Should Microsoft Corporation Throw in the Smartphone Towel?

Making a dent in smartphones has been a long, uphill climb for the king of software, and it doesn't appear to be making much headway.

Aug 20, 2014 at 8:00AM

The good news for smartphone OS providers is that consumers can't seem to get enough. For the first time ever, according to research firm Gartner, shipments of smartphones surpassed a whopping 300 million units in Q2. Not surprisingly, Google's (NASDAQ:GOOG) (NASDAQ:GOOGL) Android OS continues to dominate global smartphone market share.

There were a couple of surprises in store for second place Apple (NASDAQ:AAPL), as well as Microsoft's (NASDAQ:MSFT) Windows Phone OS -- and they weren't good. Even as shipments of smartphones running iOS increased compared to the same period in 2013, Apple continues to lose overall market share. But even more surprising is how poorly Windows Phone performed in 2014's second quarter. Microsoft's smartphone OS isn't just having difficulty gaining traction, its taking two steps backward for every step forward. So, how long will Microsoft CEO Satya Nadella continue down what is clearly a losing path?

How long can this continue?

It's been about four years since Microsoft first introduced its Windows Phone to the world. A lot has changed since then, to say the least. Way back in 2010 Nokia's Symbian OS ruled the smartphone OS roost, followed by Android, and what is now BlackBerry, with iOS a close fourth. By the end of 2010, believe it or not, Microsoft had already captured a then-impressive 4.2% of the OS market.

Fast-forward to 2014's Q2 and the market share of Windows Phone has fallen to 2.5%, down from last year's 3.4%. Microsoft's year-over-year smartphone OS declines don't bode well for Nadella's "mobile-first, cloud-first" mantra. Actually, Nadella's emphasis on mobile and cloud is at least half-way working. Microsoft is a leader in cloud solutions, and its results in the burgeoning market are encouraging. With an annual run rate of over $4.4 billion, Microsoft is arguably king of the cloud. But that still leaves a gaping hole in Nadella's two-pronged plan.

A few specs

Smartphone vendors shipped a record 301.3 million smartphones in 2014's second quarter, up over 25% compared to the same period a year ago. The two dominant smartphone OS players, Google and Apple, accounted for over 96% of the global smartphone OS marketplace, up from a "mere" 92.6% in Q2 of 2013. That sounds good if you're an iFan, right? But the jump in total market share of the big two was due to Android, which now accounts for 84.7% of all smartphone operating systems worldwide.

Apple, while retaining its place as the clear number two OS, saw its piece of the smartphone pie decline compared to 2013's Q2, from 13% to 11.7%. At first glance, Apple's decline in smartphone share might lead you to believe that Microsoft's mobile push was the beneficiary of its rival's rough Q2. Unfortunately for Nadella and team, that's not even close to true.

Where to go from here

After completing its $7.2 billion deal with Nokia earlier this year, throwing in the mobile towel isn't an option for Microsoft -- yet. Sure, Google unloaded its own devices unit recently, but that was after years of fruitless attempts to turn its Motorola Mobility unit into a money-maker. It's too early for Nadella to consider taking the same path as Google and off-loading it devices and services unit, so what are his options? Coincidentally enough, though, following another of Google's moves could help.

Nearly 60% of Android OS shipments in Q2 were smartphones that cost less than $200, off contract. And that trend is expected to continue, according to Gartner, as manufacturers focus on emerging markets. That's an opportunity for Microsoft's mobile efforts, as it already sports a decent low-end lineup thanks to Nokia, and is continuing to roll out new, low-cost smartphone alternatives. And despite rumors to the contrary, Microsoft has wisely said it has no plans to exit the low-end smartphone market.

As it stands, Microsoft has formed precious few partnerships with other device manufacturers, meaning the vast majority of Phone OS users own Microsoft smartphones. Getting Windows Phone into the hands of users, regardless of who built the device, will help Microsoft gain adoption of its OS. And as users look to replace their units, they'd be more apt to consider a Microsoft-built device.

Final Foolish thoughts

No one expected Microsoft to dive into smartphones and immediately command a large part of the OS market; too many players were already too entrenched. But after four years, even the most die-hard of Microsoft smartphone OS aficionados are left scratching their heads. Call it quits? Nadella's hands are figuratively tied, for now. Inking more smartphone manufacturing partnerships and employing a laser-like focus on emerging markets could help turn the tide. Something needs to be done, because throwing in the towel simply isn't an option.

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Tim Brugger has no position in any stocks mentioned. The Motley Fool recommends Apple, Gartner, Google (A shares), and Google (C shares). The Motley Fool owns shares of Apple, Google (A shares), and Google (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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