets its opportunity on the combination of assets: "Nokia would bring assets such as its brand, hardware, productization, global reach, application store, operator billing support, maps, and location-based assets to the partnership. Microsoft would bring their next-generation smartphone platform with Windows Phone, as well as search, broader advertising, e-commerce, gaming, and productivity assets such as Bing, AdCenter, Xbox Live, and Office." Nokia intends to compete against other Windows Phone 7 partners through its assets as well as with the "distinctive Nokia design" in its devices. Realistically, Nokia may not have to compete, in the end, as the company clearly expects preferred treatment from Microsoft.
"The Microsoft partnership would provide us, however, with opportunities to innovate and customize on the Windows Phone platform with a view to differentiating Nokia smartphones from those of our competitors who also use the Windows Phone platform," Nokia states. This is a rather surprising statement that indicates that Nokia will have access to information and resources that other partners will not be able to use. Considering that Microsoft is collecting royalties from its partner for every Windows Phone 7 phone sold, this is, more or less, a request to drop WP7 now and move to Android. Given the circumstances and competitive risks from the Nokia/Microsoft partnerships, as well as the obvious relationship between Elop and Ballmer, current Windows Phone 7 partners could consider the platform more a threat than an opportunity. If that's the case, then Microsoft and Nokia may be on their own.
Nokia may be important to Microsoft, but neither Nokia nor Microsoft has shown that it has what it takes to compete in the modern smartphone battle. If Nokia really needs two years to transition and Microsoft makes more dumb moves to alienate the partners that got WP7 off the ground, the platform will be toast and Nokia will die along with it.
Microsoft needs all the support it can get these days, yet it decided to pour a rumored $1 billion into Nokia -- and Nokia already gives examples of how the Microsoft partnership could pay off: "We also expect to receive substantial sales and marketing support from Microsoft for our combined devices and services efforts with the goal of lowering those operating expenses over the longer term." And: "[T]he planned Microsoft partnership should enable us to make more focused R&D investments in operating systems and services, which is expected to result in lower overall R&D expenses over the longer term in our devices and services business."
Is anyone still interested in competing with Nokia? I have rarely seen a case where Microsoft has shot itself in the foot in such an effective way. The brown Zune MP3 player may have killed Microsoft's ambitions to compete with a music player. The Nokia partnership and the way it is communicated, however, could eliminate Microsoft's next mobile platform and bring into question the company's role as a major OS provider down the road.
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