Microsoft Just Bought Its Next Multi-Billion Dollar Writedown

Microsoft's (NASDAQ: MSFT  ) decision to purchase Nokia's (NYSE: NOK  ) handset business will prove to be yet another costly blunder.

By acquiring Nokia's hardware assets, Microsoft has put itself in total control of the Windows Phone ecosystem. Unfortunately, that isn't exactly a great position to be in. Although the popularity of Windows Phone has increased in recent months, the operating system continues to lag far behind iOS and Android, and there's no reason to believe that it will ever catch up.

The Android and iOS duopoly
In terms of smartphone operating systems, there are only two that matter: Apple's (NASDAQ: AAPL  ) iOS and Google's (NASDAQ: GOOGL  ) Android. Together, the two accounted for 92.5% of the smartphones sold worldwide last quarter.

Google's Android took the lion's share, with almost 80% of the market. As Google maintains Android as an open-source operating system, it has dominated in developing markets, such as China and India , where customers are budget-constrained.

Apple, meanwhile, has seen its share of the smartphone market drop dramatically in recent years, down to just 13.2% last quarter, a decline of 20% from the prior year. But iOS still controls a large chunk of the market in many developed economies, including the U.S.. Moreover, it continues to be the preferred platform for mobile app developers.

Most apps start on iOS, and then (assuming they're popular), eventually make their way to Android. Examples of this abound -- Mailbox, Tinder, Instagram, to name a few. But support for other platforms is low. Windows Phone isn't as bad as BB10, but still lacks numerous, high-profile apps such as Flipboard, Google Maps, and HBO Go, not to mention lesser-known niche apps that users of particular mobile operating systems may have grown accustomed to.

No niche for Windows Phone to fill
Fundamentally, there just isn't a market niche for the Windows Phone platform to occupy. iOS offers a great mobile experience with a wide selection of apps. Android keeps most of things people love about iOS, but is available on handsets of all shapes, sizes, and price points. But Windows Phone? Outside of a better interface (debatable), Windows Phone brings nothing new to the table.

Microsoft believes that having one operating system across all devices is an advantage to users -- consider Windows 8, an operating system designed to work on both tablets and PCs -- but there's no evidence to suggest that this is the case. To date, Apple has kept its PC and mobile operating systems separate (and plans to do so for the foreseeable future), and remains one of the largest manufacturers of both tablets and smartphones. Meanwhile, Microsoft's Surface has sold poorly, and reception to Windows 8 has been tepid at best.

In its presentation on the Nokia deal, Microsoft projects that Windows Phone can capture 15% of the smartphone market by 2018. Given that it's currently at 4%, but growing rapidly, 15% in five years might appear to be a realistic goal.

But the economics just don't support it. Operating systems are a platform business that benefit from network effects. That is to say, the more people use a particular operating system, the more useful it becomes. More developers focus on it. More software is written for it. In the past, Microsoft benefited from this phenomenon -- Windows controlled the bulk of the traditional PC market, with Mac OS maintaining a minority position.

Windows Phone existing as a second, major minority player would stand in stark contrast to the history of platform-dependent businesses.

Windows Phone grows among feature-phone users
Of course, looking purely at Windows Phone's growth, one might be inclined to believe it has a shot. Recent growth has been great -- Windows Phone is up 78% on a year-over-year basis -- but it's worth considering where that growth is coming from.

Mostly, it's coming from owners of feature phones. According to Kantar, most Windows Phone buyers are first-time smartphone owners -- 42% to be exact. Intuitively, this makes sense -- if at this point, a user hasn't made the jump to a smartphone, he or she probably isn't too technically inclined, and therefore wouldn't see the value in a robust app ecosystem.

Moreover, the markets where Windows Phone is showing promise -- the U.K., Mexico, France and Germany -- aren't the most important. Windows Phone remains a distant third in the U.S., and is almost non-existent in key emerging markets.

In China, Windows Phone accounts for just 2.2% of the market. Android, meanwhile, accounts for 70% of sales, and is now installed on more than half of all existing smartphones in the country. It's largely the same story in India, where vendors like Samsung and Micromax dominate with their Android-based smartphones. IDC put Nokia's market share at just 5% in the second quarter.

Microsoft morphing into Apple-light
By buying Nokia's handset business, Microsoft is more or less becoming "Apple-light" -- adopting a strategy of building integrated devices, creating both the software and the hardware. While this strategy has worked well for Apple, there's no reason to believe that it will work out for Microsoft.

Indeed, the economics of the operating system business suggest that Microsoft's modest 15% market-share target is too much. Android and iOS already receive the bulk of developer support, and as long as that's true, Windows Phone will continue to offer an inferior experience.

Nokia shareholders should cheer the deal, but Microsoft's efforts amount to throwing good money after bad. The mobile operating systems business is a two-horse race, and that isn't going to change anytime soon.

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Read/Post Comments (8) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 09, 2013, at 3:22 PM, GameBot wrote:

    Wow, lots of unsupported claims and assumptions.

    Suggesting first time smart phone buyers are not that bright, is shameful.

    Many people buying smart phones for the first time are simply uninterested in spending a large amount of money on a phone. Strange you would think this makes them less savvy I would think it shows them to be rather bright.

    You state there is "No reason to believe" and then don't explain why. that is against all rules of investing.

    You need to support your claim rather leave them dangling and then later act like you made some points.

    You also state the mobile OS market is a "two horse race" yet you provide zero proof and not even an attempt to say why that might be so.

    Many people believe there is room for 3 or 4 OS in the mobile sector. T(including me)

    This type of story feels like poorly thought out click bait.

  • Report this Comment On September 09, 2013, at 3:31 PM, CrawFu wrote:

    What choice did MS really have? Nokia was a sinking ship, and if they went under then the Windows phone platform would more or less go under with it. The platform may die out anyway, but this really seems like MS's only viable option to keep it on life support.

  • Report this Comment On September 09, 2013, at 3:39 PM, Walter118 wrote:

    Now mark my words. Your infatuation level with Apple Land is comparable to the childe fascination with Disneyland. It will happen to your shocking astonishment before the end of 2015, perhaps even sooner, that you learn MS with its W8/WP8 devices (incl. mobile) overpassed Apple in global market share and shortly after that in US. My recommendation, start curing your I-fanaticism as soon as you can. Apple has simply very little innovation to show to foul its, even most loyal supporters for too long.

  • Report this Comment On September 09, 2013, at 4:13 PM, Bull683 wrote:

    Laughable, I have had a Windows Phone for nearly four years and just revamped my household with five new Windows 8 Phones. I have never felt more secure in my decision. Why? Nokia phones are the best-built phones on the market and 30,000 employees from Nokia are headed to Microsoft and will build phones under Nokia's technology patents. Microsoft obviously has a ton of cash. Enough to sustain themselves for years and be a player in the Android soaked market. Check your facts from market research firms and you will see that Android will drop their market share significantly by 2017, as Microsoft gains. Your “all devices on the same system” theory is nothing short of asinine. My company is starving for compatibility without dancing to varying protocols and cross-system parameters all the while, needing a system that is cost effective. Cloud computing is the way to go and having my laptop, tablet, and phone all connected to the same system is a beautiful way to go about a simplified life. On another note, a fellow employee had used his company clamshell phone for the last eight years. He is retiring soon and wanted to upgrade to a personal smart phone. He saw my Lumia 925 and even though I printed out a comparison with Android phones, he bought the Lumia 925. He loves it!

  • Report this Comment On September 09, 2013, at 4:40 PM, daveshouston wrote:

    Say you're on board a sinking ship with lots of cash. What to do? What to do?

    Why of course! Buy another sinking ship.

  • Report this Comment On September 09, 2013, at 4:42 PM, Solov wrote:

    Thing is though... people who actually tried WP8 will unlikely go to either iOS or Android. It's just not the same thing.

    And iOS time is pretty much over too (not that it'll disappear, but it'll continue shrinking). It used to be king when every other smartphone hardware sucked. Now iPhone isn't best at pretty much anything, why pay extra then?

  • Report this Comment On September 09, 2013, at 4:50 PM, Solov wrote:

    Dave, sinking ship as in growing revenues (70B+) and profits(20B+) year over year in last 30 years?

    If one wanted to be a cynic, one could argue that MS can buy a Nokia a quarter...

  • Report this Comment On September 09, 2013, at 6:04 PM, jsnod25 wrote:

    Lets not forget that they spent overseas funds to make the purchase. Without having to pay a repatriation fee of 30%, they really only paid $5.04 billion. They made a great purchase in that regard.

    Also, they DO have a niche market in the business world, where productivity matters, and corporations don't want to dilly dally with cross-platform enterprise solutions. Read the headlines across the world, where companies are adopting WP8 in favor of Blackberry for the most part, and many companies don't even consider Android as an option sue to security concerns, nor apple's iPhone due to extreme costs and incompatibility with existing network infrastructures.

    I feel after reading this article, you are clearly a iPhanboy, and really have little ability to effectively take facts into account for a proper analysis. Maybe USE the products your writing about before bashing them. The worst situation a consumer could put themselves in, is to use a PC at work, a mac at home, and an android for mobile, or a PC for work and home, an android for mobile, and a iPad for whatever else they are needing a tablet, or a PC for work and home, a iPhone for mobile and an android tablet. I see it all the time, and it pains me.

    One thing Microsoft (and apple) can do that android can't, is make a unified system, across all platform's. The biggest problem for apple is that you have to buy an expensive computer, expensive tablet and expensive phone, which most consumers just cannot afford. Microsoft's (and OEM partners) are able to offer a more comprehensive solution at half the price, one that most people are already familiar with, and need little learning curve to master.

    this is just my 2 cents. I worry for apples future, but not Microsoft.

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